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WorldMay 1 2014

Bahrain’s banking sector rises to domestic challenges

Bahrain's central bank has steered the country's banking sector through a period of economic and political turbulence. With strong fundamentals and ample growth prospects, particularly in the Islamic finance segment, the country's lenders are now in a good position, but their future growth still hinges on the country maintaining social stability. 
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Bahrain’s banking sector rises to domestic challenges

Like its Gulf Co-operation Council (GCC) counterparts, Bahrain’s ambitious plans for economic development were hit hard by the global financial crisis. Projects conceived in the early years of the 2000s, intended to mark the country’s position as a regional financial hub, were swiftly neglected as credit lines diminished and the real estate market collapsed. Soon after this economic crisis hit the Gulf, the authorities in Manama were then faced with the kind of systemic political unrest witnessed across much of north Africa and the Levant in the early months of 2011.

Though the political activism that hit Bahrain was defined ostensibly along sectarian lines, as an expression of long-standing political and economic grievances, the impact on the country’s economic trajectory was less severe than anticipated. “Bahrain was relatively unscathed compared to other regional centres. In 2009, some Gulf countries were providing guarantees for major institutions and injecting liquidity into their financial systems. Bahrain was able to avoid this kind of intervention due to the proactive vigilance of the regulator – the Central Bank of Bahrain [CBB],” says Robert Ainey, chief executive of the Bahrain Association of Banks.

Despite real gross domestic product dipping to 2.1% in 2011, from 4.7% in the previous year, coupled with a further depression of the country’s real estate market, the government’s implementation of an infrastructure development package has since helped the economy to achieve some stability, though high levels of public debt remain a problem. 

Reactive reform

For the banking sector, this upheaval has come at a time when other regional financial centres, including Dubai and Doha, are in the ascendency. While the anticipated exodus of foreign lenders from Manama never materialised, with the notable exception of France's Crédit Agricole and Japan's Bank of Tokyo-Mitsubishi, the authorities have been left with the difficult task of shoring up Bahrain’s reputation as a financial centre while enacting reforms to support the growth of the banking sector in the wake of the financial crisis.

Chief among these reforms has been the CBB's policy of encouraging greater consolidation of the fragmented banking market. Adjustments to market risk capital charges, the encouragement of developed risk-managed frameworks and higher capital adequacy ratios have all contributed to increased merger and acquisition activity across the sector in recent years.

“Between 2009 and 2013, we have managed to merge nine banks, while we are currently looking at two more mergers involving four entities. It is a step in the right direction and our objective is to empower our banks to do better business and to get involved in bigger transactions,” says Khalid Hamad, executive director for banking supervision at the CBB.

This wave of consolidation has coincided with a broader reassessment by wholesale banks looking to de-risk their investment profiles. With a focus on high-risk, high-return investment options throughout the 2000s, particularly those located in the GCC, the wholesale sector is reconsidering its approach to achieving sustainable returns. Increasingly, new retail functions are being pursued by conventional wholesale banks, along with sharia-compliant options, as a means of diversifying their risk.

“As elsewhere in the world, there has been some pressure in the region to integrate retail and investment banking operations. While investment banks were hit by the crisis, retails banks have very strong deposit bases, which investment banks can in principle help to mobilise to drive key projects. Of course, there are regulatory and prudential challenges that would have to be dealt with,” says Jarmo Kotilaine, chief economist at the Bahrain Economic Development Board.

Islamic might 

Carving out new growth opportunities has also led to a renewed emphasis on Islamic finance. Long considered a pioneer in sharia-compliant finance, both the public and private sector in Bahrain are assessing ways to harness this expertise. In December 2013, the CBB harmonised regulations concerning the issuance and listing of conventional and Islamic securities, designed to improve the efficiency and transparency of the process. Under the new framework, there will be a reduced waiting period for the approval of issuances, as well as the option to receive applications from other GCC issuers providing they adhere to regional unified standards.

Consolidation has also been a salient feature of the Islamic banking market, with a number of key mergers occurring over the past two years. In January 2013, Elaf Bank, Capivest and Capital Management House merged to form Ibdar Bank, while the Islamic Al Salam Bank merged with conventional retail and commercial player BMI Bank in February 2014.

“Sharia-compliant finance and the solid basis of sharia financing is a driving force in the sector because Islamic institutions have performed with relative strength throughout Bahrain’s most difficult years,” says Dr Mohammed Burhan Arbouna, head of sharia compliance at Al Salam Bank.

Al Salam’s performance in 2013 registered a 20% increase in profits from the previous year, reflecting the strength of the sector in Bahrain. According to central bank figures, the consolidated balance sheet of Islamic banks ranged from $25.5bn to $24.7bn between 2009 and 2011, before gradually reaching $26bn in the second quarter of 2013. This track record of stability is partly due to the nature of Islamic finance, which avoids debt, derivatives and short selling, in favour of asset-backed options, but also due to the strong regulatory environment, adds Mr Arbouna.

Domestic bliss?

While Bahrain’s banks continue to deleverage and consolidate, a number of promising growth prospects for the sector have emerged. The $10bn aid package, granted by GCC members to Bahrain following the political unrest in 2011 is financing a number of key infrastructure projects covering housing, water and power facilities. To date, $4.4bn-worth of projects have been announced. Though financed through a GCC fund, this type of economic stimulus mirrors other initiatives to be implemented across the region and will likely have multiplier effects for the economy and the banking sector.

“What is desperately needed across some parts of the GCC, including Bahrain, is more affordable housing for the lower and middle classes. Alongside that investment, infrastructure developments for electricity, water, sewage and road works will all be required. I think these types of programmes will be a huge boon to the financial industry over the long term,” says Mr Ainey.

While the growing stature of financial centres such as Dubai, which has now dwarfed Bahrain in terms of size, seem likely to add to the competition for financial services in the region, few local observers seem concerned about the country’s long-term prospects. “We do not see ourselves in competition with other jurisdictions. At the regional level we see any initiative outside of Bahrain as complementary,” says Mr Hamad.

Considering the investment required for anticipated infrastructure projects across the region, coupled with the growing size and sophistication of the GCC’s economy, the notion of a zero-sum game in financial services was misguided, according to Mr Kotilaine. Crucially, Bahrain’s competitiveness in banking and financial services has been structured upon a sound regulatory environment, guided by the CBB. As such, the operating environment allows local banks to develop new products and services for the regional market as more progressive regulations are introduced.

Similarly, long-standing advantages, including the cost of doing business, the cost of living, easy access to the Saudi Arabia market and a skilled local workforce will enable the country's banking sector to retain competiveness in a challenging regional market.

Much will depend on the domestic economic and political outlook, however. Low-level unrest persists on the streets of Manama, while a political agreement between opposition protesters and the government remains elusive. Moreover, the economy, while showing stable signs of non-oil growth, will be subject to any oil price shocks as Bahrain’s breakeven oil prices remain the highest in the GCC, according to Oliver Masetti, a research analyst with Deutsche Bank. Should Bahrain fail to achieve lasting political and economic stability, much of the financial sector’s progress may be curtailed in the years ahead.

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Read more about:  Middle East , Bahrain