The past few years of lower global oil prices have had a big impact on Bahrain’s economy, cutting into state revenue and requiring a major effort to rein in public spending. In fact, the impact has been more apparent than in many of the country’s Gulf Co-operation Council (GCC) neighbours, given Bahrain’s higher break-even point for oil per barrel. Despite this, the country’s banking sector has remained relatively stable, with good liquidity and overall lending growth.
“There is no specific risk for the Bahrain banking sector as such, other than the general issues associated with the slowdown of growth in the region and globally,” says Khalid Hamad, executive director for banking supervision at the Central Bank of Bahrain. “The banking sector adequately and successfully implemented International Financial Reporting Standard 9 in 2018, which resulted in providing for more credit risk provisions by banks.”
Bahrain is also pushing hard to establish itself at the forefront of the region’s fast-developing financial services industry, with the creation of Bahrain Fintech Bay, a joint-venture fintech incubator, as well as the introduction of forward-looking regulations.
“The creation of a fintech hub was one of the important developments in 2018; it started before but gathered momentum in 2018,” says Jean-Christophe Durand, CEO of National Bank of Bahrain (NBB).
A profitable sector
Financial services are estimated to make up about 17% of Bahrain’s total gross domestic product, highlighting the importance of the sector to the overall economy.
Bahrain’s banking sector had total assets of $192.1bn as of November 2018, according to the central bank, with 386 financial institutes present, including 98 retail banks. This was up from total assets of $187.4bn at the end of 2017. Meanwhile, the seven local retail banks listed on the Bahrain Stock Exchange posted a net profit of $873m for the first nine months of 2018, up 14% over the same period of 2017, according to the Bahrain Association of Banks (BAB).
“We’ve got the Bahraini banking sector on a 'stable' outlook,” says Redmond Ramsdale, head of GCC bank ratings at Fitch Ratings. He adds that Fitch expects a slight uptick in lending growth of between 3% and 5% for 2019. “Our view is that the Bahraini banks remain well placed to extend credit to the government and to the economy. Their average loan-to-deposit ratios are in the high seventies, compared with their GCC peers, which on average are in the low nineties.”
The banking sector’s capital adequacy ratio stood at 18.8% in March 2018, down from 19.4% in September 2017, with the ratio of non-performing loans decreasing from 5.7% to 5.5% in that period.
“The average impaired loans ratio for Bahraini banks is reasonable, at about 4%, slightly above the GCC average but not significantly,” says Mr Ramsdale. “The real estate sector is the biggest concern for us in terms of asset quality in 2019, with the main pressures on the commercial real estate side, where we have seen a reasonable amount of oversupply.”
Changing landscape
Commercial real estate financing accounted for 18.4% of all loans from Bahrain's retail banks as of March 2018, suggesting cause for concern. However, strong state spending in recent years on large-scale industrial projects – notably Aluminium Bahrain’s Line 6 expansion project and the modernisation of Bahrain Petroleum Company – has offered significant new lending opportunities to banks.
“Bahrain has been very active in terms of projects over the past three years. Industrial projects and infrastructure projects are giving the banks the opportunity to finance larger projects,” says NBB’s Mr Durand. “It has given opportunities not only to international banks but more importantly to regionally local banks to get involved, and to start participating in these transactions. It is a healthy evolution. A decade ago all of the large projects were purely financed by international banks. They’re still present, but the proportion is less.
“I think support for small companies is also a theme that has gathered momentum, because it is strategic for the country, and I think in the past there was not much effort made by banks in general to support this sector.”
Mr Durand adds: “That’s an area where profitability is good. Of course, risk management needs to be monitored carefully, but at the same time it provides diversity and the ability to develop new products.”
Helping hands
The fiscal landscape in Bahrain changed markedly in the last few months of 2018. A $10bn support package was agreed with neighbours Saudi Arabia, Kuwait and the United Arab Emirates, and the government released details of its Fiscal Balance Programme (FBP), which targets the elimination of fiscal deficit by 2022.
The financial aid package will help to support the public budget of Bahrain, improving investor confidence and raising government revenue, while the FBP is aimed at reducing public expenditure, primarily through a voluntary retirement scheme for public sector employees and the cutting of subsidies. The FBP could negatively affect the banking sector, though banks are optimistic that they can find a way to benefit.
“I would say the banking sector can take advantage of this situation, because there will need to be more private finance as opposed to government spending, so probably we’re talking about banks having a bigger role to play, both in terms of financing and finding investors,” says Mr Durand.
Bahrain’s population is increasingly embracing digital financial offerings. A January 2018 survey by the central bank’s Financial Stability Directorate found that almost one-third of Bahrain’s population had an e-banking account, while almost one-quarter had a mobile banking account.
There is also a strong push towards establishing Bahrain as a regional hub for the development of new areas of financial services.
“Like many highly developed financial systems, Bahrain is on the cusp of major disruption thanks to fintech,” says David Parker, executive director of financial services at Bahrain’s Economic Development Board (EDB). “We made a commitment to encourage such disruption as much as possible, to complement what is already the largest traditional banking centre in the region.”
Trip round the bay
In February 2018, the country launched Bahrain Fintech Bay, a joint-venture incubator managed by the EDB and international incubator Fintech Consortium. This followed the launch in 2017 of a regulatory fintech sandbox in Bahrain.
As of early 2019, Bahrain Fintech Bay was home to 30 early-stage fintech companies, with plans to double that figure in the near future. Meanwhile, in October 2018 a senior government official told reporters that Bahrain would soon be launching a $100m fund focused on the fintech sector.
“What distinguishes Bahrain is that we are considering the fintech wave as a national mission,” says Waheed Al Qassim, CEO of the BAB, pointing to the investments being made, as well as the efforts by the central bank to establish the necessary regulatory environment. “BAB is working with the education and the legal system to support fintech.”
December 2018 saw the issuance of central bank rules on open banking, designed to encourage innovation in the provision of banking services, allowing customers access to their bank account information in an aggregated manner, through a single platform, and licensing third parties to initiate payments on behalf of customers, making transfers via a phone-based app.
The central bank has also drafted regulations for digital financial advice providers, which will enable licensees to use technology to offer financial advice to clients, and crypto-asset platform operators, which will provide regulations for the licensing and supervision of crypto-asset services. “Bahrain is determined to build a digital-first regulatory regime that makes us the go-to destination in the Middle East to build, test and scale innovative technology,” says the EDB’s Mr Parker.
Bahrain is not alone in trying to become a regional hub for fintech development. However, those involved in the sector do not believe that the competition will negatively affect Bahrain’s chances. “The race to become the dominant force in fintech is a competitive one. However, it is not a zero-sum game,” says Mr Parker. “If Bahrain wins, then Dubai doesn’t automatically lose. There is space for countries, companies and entrepreneurs to compete, but also to collaborate. One of the defining factors of modern technology is collaboration.”
Islamic options
One area of the banking sector that continues to grow impressively is Islamic finance. Bahrain has long been considered a pioneer when it comes to sharia-compliant finance, and the sector continues to expand and mature.
“The growth of Islamic banking [in Bahrain] in particular has been remarkable, with total assets in this segment jumping from $1.9bn in 2000 to $27.8bn by November 2018,” says Adnan Ahmed Yousif, president and chief executive of Al Baraka Banking Group, an Islamic wholesale bank listed on the Bahrain Bourse and Nasdaq Dubai. “The market share of Islamic banks correspondingly increased from 1.8% of total banking assets in 2000 to 14.5% in November 2018.”
There are currently 21 Islamic banks operating in Bahrain, along with seven takaful companies and two re-takaful companies. In March 2018, Gulf International Bank, headquartered in Bahrain but majority owned by the Public Investment Fund of Saudi Arabia, rolled out ‘meem’, the region’s first sharia-compliant digital banking service, in Bahrain. This followed the successful launch of the service in Saudi Arabia in 2015.
Meanwhile, in November 2018 Bahrain’s central bank announced that it was considering guidance for Islamic windows and investment accounts, with rules so far limited to fully fledged Islamic banks, as well as considering whether to establish a benchmark rate for use by Islamic banks. This follows the tightening of governance rules for Islamic banks, which now require them to undergo independent external audits with a more stringent framework for sharia boards.
Al Baraka’s Mr Yousif describes the benchmark rate as an important issue that has been discussed for a long time, with the purpose of replacing the current practice of using the interbank rate for sharia-compliant financing. “In recent years, regulators in the Gulf and south-east Asia have increased their oversight of how Islamic banks follow Islamic principles, which include bans on interest payments and pure monetary speculation,” he says. “Therefore, it is vital for Islamic banks to have their own way in pricing financing, investments and other activities they provide.”
In May 2017, the central bank also introduced overnight sharia-compliant wakalah liquidity management, considered the first of its kind in the region, created to absorb excess liquidity from Islamic retail banks by placing it overnight with the central bank.
Scope for consolidation
Across the Gulf, the banking sector has seen regular merger and acquisition (M&A) activity in recent years, and more is expected in the near future. Bahrain is no exception: there are about 100 banks operating in the country, more than in any other GCC member.
“Bahrain is certainly overbanked,” says Fitch’s Mr Ramsdale. “There are a lot of small retail banks and retail Islamic banks. The operating environment remains challenging throughout the region, and where shareholder value can be increased, this tends to drive quite a lot of M&A. We are surprised that there hasn’t been more M&A in Bahrain.”
In January 2019 it was announced that Kuwait Finance House and Bahrain’s Ahli United Bank had agreed terms on a merger which, when completed, will create the sixth largest lender in the Gulf region, with combined assets of $94bn. The following month, the Central Bank of Kuwait granted its initial approval of the merger.
Meanwhile, in October 2018 NBB announced that it was considering a voluntary offer for additional shares of Bahrain Islamic Bank, which would create a lender with about $11.5bn in assets.
“The Central Bank of Bahrain and our association are encouraging consolidation in the banking sector,” says the BAB’s Mr Al Qassim. “I believe that gradually there will be no space for smaller players anymore as they cannot absorb the costs of new standards such as Basel III or become sufficiently resilient. In addition to international regulations and restrictions on correspondent banking, the growing digitalisation transformation all needs huge investment by the banks. To do so, banks need more capital and the only way to obtain it is through acquisitions and mergers.”
The next few years are likely to see major developments in the Bahraini banking sector, as the country further positions itself at the forefront of the regional financial industry. Despite having one of the oldest banking sectors in the region, Bahrain is proving to be adept at change.
