As Kuwait, the world’s seventh largest oil producer, revels in record oil prices in excess of $130 a barrel and record surpluses in all major economic balances, its banking sector is also enjoying booming profits but is clearly diversifying its activities, with many banks embarking on or strengthening their operations outside Kuwait.
In early May, National Bank of Kuwait reports show that the country’s budget surplus for 2007-08 (ending March 31) rose 59% to Kd11.4bn ($42.6bn) before the allocation of 10% of revenues to the Reserve Fund for Future Generations (RFFG). Oil revenues were 138% higher than forecast and 22% higher than the previous fiscal year, rising to a massive Kd17.7bn. The price of Kuwait export crude averaged $75.3 a barrel during the fiscal year and production averaged 2.48 million barrels a day, slightly exceeding the previous year’s figure and indicating that the oil bonanza will accelerate revenues even further if current conditions continue.
Caution at central bank
With increasing oil revenues producing rising surpluses for the past four years and the 2007 current account surplus accounting for 40% of gross domestic product (GDP), the governor of the Central Bank of Kuwait, Sheikh Salem Abdul Aziz Al-Sabah, says: “The macroeconomic picture is rosy but I have to be cautious. What is important is how to utilise these surpluses, to use them wisely and rationally. We need to manage them for future generations and we have to start modernising infrastructure and have a very focused attitude towards education as well as health.”
Kuwait is spending heavily on infrastructure. According to recent MEED Projects data, Kuwait has $55.5bn in oil and gas projects awarded or under way, more than a fifth of the Gulf Co-operation Council (GCC) total of $269bn.
However, although there is a big focus on oil and gas, Kuwait is a relatively undiversified economy: half of its GDP is generated from oil-related activities. This results in the Kuwaiti banks having limited non-oil related exposures and sizeable balance sheet concentrations, both to the oil sector and to individual entities, according to Moody’s Investors Service’s recent report on Kuwaiti banking. “As is the case in most small oil-exporting countries, Kuwait’s non-oil economy is dominated by consumer and government-service firms, while the small size of the indigenous market (total population of 3.4 million) and the oil-dominated currency value mean that profitable manufacturing opportunities are limited to oil-related products.”
Little diversity
Unlike Dubai, with its tourism and financial centre, and to some extent the much bigger economy of Saudi Arabia, Kuwait has not diversified significantly away from the oil sector nor created new sectors that could provide major additional growth opportunities for banks. While oil activities provide a rich vein of growth for the banks, Moody’s believes Kuwait’s banking system is relatively saturated. There are 16 banks (including Islamic banks, a specialised bank and seven foreign banks’ branches) competing to serve the 3.4 million population where the banks’ traditional target market has been local Kuwaitis, who make up only a third of the country’s total population.
As of March 2008, banks in Kuwait operated 286 branches, mostly concentrated in the capital city and, with the Central Bank of Kuwait regarded as a tough regulator and imposing strict limits on both lending and borrowing ratios, the banks do face growth challenges. As a result, more banks are looking to expand both in the region and internationally.
National Bank of Kuwait (NBK), the country’s largest bank with 29% market share, began the trend years ago and has continued to build a broad network across the Middle East, with recent acquisitions in Egypt and Turkey. Kuwait Finance House, a prominent Islamic financial institution with a 22% market share, followed NBK in recent years, creating relatively large subsidiaries in Bahrain, Turkey and Malaysia, and diversifying out of Kuwait significantly.
Recently, other institutions have jumped on the bandwagon. Commercial Bank of Kuwait, with 11% market share, and Burgan Bank, with 7% market share, have taken their first major steps into regional markets. Other major commercial banks, such as Gulf Bank and AlAhli Bank of Kuwait, are slowly moving out of their Kuwait comfort zone, and Kuwait-based Gulf Investment Corporation, the large GCC-owned investment bank, is reviewing its strategy and, for the first time, establishing operating entities elsewhere in the Gulf to be closer to its activities.
Looking to Syria
Commercial Bank (CBK), Kuwait’s fourth largest bank, is negotiating to significantly increase its stake in Cham Bank in Syria. Chairman Abdul Majeed Al Shatti told The Banker in early May that CBK was in final negotiations to buy an increased stake in excess of 30% in Cham Bank, which was established in 2006 with a paid-up capital of S£5bn ($97.9m). Reports suggest that Investment Dar, a Kuwait Islamic investment firm that owns half of British luxury car-maker Aston Martin, was willing to sell its 12.5% stake in Cham to CBK. Mr Al Shatti said that the move was part of a strategy to expand outside Kuwait; and CBK was the first non-Syrian bank to get a licence in Syria.
CBK plans to move into other Gulf countries, according to Mr Al Shatti. It is negotiating the acquisition of Yemen Gulf Bank, which he hopes to complete within three months. “There is a lot of business in this area, there are a lot of surpluses and these need to be invested.” In its expansion efforts, CBK had made an offer for Egypt’s Al Watany Bank in recent months but was beaten in the end by NBK. In the longer term, CBK has plans to expand into Asia and is looking at Pakistan, India, Indonesia and the Philippines.
Islamic dimension
Given the growing interest in Islamic finance, CBK has decided as part of its expansion plan to put in a request to the Central Bank of Kuwait to offer Islamic banking. “We want to do both [conventional and Islamic], we want to become a modern Islamic bank, we want to attract people who want Islamic products and also those who want conventional,” says Mr Al Shatti. “In Saudi Arabia and Egypt, banks do both, and we want to do both in Kuwait.”
Mr Al Shatti believes that allowing banks to do both will increase competition and credibility, as well as raise standards and innovation. “Monopolies are not good, so Islamic finance needs to be diverse,” he says. “Today, Islamic finance is geared towards real estate. We can introduce competition.”
CBK is now awaiting a decision from the central bank; under Kuwaiti law, conventional and Islamic banks are separate but the central bank can give permission to a conventional bank to establish a subsidiary to do Islamic banking. No such new entities have been approved so far (see interview, page 114) but Mr Al Shatti is keen to make his dual model work.
Geographical expansion
Burgan Bank, the fifth largest bank in Kuwait, has just announced that it plans to transform itself into one of the most geographically diverse banks in the Middle East and north Africa (MENA) region. In early May, it agreed to buy the four regional operations of Bahrain’s United Gulf Bank (UGB) for Kd194m ($726.4m) as part of an international expansion programme.
Under the deal, the conclusion of which was expected by the end of June pending regulatory approvals, Burgan has agreed to buy UGB’s holdings in Algeria Gulf Bank (60%), Bank of Baghdad (45%), Jordan Kuwait Bank (44%) and Tunis International Bank (77%).
This represents a transformational deal both for Burgan and UGB, which are both controlled by KIPCO (Kuwait Projects Company), a large Kuwaiti conglomerate. “The purchase of holdings in these four banks is the first step in our regional expansion strategy,” says Burgan chairman Tariq Abdul Salam. “By acquiring these major operations in some of the most vibrant economies in the MENA region, we will be able to use our expertise in commercial banking to become one of the strongest full service banks in the region.”
The bank is expected to issue 200 million new shares, almost a fifth of its outstanding shares, to help finance the transaction. Following the deal, Moody’s placed Burgan’s rating on review, with direction uncertain.
“Burgan Bank is expanding abroad because competition is increasing at home and the central bank is restricting lending,” Mustafa Behbehani, director of Gulf Consulting is quoted as saying. Burgan chief executive Jonathan Lyon was reported to be looking also at opportunities in Syria, Mauritania and Egypt.
“The sale of UGB’s regional operations to Burgan will allow UGB to concentrate on investment banking and asset management,” says UGB managing director Masaud Hayat. “The anticipated profit we will make on the deal is an excellent return on our original investment and I expect this transaction to provide the catalyst for further growth in our business.”
Following the deal, Moody’s put UGB’s rating on review for possible downgrade as a result of the bank’s apparent change of strategy from a regional universal bank to a more focused investment banking profile.
Building up branches
These recent announcements follow important acquisitions in March and April in both Turkey and Egypt by NBK, the highest rated Middle East bank. First NBK concluded its expansion in the high growth Turkish market with the conclusion of a 40% acquisition for $160m of Turkish Bank, a relatively small but well-placed institution with a 22-branch network. In April, it concluded the acquisition for $1bn of Egypt’s Al Watany Bank, which has a 26-branch network.
Commenting on these key acquisitions, Ibrahim Dabdoub, CEO of NBK Group, said: “The acquisition of Egypt’s Al Watany Bank, the acquisition of a 40% stake in Turkish Bank and the increase of our ownership stake in the International Bank of Qatar to 30% signal our determined commitment to regional expansion as a strategy to sustain the bank’s growth in the future. It also reflects NBK’s increasing interest in the growing Egyptian banking sector. NBK believes that the Egyptian economy will continue its strong growth over the long term.”
Banking veteran Mr Dabdoub is looking to expand the network in Turkey and is optimistic about Egypt, believing it is still not overbanked and offers plenty of opportunities. He is also hopeful that NBK may eventually be able to take a stake in Saudi Hollandi Bank and open a branch in Riyadh in addition to the existing one in Jeddah. NBK is also working on establishing an Islamic private bank in Switzerland with a Saudi partner; Mr Dabdoub expects to have regulatory approval for this by the summer. After this recent splurge, Mr Dabdoub intends to digest this expansion quietly, much preferring to see solid, consistent 15% to 20% growth than volatile and possibly dangerous higher growth rates.
Wider ambitions
Kuwait Finance House (KFH), the second largest bank by assets, sees tremendous opportunities in the GCC, Turkey and the Far East, especially in wealth management. KFH general manager Mohammad Al-Omar wants to expand in Malaysia, where the institution already has 9.8% of its direct investments, and also wants to develop in Singapore and Australia.
In terms of geographic diversification, KFH, as an Islamic bank, already has a diverse direct investments portfolio, plus independent banks in Turkey, Bahrain and Malaysia. The portfolio is mostly in Kuwait with 58.8% (including a 42-branch domestic network), followed by the United Arab Emirates (12.1%), Bahrain (10.5%), Malaysia (9.8%) and Turkey (5.9%), providing an increasingly broad spread.
Elsewhere, Kuwait’s financial institutions are broadening their horizons. GIC, a regional financial institution with shareholders’ equity in excess of $1.6bn, is riding the booming project market in the region and has decided to establish three offices, in Riyadh and Dubai (both in the Dubai International Financial Centre and locally) and a representative office in Doha. Being one of the largest private equity players in the GCC, GIC is keen to expand not just in the GCC states but in relevant areas throughout the region, says chief executive Hisham Razzuqi.
The Securities House, a long-established Kuwait investment company, has recently launched a fully sharia-compliant wholesale investment bank in London. Gatehouse Bank has become the fifth Islamic institution to be licensed by the UK’s Financial Services Authority and will focus on Islamic capital markets, institutional wealth management and Islamic treasury business. David Testa, Gatehouse chief executive, believes that the new bank, with its paid-up capital of £50m ($98.2m), is well positioned and staffed to play a major role in shaping the future of Islamic financial services.
Robust players
So what is the future for the Kuwait banking sector, and for Kuwait as a financial centre, with aggressive competition coming from elsewhere in the Gulf? Results for 2007 show that the major banks are in robust condition and are highly profitable. Two banks, KFH and NBK both topped the $1bn mark in net profits and the top seven banks all showed returns on capital in excess of 23%, with three in excess of 31%. All maintain strong Bank for International Settlements (BIS) capital ratios, KFH with 23.26%, and low non-performing loan ratios, with no bank directly affected by the US subprime crisis.
With first quarter 2008 performances building on 2007 results, banks are in good shape but still face challenges. Last July, the central bank imposed an ‘80-20’ rule, which has had a sharp impact on bank lending. The rule limits bank lending to 80% of customer deposits and immediately led to a tightening of credit available in the market because most banks were over the limit.
Banks are affected by another central bank policy relating to consumer loans and customer payments, which deems that loans should not exceed five years and debt repayments should not exceed 40% of disposable income. This radical approach (by Western standards) to reducing consumer debt problems is supported by CBK’s Mr Al Shatti and others on social grounds, but the policy clearly limits banks’ room for manoeuvre and is expected to reduce the use of credit cards significantly.
With regard to foreign banks, the central bank is in favour of lifting the one-branch restriction but this needs to be approved by parliament, so the current seven foreign banks are still relatively restricted in what is a tight retail banking market and this may take some time to change.
Financial hub prospects
Is Kuwait likely to threaten other financial centres in the Gulf? The central bank governor says that plans for Kuwait are before the Council of Ministers and should be made known by the end of the year, but even if a specialist strategy is decided on, other financial centres in the region may already be too far ahead.
Kuwait has a strong, highly profitable, tightly regulated banking sector that serves its needs well. But, as the banks have shown, there are limitations to domestic growth and most are actively seeking expansion abroad to maintain growth. Whether they can make a success of all their overseas ventures remains to be seen, as does Kuwait’s efforts to reinvent itself as a viable financial centre. Whatever happens, though, Kuwait’s steady, conservative approach indicates that it will stay highly profitable.
