Moves by Kuwait's central bank to sharpen regulation, improve liquidity and encourage greater take-up of fintech have nurtured the development of the country's burgeoning Islamic finance sector. James King reports.

Kuwait Finance House

The Kuwaiti banking sector enjoyed another strong year of growth in 2018. But the country’s Islamic banks emerged as the standout performers within this wider story. By most performance metrics, sharia-compliant banks outperformed their conventional peers. Notably, this has occurred against a backdrop of profound transformation for Kuwait’s Islamic finance sector. 

On the one hand, a cross-border merger between Kuwait Finance House (KFH), the country’s largest Islamic bank, and Ahli United Bank of Bahrain (AUB), is moving forward. On the other, sharia-compliant Kuwaiti banks are pushing ahead with product and service innovations that are likely to shape the industry’s growth elsewhere.

Enhanced status

Collectively, these changes – and others – are adding weight to Kuwait’s status as a regional hub for Islamic finance. This recognition should only grow in the coming years, as efforts by the regulator, the Central Bank of Kuwait, to promote Islamic finance mix with the experience and know-how of its leading private sector banks to place the country firmly on the global industry’s map.

“The Islamic finance industry is a vital part of Kuwait’s financial system, and it has exhibited resilience in the face of less favourable economic conditions. With enhancements to the further evolution of the Islamic finance ecosystem, particularly in its regulatory framework, Kuwait has great potential not only to sustain the industry’s double-digit growth but also to increase its share of overall financial assets,” says Adel Al-Majed, chief executive officer of Boubyan Bank, one of Kuwait’s leading Islamic lenders.

By the third quarter of 2018 the return on average equity for Kuwait’s Islamic banks was 12.2%, compared with the 9.7% posted for the conventional lenders over the same period, according to data from the Central Bank of Kuwait. These strong numbers are reflected across most key indicators, with Islamic banks outpacing their conventional peers in terms of year-on-year profit growth and asset and deposit growth over the same period.

KFH saw net profits surge by 23.5% in 2018 to reach $747.3m. The bank’s total financing income grew by 16.4% over the same period. This performance underscores the bank's strategy of disposing of non-core assets and exiting peripheral business lines to focus on the key components of its business. 

In a statement on the bank’s 2018 results, KFH’s chairman, Hamad Abdulmohsen Al-Marzouq, said: “In line with the set plans and the overall performance of the group, growth in 2018 profits has been achieved despite the challenges posed by the markets and economic developments locally and internationally. KFH is consistently progressing towards achieving sustainable profitability by focusing on operating profits from core banking activities, [and] matching revenues from local and foreign markets.”

Other Islamic banks have enjoyed similar success. Boubyan Bank, for instance, saw net profits grow by 18% in 2018 as total assets increased by 9%. Net profits at Warba Bank, meanwhile, increased by 71% over the same period, a performance that the bank attributed to the increases size of its financing and investment portfolios.

New regulations

Moving forward, Kuwait’s Islamic banks will benefit from an improving regulatory environment as changes to their supervisory system begin to take effect. The Central Bank of Kuwait has, for instance, finalised a draft law for the implementation of a higher sharia authority in the country. This would follow a similar approach taken by other Gulf countries, as well as Malaysia, and improve the operating environment by standardising opinions on sharia compliance through a central body.

In addition, the government’s issuance of high-quality liquid assets, through the tawarruq instrument, has also eased the business environment. “The issuance of sharia-compliant instruments by the government since 2016 has also improved the availability of high-quality liquid assets for Islamic banks, and afforded them greater flexibility in managing their balance sheets,” says Nitish Bhojnagarwala, vice-president and senior credit officer at rating agency Moody’s.

Structural changes are also shaping the industry’s outlook. Kuwait’s Islamic finance market is likely to experience a seismic change through the proposed merger between KFH and AUB. If executed, it would represent the first sizeable cross-border banking merger in the region, while creating a regional Islamic banking champion of considerable size. 

On January 24, 2019, a statement issued by the two institutions indicated that terms for the merger had been agreed with KFH offering one share for every 2.326 AUB shares. According to research from Reuters this represented a 17% premium on AUB’s share price at the time of the announcement. The deal still remains subject to due diligence and the approval of the regulators.

Digitalisation trend

Meanwhile, digital innovation by Kuwait’s Islamic banks has emerged as one of the most dynamic trends to shape the industry’s outlook. Boubyan Bank, the country’s second largest Islamic bank, has assumed a leading role in this space as its name has become synonymous with digital banking in the country. “At Boubyan we have worked hard to change the perceived image of Islamic banking as being too traditional, and we have aimed to project ourselves as a modern Islamic bank, and that has been the main reason for our growth,” says Mr Al-Majed.

Boubyan Bank’s strategy has seen the lender introduce a number of firsts to the Kuwaiti market in terms of products and services. The bank’s internal culture also operates along the lines of a disruptive start-up, with Mr Al-Majed emphasising to The Banker that new ideas are encouraged and that departments, as well as individuals, are given the licence and resources to test new concepts.

“In the past three years we have been trying to stay ahead of the curve and maintain our innovative edge by bringing world-class banking technology to Kuwait. We have introduced contactless ATMs and developed Kuwait’s first chatbot. To continue to stay ahead we have embraced a digital transformation journey and have set up our digital squads for quick development and deployment, and also has partnerships and an innovation department that encourages best-in-class start-ups and world-class fintech firms to partner with Boubyan,” he adds.

Fintech impact

As Kuwait’s Islamic banks embrace a brighter future, their outlook, just like that of their conventional peers, will be shaped to varying degrees by the impact of fintech. The Central Bank of Kuwait’s creation of a regulatory sandbox for fintech operators, for instance, is a good indicator of the market’s direction of travel. A more accommodative regulatory stance might ultimately give way to the introduction of new players and intermediaries with the potential to disrupt traditional bank offerings. And, as the demands of banking in a young and tech-savvy market such as Kuwait’s begin to add up, the country’s Islamic banks will have to adapt to survive.

“The evolution of technology is considered the fourth [industrial] revolution and it is having significant impact on the financial sector, from the application of blockchain, to [the development of] financial products, to the customer experience," says Mr Al-Majed.

To meet this challenge, Kuwait’s Islamic banks are working hard to embrace change across their front-, middle- and back-office operations. KFH has introduced an automated bot, known as Baitak Assistant, to handle consumer loan applications. This technology automatically generates credit reports for loan applicants and sends all relevant materials to a relationship manager, reducing the paper trail for each loan application and freeing up time for bank staff.

Against a backdrop of an improving supervisory environment and investments in technology, Kuwait’s Islamic banks can expect to enjoy another year of strong growth. And, for the country itself, its credentials as a regional hub for Islamic finance will grow with them. In the coming years, the next step for Kuwait’s Islamic banks will be the global stage, as bigger Islamic financial institutions begin to emerge and pioneering investments in innovation begin to bear fruit. 


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