Despite its small size, Kuwait has long been a key player within the global Islamic finance industry, and with its sharia-compliant institutions posting strong figures in 2014, this position only looks likely to strengthen.

Kuwait punches well above its weight on the global stage of Islamic finance. Despite the country’s relatively small size, it ranks fourth globally in terms of total sharia-compliant assets, which are estimated to be about $90bn according to research from EY. Though this ranking excludes Iran, which has a fully sharia-compliant financial system, it positions Kuwait in a league with much larger economies in the Middle East and beyond.

This position of strength is the result of Kuwait’s roots as one of the earliest pioneers of Islamic finance – Kuwait Finance House (KFH) was established in 1977 – but it also stems from the extraordinary growth enjoyed by the industry in the intervening years.

This is particularly true for Islamic banks, which dominate the country’s sharia-compliant financial sector with about 84% of total assets. The compound annual growth rate of these lenders’ assets between 2010 and 2013 reached 11%, significantly outperforming their conventional peers, which recorded 3% growth. Over the same period, deposit growth for Islamic banks in Kuwait hit 9% while conventional lenders achieved 5%. More impressively, sharia-compliant banks in the country enjoy a 45% market share today, according to EY.

A strong 2014

This growth story was maintained in 2014, with most Islamic banks registering strong performances. KFH, the country’s largest Islamic bank, posted net profit growth of 9.1% last year, while net finance income increased by 8%. Meanwhile, deposits grew by 14.4% over the same period.

Ahli United Bank Kuwait, the country’s second largest Islamic bank by sharia-compliant assets, enjoyed a record-breaking year in terms of net profits – $482.5m – which was a 31.7% increase from the $366.5m achieved in 2013.

Among the smaller players, Warba Bank saw its fortunes improve in 2014 with a 103% growth in net profits following a disappointing performance in 2013. Meanwhile, Kuwait International Bank saw its net profits climb from Kd13.2m ($44m) to Kd13.6m last year.

KFH thinks ahead

Kuwait's Islamic lenders are now looking to build on these strong results. For some, this includes a renewed focus on growth in the booming corporate sector, while for others it will mean a process of broader restructuring to cut costs and achieve greater operational efficiencies.

KFH is in the process of addressing its organisational structure to improve its longer term growth prospects. “KFH will be focusing on banking and more specifically on stable, sustainable revenues that we can generate year in, year out. We are moving away from speculative returns and we are now consolidating our investment subsidiaries. Major cost reductions are expected through the synergies this will generate,” says Mazin Al-Nahedh, chief executive of KFH.

Mr Al-Nahedh took on his role at KFH in October 2014, following 21 years at the National Bank of Kuwait, and is now faced with the significant task of restructuring the country’s second largest lender. This process will be important; KFH’s existing business arrangements are complex and span multiple markets and sectors. “Our organisational structure is being shifted from distinct, standalone structures to a centralised system based in Kuwait,” says Mr Al-Nahedh.

In Kuwait, KFH is also pursuing the major growth potential offered by the corporate sector. As construction and development projects begin to gather pace, a number of Islamic lenders are now seeking to capitalise on anticipated growth from larger and mid-sized corporates.

“In terms of the corporate sector, we are embarking on a significant drive to grow our market share. KFH, relative to its size, has less of a presence in the corporate space and this is something we want to address. [In particular], we are under-represented in the mid-market and larger corporate space so this will be a priority moving forward,” says Mr Al-Nahedh. 

In tandem, the bank is pushing hard to cater to small and medium-sized enterprises. “SMEs will be an important driver of growth for the Kuwaiti economy over the long term. KFH is currently in discussions with the government to participate in the National SME Development Fund,” says Mr Al-Nahedh.

Ahli United expands

For Ahli United Bank, the prospects also look bright following its stellar 2014. “The Kuwaiti economy and banking market were stronger last year [than they had been previously]. We were happy with our performance. Financing levels increased, while our provisions are within good conservative levels,” says Ahmed Zulficar, deputy chief executive at Ahli United Bank Kuwait.

Notably, the bank’s performance over the past few years has been particularly strong, with sustained growth both in terms of profits and return on equity. “We had the highest return on assets, at 1.4%, and return on equity, at 15.1%, in Kuwait last year,” says Mr Zulficar.

According to Mr Zulficar, the retail sector will be a key source of growth in the future for Ahli United as Kuwait benefits from the trickle-down effect of major project and infrastructure spending, complementing the bank’s existing strengths in the corporate sector.

“In the retail space we will look to tap into the graduate and first-time job market. The level of project development occurring in the country will facilitate an increase in employment and salaries so we expect our retail business to flourish. We are also seeing strong credit growth from corporates, which is pleasing. We have a good customer base and the market continues to expand,” he says.

Commercial Bank's transition

Additional entrants to the Islamic finance sector are expected in Kuwait in the coming years. In April 2014, a majority of shareholders at the Commercial Bank of Kuwait (CBoK) agreed to convert to a fully Islamic lender, pending regulatory approval. “Islamic banks are doing very well in Kuwait, particularly in relation to the financing of real estate, but also in providing sharia-compliant accounts and services to their customers,” says Elham Mahfouz, chief executive of CBoK.

“We haven’t taken any steps as yet to become a sharia-compliant lender. Our shareholders have a strong preference for this transition but we haven’t conducted any work as yet to meet this objective. Any conversion to be a sharia-compliant bank is subject to the approval of the regulatory authorities,” she adds.

This potential transition would have significant implications for Kuwait’s banking sector. If approved, the CBoK’s conversion to sharia compliance would ultimately tip the structure of the banking market’s assets to one dominated by Islamic lenders.

Operating challenges

With the domestic economy in good shape, Kuwait’s Islamic banks look set to maintain their healthy growth in the coming years. However, certain operating challenges do remain, though these are not unique to Kuwait. In line with the global industry trend, sharia-compliant lenders in Kuwait tend to have a higher cost-to-income ratio than their conventional peers.

According to the International Monetary Fund (IMF), this is the product of certain sharia-based restrictions on products and services that are available to conventional competitors and the higher legal costs of meeting sharia-based operating requirements, among other issues.

Data from The Banker Database, covering figures to year-end December 2013, indicates that the cost-to-income ratio for KFH was 40.72%, while at other Islamic lenders, Boubyan Bank and Kuwait International Bank, the figure reached 43.37% and 37.75%, respectively. This compares less favourably with leading conventional peers, including the National Bank of Kuwait (33.07%), Burgan Bank (27.59%) and the CBoK (24.1%).

In addition, Kuwait is still making inroads into the development of the Islamic finance sector when it comes to supporting the ssector's infrastructure. As the IMF noted in December 2014: “Financial infrastructures continue to undergo reforms and are being adapted to take account of the unique features of Islamic banking. The credit registry, designed to assist banks in assessing borrower credit-worthiness, serves conventional and Islamic banks equally. Reforms are ongoing to strengthen the insolvency regime in collaboration with the World Bank, but these will need to be accompanied by reforms at commercial courts and the judiciary infrastructure.”

Liquidity management problems

Meanwhile, liquidity management continues to be a longer term problem for the sector as access to investment-grade sukuk remains limited. To date, Kuwait is yet to approve legislation permitting the issuance of sovereign sukuk. This regulatory lag is in part a product of the country’s strong fiscal position, with budget surpluses being the norm over the past decade, though Kuwait's lack of a unified regulator for the industry is a contributory factor. Instead, the country's central bank, its capital markets authority and the Ministry of Awqaf and Sharia Affairs all have a hand in the industry’s oversight.

Despite this lack of sovereign issuance, the country’s Islamic banks have tended to deal with liquidity management issues relatively well thanks to the introduction of alternative mechanisms. In particular, the Central Bank of Kuwait has provided a tawarruq instrument to the market, loosely based on the concept of a commodity murabaha, to enhance the liquidity management options available to Islamic banks.

Kuwait’s National Assembly is now looking to address this situation, with the expectation that approval to permit sovereign issuance will come by July this year. “Gaining parliamentary approval for the issuance of sovereign sukuk will be an important milestone in the development of Islamic finance in Kuwait. While Islamic lenders are coping with their liquidity management issue well, sovereign sukuk issuance would certainly help this process,” says Mr Zulficar at Ahli United. 

Over the longer term, Kuwaiti lenders will also be helped by the growing size and depth of the global sukuk market. According to research from Standard & Poor’s, total sukuk issuance in 2014 reached $116.4bn. Not only was this an increase from the $111.3bn registered in 2013, it was also the second highest yearly issuance recorded.

Notably, Kuwait’s Islamic banks have not been absent from these developments. In 2014, KFH achieved the important milestone of surpassing $3bn in secondary sukuk trading, globally. This is notable not only because it emphasises the bank’s position as a major global player in the sukuk market, it also demonstrates the growing depth and liquidity of the country's Islamic finance markets. Traditionally, the shortage of investment-grade sukuk meant that most were held until maturity. The growth of the secondary market is therefore a promising development.  

Despite these common challenges, Kuwait’s Islamic lenders are likely to continue along their promising upward trajectory in the coming years. With the country's economy back on track and growth expected in both the corporate and retail sectors, confidence remains high. Moreover, as the likes of KFH develop their international footprint and play a greater role in facilitating the growth of sukuk on a global scale, the country will continue to be a leading light in the industry. 


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