Kuwait’s Islamic financial services (IFS) industry is one of the fastest-growing segments of the financial sector, home to an increasing number of sharia-compliant banks and insurance companies. The emergence of these industries over recent decades has brought sharia-compliant capital to account for a significant proportion of total capital domiciled in Kuwait – around 45%, according to the World Bank, which is the second-highest rate in the GCC.
Kuwait has also emerged as a player with weight in the global Islamic finance market. According to professional services firm EY, it is one of a core group of nine countries that account for 93% of industry assets, estimated to have exceeded $920bn in 2015. The World Bank reported that Kuwait’s share of global Islamic banking assets in 2016 was around 5.9% of the total, making it the fifth-largest sharia-compliant banking industry in the world that year.
As a founding member of the Organisation of Islamic Cooperation, Kuwait has long been at the centre of the development of the global IFS industry. The international organisation, which today has 57 member states, began to explore the potential of sharia-compliant financial services in the early 1970s. Over subsequent decades it has helped to put forward a constant agenda of meetings and conferences on various IFS subjects, such as the establishment of Islamic standards for banking, sukuk (the sharia-compliant equivalent of bonds) and takaful (sharia-compliant insurance).
Within Kuwait, the catalyst for the development of IFS was the founding of Kuwait Finance House (KFH) in 1977, the first Islamic bank in the country and a leader in sharia-compliant products and services to this day. Throughout the 1980s and 1990s KFH held a monopoly over the local Islamic banking sector, a status reinforced by the banking law of 1968 that prohibited privately headed Islamic financial institutions from establishing operations in the country.
In the early 2000s, however, a change in the rules allowed for a second phase of growth in the country’s nascent industry. With the passing of Law No. 33 of 2003, a door was opened to new sharia-compliant financial institutions. The first to arrive, Boubyan Bank, was established in 2004. Three years later the Kuwait Real Estate Bank – which had operated in Kuwait as a conventional finance lender since 1973 – converted to sharia-compliant status and rebranded as Kuwait International Bank (KIB). In 2010 Ahli United Bank of Kuwait (AUBK) also converted its business to operate in the Islamic market. The same year saw Warba Bank, a new sharia-compliant institution, obtain a licence to conduct business in Kuwait.
The steady stream of market entrants has established a growth trend for sharia-compliant finance that has outpaced the conventional segment in recent years. Between 2011 and 2014 the assets of Kuwait’s five Islamic banks expanded faster than their traditional counterparts in every year but one, with Islamic banks growing by 13% in 2014 compared to 4% in the conventional segment. The possibility of even more market entrants remains. In 2014 the shareholders of the Commercial Bank of Kuwait approved a plan to convert the institution into a fully-fledged Islamic operation; however, this had not yet been implemented at the time of publishing.
One institution is responsible for the bulk of the IFS sector’s hold on nearly half of Kuwait’s total banking assets. KFH, with assets of around KD16.5bn ($54.6bn) at the close of 2016, is the largest sharia-compliant bank in the domestic market and the second-largest bank in the country, as well as being the only Islamic bank to make it into Kuwait’s “big five” (see Banking chapter). It is also the second-largest sharia-compliant bank in the world, with holdings in Bahrain, Saudi Arabia, the UAE, Turkey, Malaysia and Germany. The bank’s largest shareholders include the Kuwait Investment Authority (the state’s sovereign wealth fund), the Kuwait Awqaf Public Foundation, the Public Authority for Minors’ Affairs and the Public Institution for Social Security.
The Ahli United Bank Group (AUB Group), with total assets of around KD9.5bn ($31.4bn), is the only Islamic bank in the market that comes close to the dominant KFH in terms of size. With institutions in eight countries, the group’s Kuwait operation, AUBK, had total assets of KD3.8bn ($12.6bn) at the end of quarter one of 2017. While its conversion to sharia compliance in 2010 established the institution in its present form, its history in the country extends as far back as the 1940s, when it was one of many banks affiliated with the Imperial Bank of Persia. During the 1970s – named the Bank of Kuwait and Middle East at the time – it operated as a Kuwaiti government-owned institution, which the AUB Group bought into in 2002. Today the AUB Group retains a 74.9% stake in AUBK, which connects the Kuwaiti institution to the group’s wholly-owned operations in Bahrain and the UK, as well as its majority-owned and minority interests in Egypt, Iraq, Libya and Oman. AUB Group also holds a 50% stake in Legal & General Gulf, an insurance joint venture with UK-based Legal & General.
Boubyan Bank, with assets of approximately KD3.5bn ($11.6bn), is the third-largest Islamic bank in the country. Since its entry to the market in 2004 it has undergone a number of structural changes, most notably the 2009 decision of National Bank of Kuwait (NBK) – the country’s biggest lender – to buy a 47% stake in the company, which then increased to nearly 60% by 2012. At this stage, the bank was midway through a strategic overhaul, carried out with international consultants, which saw it return its focus to the retail segment and the development of a large branch network.
The bank now operates as a subsidiary of NBK and is focused entirely on the domestic market. Despite its subsidiary status, the bank maintains its own group, which includes Boubyan Brokerage and Boubyan Takaful in addition to the bank operation.
With assets of around KD1.8bn ($6bn), KIB is the fourth-largest sharia-compliant financer in the country. It, too, is a domestically focused institution, with a network of 26 branches across the state. Its biggest shareholder is Kuwait’s Bukhamseen Group, a holding company with interests in fields as diverse as insurance and restaurants, which retains a 21.73% stake in the bank. Other significant shareholders in KIB include the Public Institution for Social Security, with 9.17%; Al Huda Hotels and Tourism Company with 7.25%; and Al Baraka Kuwait General Trading and Contracting holding 5.83%.
Warba Bank is both the most recent market entrant and the smallest of the five Islamic banks in the country, with total assets of KD1.1bn ($3.6bn) in 2016. Key shareholders include the Kuwait Investment Authority, which retains a 25% stake, the Public Institution for Social Security with 6.83% and the Al Sayer Group Holding Company, one of the state’s oldest trading companies formed in 1954, with 7.1%. In the first half of 2017 the bank marked the end of a two-year strategy that saw it significantly increase its profitability. It is currently working on a 2017-21 strategy with global consulting firm McKinsey and Company, by which it aims to increase its market share in both the retail and corporate banking segments.
Kuwait’s Islamic banks, like their conventional counterparts, have faced a challenging economic environment over the past year as a result of suppressed oil prices. All banks in Kuwait are dependent on government investment in large projects for a sizeable proportion of their income. While Kuwait’s strong external position and its large sovereign wealth fund have helped it to maintain its capital spending programme, banks with income streams generated by governments elsewhere in the Gulf were more exposed to the oil price deterioration.
While sector assets, including those of conventional and Islamic lenders, grew by 3% in 2016, the expansion was down on both the previous year and in relation to recent trends. Kuwait’s five Islamic banks put up a mixed performance in terms of asset expansion. According to 2016 financial disclosures, their combined assets stayed almost static over the year, showing a marginal decrease of 0.14%. Within this aggregate total, however, their performance differed significantly. Warba Bank, on the one hand, posted the highest asset growth at 45.2% for the year on the back of its recent structural reform. AUBK, on the other hand, saw its assets decline by 7.8%. Four out of the five Islamic banks in Kuwait achieved a year-on-year rise in net profit in 2016; however, the 14.7% decline in net profit posted by the largest bank in the segment meant that the aggregate profit for the year was stagnant at -0.09%.
Given the size of the Islamic banking sector in Kuwait, there is a strong correlation between the performance of these five institutions and the growth of the wider IFS market. Their ability to maintain profit growth and finance activities over the coming period is therefore one of the key issues within the wider industry, which includes insurance.
While Islamic banks account for the bulk of sharia-compliant assets in the country, Kuwait is also home to a vibrant takaful industry. As of 2017 more than a dozen of Kuwait’s insurance companies operate according to the principles of sharia, and are part of a wider GCC market worth approximately $9bn, according to Middle East Global Advisors. However, despite the relatively large number of takaful providers, they have yet to penetrate the domestic insurance market as successfully as their Islamic banking counterparts. Kuwait’s “big four” insurance companies – Gulf Insurance Group (GIG), Al Ahleia Insurance, Kuwait Insurance Company and Warba Insurance – account for the bulk of the insurance sector’s written premiums and all are conventional operators (see Insurance chapter).
The takaful operators, therefore, populate the remainder of the market where challenges to sustainable growth are significant. Chief among these is a lenient regulatory regime, which through a lack of stringent actuarial controls, results in fierce price competition. Many companies are willing to accept underwriting losses in order to attract premiums, which are then invested in the pursuit of a margin. The larger insurance companies operating in Kuwait generally follow strict risk-management protocols with regard to their investment activities, and therefore tend to direct their non-designated and shareholders’ funds to fixed-income assets or high-quality listed instruments. Smaller companies, conversely, often seek higher investment earnings by implementing strategies with a greater emphasis on equities. Consequently, their investment income is more volatile, while their financial statements – where available – often feature significant levels of unrealised income.
Expanding the takaful segment in Kuwait is further complicated by the small role life insurance products have in the local market – an area where takaful is usually successful. As is the case in the wider GCC, Kuwait’s insurance market is dominated by non-life insurance products, with compulsory motor coverage accounting for the single biggest share of gross written premiums, followed by property cover. Life insurance accounted for just KD52m ($172m) of the KD315m ($1bn) total in 2015, according to Swiss Re. A number of factors combine to challenge the growth of life insurance in Kuwait and the wider region. Perhaps the most salient is the wariness of this type of insurance arising from religious concerns. Here, however, takaful operators have an advantage over conventional insurers. Sharia regulatory institutions across the globe have judged takaful to be acceptable from a religious standpoint, while closer to home the scrutiny of products and services by proprietary sharia boards of individual companies provides further reassurance.
Across the GCC the emergence of takaful is helping to alter the perception of insurance, with sharia-compliant life cover, in particular, opening new markets. In Kuwait, companies such as GIG have responded to this phenomenon by offering takaful products alongside conventional insurance, a trend that is likely to continue over the long term.
Many within the takaful segment believe that a more comprehensively regulated industry is the answer to mounting competition and price undercutting. A new insurance law has circulated in draft form since 2012, but the industry is still awaiting its final approval. The proposed law’s key component calls for an independent regulator for the insurance sector. In addition to a new regulatory body, the most significant points of the law are likely to be new capital adequacy requirements, along with a section in the legislation that for the first time will directly address the processes associated with takaful. Looking to the wider IFS market, Kuwait has taken a decentralised regulatory approach, with a number of bodies sharing the responsibility of overseeing various sharia-compliant financial transactions.
Islamic banks are regulated by the Central Bank of Kuwait (CBK), which applies the 2003 Banking Law to the industry. In 2016 the CBK issued new sharia supervisory guidelines for Islamic banks, giving them until January 2018 to comply (see analysis). Takaful in Kuwait is regulated by the Ministry of Commerce and Industry, which – until the promulgation of the draft Insurance Law – applies the Kuwait Insurance Law of 1961. Despite numerous amendments, the current framework makes little distinction between conventional and sharia-compliant insurance operations.
Providers of Islamic funds, meanwhile, must be cognisant of the fund framework operated by the Capital Markets Authority (CMA). While the CMA has not established a distinct regime for the numerous sharia-compliant funds offered by banks and investment companies, there are references to them in the 2010 Capital Market Law’s by-laws.
The CMA has also recently moved to establish a framework governing sukuk issuances, which had previously been lacking in Kuwait.
New sukuk framework was introduced in late 2015. It established for the first time the requirements for appointing trustees and setting up special purpose vehicles, as well as rules on governance and ensuring sharia compliance. Consumer protection is also highlighted in the regulations, with requirements for a credit rating for public issuance and the need for approval by both the CMA and the CBK.
The introduction of a comprehensive regulatory framework for sukuk issuance represents an important advance for the IFS sector. Kuwait is an active centre of conventional bond issuance – in the first quarter of 2017 there were 32 outstanding bond issues from Kuwaiti corporates and the country made its first international sovereign issuance in March 2017 – but the lack of rules for sukuk offerings has hindered the development of sharia-compliant debt. The absence of quality fixed-income instruments in the market has posed a challenge to takaful providers, as it has compelled them to raise the equities and real estate investment allocations of their investment strategies in order to compensate – a phenomenon which represents a solvency risk.
Knowing how much of an effect the new regulations will have on sukuk issuance in the medium term remains to be seen, but the demand for them is clear. In global terms, Thomson Reuters reported that worldwide sukuk issuances reached $39.8bn by the third quarter of 2016, with an additional $362.8bn outstanding. On a local level, global ratings agency Fitch believes that Kuwaiti corporates are more likely to issue sukuk than conventional bonds due to the new regulations, along with the fact that “there is a wider local and regional investor base for sukuk and because some corporates are restricted to sharia-compliant borrowing by their own rules”.
The question of regulation is likely to remain a key theme over the medium term. The recent sukuk framework may result in a change to the current preference of issuers conducting offshore deals in locations such as the Dubai International Finance Centre, where the presence of a tribunal arbitration centre has acted as a draw for offerings from around the GCC. Enhanced bankruptcy and insolvency laws would further amplify the effects of the sukuk framework, with IFS market participants frequently citing the area as one in need of improvement. However, the parliamentary nature of Kuwait’s political system means that broad legislative change is complex and lengthy, thus upgrading of the entire issuing environment is a long-term undertaking.
Meanwhile, the takaful industry awaits the promulgation of the much anticipated new insurance law, which will replace a framework that is more than 50 years old. A dedicated regulator for the insurance sector remains a strong possibility, and one which would likely result in firmer capital requirements and stronger actuarial oversight of Kuwait’s growing sharia-compliant insurers. In terms of business expansion, both Islamic banks and insurers stand to benefit from the global emergence of the IFS market. Total Islamic financial assets have grown rapidly in recent years, from $1.7trn in 2012 to approximately $2.2trn in 2016, according to the World Bank. This trend is expected to continue, with global Islamic finance assets likely to reach $3.2trn by 2020.
Despite some regulatory challenges, the World Bank places Kuwait in the top-10 countries in terms of the development of its “Islamic economy”. Assessed in the areas of financial size, governance, awareness and social contribution, Kuwait ranks seventh globally – higher on the leaderboard than some regional financial centres and even bettering some global pioneers of Islamic finance, such as Indonesia. Kuwait’s IFS sector, which already plays a crucial function in the economic life of the country, is likely to see its role become more prominent over the coming years.
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