Within the realm of financial services in Bahrain, most of the attention in recent years has been on the wholesale sector, where the internationally focused nature of the business left banks relatively more exposed to the effects of the global financial crisis. In contrast, retail banks in Bahrain have been steady, continuing to serve their customers and grow their loan books. Retail banks are expecting a positive year in 2013 as projected economic growth and positive employment figures should bring more new customers into the mix.

Over a longer forecasting period, top-down spending is important, as Bahrain appears set to enjoy a round of infrastructure upgrades that will not only directly benefit the economy, but also filter through to retail lenders’ balance sheets by creating opportunities for loans to contractors and through tangential benefits to other parts of the economy.

For retail banks this means not only financing opportunities, but also additional potential due to the creation of new jobs. This is important because growth in retail banking requires access to a sustainable stream of new customers, instead of an economic environment without job growth.

ADVANTAGES: A retail licence is considered an advantage in Bahrain’s banking sector because it provides the ability to take deposits from consumers below the threshold of BD7m ($18.4m), which wholesale banks cannot do. In the current economic environment, retail lenders’ current and savings accounts (CASA) represent a safe and reliable source of low-cost funds. CASA assets enable retail banks to take in money, lend it at a higher rate, and count the difference as profit but at a lower cost to the bank than many other options. Rates paid to consumers for current or savings accounts are lower for the bank than if it had sold bonds, for example, and used the proceeds for the same loans that the CASA accounts were applied to. This is because bond investors typically demand a higher rate of return for their investment than consumers. This time-tested model offers the chance to find profit margins without having to search out the highest potential returns – those that may offer the biggest reward but also come with the greatest risk. Lower-cost funds provide the opportunity for profit margins while avoiding higher risk.

NEW INTEREST: Wholesale banks are warming up to the idea of adopting at least parts of this type of banking into their business. Whilst most had been occupied with investments with a higher risk and return during the 2000s, the current economic climate may be perceived as one in which a diversified combination of lower-risk and higher-risk investments is a better option for sustainable returns.

As wholesalers hope to acquire retail functions, some conventional players may look to sharia-compliant institutions in order to gain access to this market segment, which prefers to maintain CASA with sharia-compliant institutions. The same is true for existing retail banks in the conventional segment that do not have Islamic windows or subsidiaries. Buying an Islamic subsidiary would allow a conventional retail bank to expand its ability to take CASA deposits by opening up the sharia-compliant segment of the market and providing the bank with the necessary capacity to access a greater range of customers.

COMPETITION FOR CLIENTS: The upshot for 2013 is that retail banks, both conventional and Islamic, have become attractive candidates for purchase, should any of their shareholders express interest in selling. This could also mean increased competition, as new licensees in the sector could create an environment in which a greater number of lenders are competing for the same number of consumers.

Thus far, according to the Central Bank of Bahrain (CBB), lenders have not been cutting interest rates and thus, have not increased competition. Interest on personal loans is typically between 5.5% and 6.5% across the sector, CBB data shows. Lenders are instead trying to win customer loyalty through improved service offerings, such as longer branch hours and better customer service.

In an environment in which profit margins are potentially squeezed by competition, banks have, in some markets, turned to fees as a way of preserving profits. Fee-based incomes in a retail setting would mean charges for basic services or raising existing fees for those options. However increasing charges may not be the solution, or no more than a small part of it, thanks to regulatory oversight, as the CBB is keen to ensure that retail banks do not charge unreasonable fees for services.

For example, regulations prohibit banks from profiting from the sale of third-party products, such as bancassurance. Loan-specific regulations include capping personal loan terms at seven years and limiting loan extensions to two years.

ROAD AHEAD: A less favourable aspect of the outlook for retail banks is that Bahraini consumers are increasingly indebted. More and more Bahrainis spend an increasingly large portion of their income servicing debt. Indeed, the issue has become severe enough for the CBB to intervene. The central bank now prohibits the extension of further credit to those who are spending 50% of their income on servicing debt, save for in exceptional circumstances. Household debt has been on the rise thanks to the buoyant economic environment that prevailed before the financial crisis, as well as because recent total loan growth has not been supported by employment increases. The most recent statistics from Bahrain’s Labour Market Regulatory Agency show employment in the country holding steady since mid-2009 at roughly 600,000 people (Bahrainis and expatriate workers combined). This suggests that consumer loan growth has not come from new borrowers entering the picture, but from increased credit extended to existing borrowers. The expectation is, however, that economic growth will bring new customers. Lending in 2011 was strongly skewed to the second half of the year, and for the first 11 months of 2012 Bahrain’s Economic Development Board reported a 7.5% rise in overall outstanding credit in an economic status update that was released in February 2013.