Buffeted by successive financial storms in the years since the collapse of Lehman Brothers, Bahrain’s financial sector is poised to take advantage of renewed optimism and confidence in key parts of the global economy. The overall shape and composition of the country’s banking sector has changed since 2008, but it has proved resilient overall and the annual reports of many leading retail lenders told a story of renewed growth over the course of 2013. A detailed “Financial Stability Report” (FSR), published by the Central Bank of Bahrain (CBB) in February 2014, showed many areas of strength and renewed vigour. The report also indicated how conventional retail banks have grown in terms of assets since 2008 to partially offset some of the withdrawals of assets from the wholesale sector, which took place after the initial 2008 banking crisis and subsequent after-shocks in the GCC region.
Bahrain has retained its status as a financial centre for the GCC region and beyond. New overseas financial institutions opened local offices in 2013, and the country continues to be a driver of innovation and expansion in the Islamic finance sector (see Islamic Financial Services chapter). In 2014 it was ranked as the GCC’s leading Islamic finance market and second out of 92 countries, according to the ICD-Thomson Reuters Islamic Finance Development Indicator.
The performance of both conventional and Islamic banking was cited in the initial report released by the IMF at the end of its May 2014 Article IV visit. “The banking sector is in good health,” said May Khamis, who led the IMF delegation. The IMF noted acceptable capitalisation of both retail and wholesale banks and a downward trend in non-performing loans (NPLs) in both conventional and Islamic sectors. “Bahrain has not been affected by the most recent bout of volatility in global financial markets,” added Khamis.
That positive analysis from the IMF came after an upbeat report from ratings agency Moody’s for Bahrain’s retail banking sector, which revised its outlook from negative to stable at the end of March 2014. The firm pointed to the capital, funding and liquidity positions of the banks and prospects for 3.8% growth in the non-oil sector, up from 3% at the same time in 2013. Moody’s cited shareholder equity of 11.3% of total assets and an aggregate Tier 1 ratio of 14.5% at the end of 2013 as indicators of strong buffers as the banks deal with a small number of large but troubled borrowers. The agency also said banks were expected to continue to exhibit sound capital metrics with deposits accounting for 76% of non-equity funding and liquid assets totalling 34% of all assets at the end of 2013.
Bahrain established the first financial centre in the Gulf when banks and investors in Beirut sought a safe offshore haven in the 1970s; it has been a leading centre of innovation and expansion in the Islamic finance sector; and it has ensured that its own citizens have been educated to take advantage of opportunities in the banking and finance sectors. The state’s efforts at diversification are paying off; according to the CBB, the finance and banking sector accounted for nearly 17% of GDP as of the first quarter of 2014, the second-largest contributor to GDP after the hydrocarbon sector, which contributed 22%.
Wholesale Vs Retail
While the total number of financial workers has fallen by 1900 since 2008, the shape of the sector has also changed in that time, with retail banks growing steadily just as the assets of the offshore wholesale banks have shrunk by over 40%. To understand where those assets have gone, and the wider implications, the CBB’s FSR, published in spring 2014, measured the proportion of Bahrain’s wholesale banking assets by region, comparing 2007, 2012 and September 2013. The CBB report stated, “It is crucial to note that the most important drop is recorded in the GCC area, which fell from 34.0% in 2007 to 27.5% at end-September 2013.” This compared with an increase in Western European deposits from 36.5% in 2007 to 40.8% in September 2013, and a fractional change in North American assets from 12.7% in 2007 to 12.86% at the end of the third quarter of 2013.
The CBB’s analysis suggests that the impacts of the sub-prime and eurozone crises may have been minimal, but that the regional after-effects of the global banking crisis, such as Dubai’s property slump, prompted investors from those GCC countries affected to withdraw funds from offshore accounts in Bahrain to shore up their domestic accounts. From 2007 to September 2013 total GCC assets in Bahrain’s wholesale banks dropped by 45.8%, according to CBB records.
Overall, the wholesale banking sector witnessed a drop in its total assets from $196.3bn in 2007 to $111.96bn, or 42.9% by the end of September 2013. This fall has clearly had an impact on Bahraini assets, even if they represented a relatively modest percentage of the total. In 2007, they accounted for 8.2% of the $196.3bn, or $16.1bn, and by the end of September 2013 this had fallen to 6.48% of the $111.96bn, or $7.26bn, which represents a fall of $8.84bn. The scale of this reduction is all the more significant when compared to Bahrain’s GDP, which was $7.15bn in the third quarter of 2013.
In contrast to this picture of shrinking assets, the retail banking sector in Bahrain has steered a steady course in recent years, improving against most performance indicators. From 2007 to the end of September 2013, retail banking sector assets increased by 47.85% from BD18.6bn ($49.12bn) to BD27.5bn ($72.61bn), according to CBB figures. The central bank says this increase was driven by domestic assets, which were 46.2% of total assets at the end of September 2013, up from 43.7% at the end of December 2012.
According to the CBB’s FSR, the retail banking sector is “lightly exposed” to foreign risk from Western Europe and the US; of the 46.25% of foreign assets, the largest proportion, at 19.28%, are from the GCC. The contrasting fortunes of the wholesale and retail sectors since 2006 can also be seen when the total assets of the sector are compared to Bahrain’s GDP. In 2006, it was 11.9 times GDP, growing to 13.5 in 2007. Between 2008 and 2010 it remained at 11.5 times GDP, despite the shocks to the global financial system. In 2011 the overall size of the sector dropped by nearly 50% to 6.8 times GDP, with the wholesale sector falling from 8.1 times GDP in 2010 to 4.5 in 2011. CBB figures show the retail sector shrank slightly during the period but increased in 2012 to 2.47 times GDP.
In the third quarter of 2013, the total assets of the banking sector amounted to $185.32bn. The CBB’s FSR sees these figures in a positive light, particularly for retail banks. “There are no major or minor effects of the drop of the overall size of the banking sector in the economy of Bahrain. This shows that the weight of wholesale banks in Bahrain is not significant compared to domestic banks. Therefore, we can conclude that retail banks in Bahrain are the main engine for the financial sector growth in the kingdom.”
Credit & Deposits
The CBB anticipates credit growth to the private sector will increase in 2014 after reaching a peak of BD7.03bn ($18.56bn) at the end of September 2013, surpassing even levels seen in 2008. According to the CBB, this reveals the recovery of economic activity in the kingdom, spurred in part by the revival of projects that have been mothballed for five years. It says banks’ lending to the government fell by 23% year-on-year from BD236m ($623.09m) in September 2012 to BD182.8m ($482.63m) in September 2013. In February 2013 deposits reached BD15.23bn ($40.4bn), which is the highest level since 2008, according to the central bank. Total domestic credit increased by 3.6% from BD6.96bn ($18.38bn) in September 2012 to BD7.22bn ($19.06bn) in September 2013, but still only represents a relatively modest 62.2% of GDP.
The banking sector in Bahrain includes both conventional and Islamic lenders and there is some crossover between the two as reflected by recent mergers and equity purchases (see Islamic Financial Services chapter). The CBB has overseen both sectors since 2006. In late March 2014, of the 406 banks and financial institutions listed on the CBB register, there were 22 licensed conventional retail banks and six Islamic ones. Conventional retail bank BMI Bank’s merger with the Islamic lender Al Salam Bank Bahrain was confirmed in February 2014. There are 58 wholesale conventional banks registered, but five of these are in liquidation. The Islamic wholesale banking market consists of 18 entities. Of the 22 conventional retail banks, seven are Bahraini and all but two operate on a universal banking model. Three of these banks dominate the sector: NBB, BBK and Ahli United Bank.
NBB was established in 1957, making it the oldest indigenous bank and its 26 branches give it the most significant presence on the high street. BBK has 20 branches, as does Ahli United, which was established in 2000. Among the remaining domestic retail banks, Bahrain Development Bank, founded in 1992, and Eksan Bank, which was incorporated in 1979, each have restricted licences. BDB focuses on loans to the small and medium-sized enterprise sector, while Eksan was created to provide housing finance to low- and middle-income families. Future Bank, which was created in 2004 as a joint venture between Ahli United Bank and two Iranian lenders, is focused on commercial activities involving Iranian companies and the GCC, but also has a retail offering via its three branches in Bahrain and representative office in Tehran. BMI Bank is the newest of the retail conventional banks and has eight branches. It confirmed its merger with Al Salam Bank Bahrain, an Islamic lender, in February 2014.
There are also 15 foreign conventional retail banks in Bahrain from 11 different countries with 25 branches between them. The two newest banks, the UAE’s Mashreq and State Bank of India, were each given licences on September 17, 2005, while the island’s oldest lender is the UK’s Standard Chartered, which has been operating in Bahrain since 1918. It currently has six branches. HSBC Middle East, incorporated in Jersey, has three branches and has been in Bahrain since 1944. The US’s Citibank has two branches and has been present on the island since 1969, while BNP Paribas operates a head office and has been present since 1975. GCC countries are represented by Mashreq Bank and National Bank of Abu Dhabi, while National Bank of Kuwait has two branches. The cosmopolitan nature of the retail sector is further underlined by Arab Bank’s five branches and the representative offices of Jordan’s Housing Bank for Trade and Finance, Credit Libanais of Lebanon and Iraq’s Rafidain Bank, which has been based in Bahrain since 1969. Pakistan has two banks: United Bank with two branches, and Habib Bank with one branch, which have both been in Bahrain since the 1960s. India also has two banks: ICICI Bank with one branch, and State Bank of India with two branches, and the two companies have been licensed to bank in Bahrain since 2004 and 2005, respectively.
Of the 58 companies with wholesale licences, five, including four from Bahrain, are listed as insolvent. Meanwhile, of the remaining 53 companies, 13 are Bahraini, eight are from Turkey, seven from Pakistan, four from India, three from the UK, three from the US, three from Saudi Arabia, two from France, two from South Korea and one each from Jordan, Luxembourg, Jersey, Ireland, Malaysia, the UAE, the Philippines and Japan.
By The Numbers
CBB figures for March 2014, released in August 2014, gave a snapshot of the health of the industry as a whole. The statistics showed conventional retail banks had a capital adequacy ratio of 18.3%, while the figure for locally incorporated wholesale banks was 21.6%. Based on the ratio of Tier 1 capital to risk-weighted assets the core capital ratio of retail banks was 15.7%, while for wholesale it was 18.7%. The leverage ratio of assets over capital and the ratio of NPLs net of provisions of capital were 8.6% and 8.9%, respectively, for retail banks versus 6% and 2.3% for local wholesale banks. NPLs were 3.8% for both retail and locally incorporated wholesale banks, compared to 9% for overseas wholesale banks. Specific provisions as a proportion of NPLs were 55.2% for conventional retail banks and 66.1% for wholesale ones, while net NPLs of net loans were 1.7% for retail and 2.5% for wholesale. “The overall size of the consumer lending portfolio in the banking sector has increased with acceptable levels of NPLs. We now find ourselves with excess liquidity with limited lending and investment opportunities, so there is still room to grow,” Abdulkarim A Bucheery, the CEO of BBK, told OBG.
Commercial real estate financing accounted for 17.4% of total retail loans by locally incorporated retail lenders, with personal and consumer finance comprising the second-largest proportion of loans in this sector at 12.6%. Exposure to real estate and construction was 35% of total retail lending. For overseas retail banks, manufacturing accounted for 19% of total loans, followed by personal and consumer finance with 16.4%, while exposure to real estate and construction was 15.1%. In the wholesale sector, manufacturing was the biggest recipient of loans from locally incorporated wholesale banks, accounting for 29.1% of all loans in March 2014, with the manufacturing and financial sectors combined accounting for 50.4% of all lending. The financial sector was the most popular recipient of overseas wholesale bank loans, with 37.5% of the total.
Return on assets was 0.4% for locally incorporated retail banks and 0.6% for overseas retail banks in March 2014 compared to figures of 0.4% and 0.6%, respectively, for locally owned and overseas wholesale banks. At the same point the return on equity (ROE) was 4% for local retail banks. Other key factors boosting bank earnings measured as a proportion of gross income include net interest income of 68.1%, net fees and commissions of 15.3%, and operating expenses of 41.2%. ROE for local wholesale banks was 2.5% with net interest income of 35.2%, net fees and commissions of 37.3%, and operating expenses of 39.3% of gross income. In March 2014 the loan-to-deposit ratio was 64.2% for retail banks and 63.7% for wholesale banks.
The CBB worked on a strict timetable to ensure full implementation of Basel III Pillar One rules by 2015. In November 2012, locally incorporated banks were told they should provide quarterly updates on capital adequacy and liquidity ratios. The CBB brought in the liquidity coverage ratio (LCR) at a level of 60% on January 1, 2015, which will rise to 100% by 2019. The 3% leverage ratio is due to start in January 2018, with reporting commencing in 2017. “From the beginning of 2013 we asked banks to report on their ratios,” Yousif Hassan Yaqoob Yousif, director of the CBB’s retail banking supervision directorate, told OBG. “The objective is that we do not get surprised.”
In March 2014 Khalid Hamad, executive director of banking supervision at the CBB and chairman of International Islamic Financial Market, told the SWIFT Business Forum Bahrain that the outlook for most banks was positive. “The vast majority of Bahraini banks which have already published their 2013 results achieved better performance as compared to 2012 and a lot of them intend to distribute dividends,” Hamad said. Although the CBB would like to see more consolidation, the performance of its three leading retail banks shows signs of healthy profitability. BBK made profits of BD37.46m ($99.27m) in the first nine months of 2014, up 8% on the same period in 2013, while NBB had profits of BD42.16m ($111.72m), a rise of 5.2%. Ahli United Bank, meanwhile, generated profits of $376.3m in the first three quarters of 2014, up 30.1%.