The financial services industry plays a crucial role in Bahrain’s economy, contributing 16.8% to GDP. Recognising the need to reduce the country’s dependence on oil, the government has prioritised the development of the sector. In order to strengthen the local economy and facilitate recovery from the Covid-19 pandemic, the government introduced the Economic Recovery Plan (ERP). The plan is centred around securing over $30bn for investment and financing infrastructure projects.
Additionally, the Central Bank of Bahrain (CBB) devised the Financial Services Development Strategy 2022-26, which outlines five pivotal priorities: job creation, legislation and policies, financial markets, financial services and financial technology (fintech), as well as the insurance segment. This strategic framework aims to achieve medium-term goals, including raising the sector’s contribution to GDP to 20% by 2026 and further expanding it to 25% over the longer term.
Structure & Oversight
Following the dissolution of the Bahrain Monetary Agency in 2006, the CBB assumed regulatory responsibilities for the banking sector and other financial services. As stipulated in its founding law, particularly Article 4, the CBB possesses the authority to license, supervise and regulate all entities involved in financial services in the kingdom. The CBB also provides banking services to the government, manages gold and foreign exchange reserves, and is responsible for currency issuance.
In 2015 the CBB established a centralised Sharia Supervisory Board (SSB), the first institution of its kind in the GCC region. The SSB introduced a sharia governance framework in 2018, ensuring oversight of compliance in the Islamic banking and insurance segments. Individual Islamic financial institutions also maintain their own sharia compliance boards.
Banks in Bahrain are obligated to maintain a capital adequacy ratio (CAR) of 12.5% of risk-weighted assets and a Tier-1 ratio of 10.5%. These requirements surpass the Basel III standards, which the kingdom has been adhering to since 2015. In addition to meeting these ratios, locally incorporated banks are mandated by the CBB to report Basel III ratios on leverage and liquidity on a quarterly basis, including the liquidity coverage ratio. Since 2019 these banks are required to report their net stable funding ratio on a regular basis.
Small Enterprises
Small and medium-sized enterprises (SMEs) contribute nearly 30% of GDP and employ approximately 75% of the private sector workforce. Recognising their importance, the government has implemented various measures to boost the growth and prominence of these businesses.
“Enabling SMEs to have convenient and speedy access to finance is not only a government objective, but also a necessity for the local economy,” Dalal Ahmed Qais, Group CEO of Bahrain Development Bank (BDB), told OBG. “Given the extensive prerequisites and rigorous risk analysis employed by traditional banks, it is imperative to adopt alternative avenues. Enhanced collaboration among government and economic stakeholders is essential to improve access to finance and facilitate the growth and prosperity of SMEs.”
The BDB plays a vital role as a dedicated financial institution in fostering the advancement and expansion of SMEs. In line with this objective, the medium-term financial services sector strategy has set a goal to progressively increase the proportion of financing allocated to SMEs in the domestic lending portfolio. The aim is to achieve a target of 20% of financing specifically allocated to SMEs by the end of 2026.
In late 2022 the BDB introduced tijara, a digital platform designed to streamline the loan application process and provide SMEs with convenient access to funding. The platform also offers payment and salary transfer processing capabilities. tijara provides a range of other services to SMEs, including the ability to view account and transaction details, download statements, transfer funds both domestically and internationally, manage beneficiaries and generate account reports.
In February 2023 the Bahrain Association of Banks convened to explore strategies to increase the share of SME financing in a phased manner to reach 20%. During the meeting, the association expressed a willingness to collaborate with Tamkeen, a semi-autonomous agency that supports private sector development, to facilitate lending arrangements by acting as a guarantor partner. This collaboration aims to reduce risk elements associated with lending to SMEs. The association has also expressed support for the CBB’s goal of creating new job opportunities in areas such as open banking, digital banking and financial transfers.
Mumtalakat, the sovereign wealth fund of Bahrain, is an important institution within the financial services sector and was managing approximately $18.3bn in assets as of 2022. Its portfolio includes holdings such as a 60% stake in the McLaren Formula 1 Team, as well as positions in prominent domestic companies like Aluminium Bahrain (Alba) and Bahrain Telecommunications Company. In March 2023 credit ratings agencies Fitch and Standard & Poor’s assessed Mumtalakat’s credit rating at “B+” with a positive outlook.
Regulatory Developments
Bahrain’s economy is experiencing a robust recovery following the pandemic, but it is not without financial repercussions for the sector. The prolonged economic downturn led to certain challenges for individuals and local businesses, particularly in meeting their loan repayment obligations. To address this issue, legislators proposed in April 2022 to increase the maximum loan repayment period from seven to 15 years. Loan deferments were initiated in March 2020, shortly after the onset of the Covid-19 crisis, and have been subsequently extended four times. The most recent extension of the loan deferral option expired in June 2023. While this adjustment may result in banks recovering their loans at a slower pace, it reduces the risk of widespread default.
The CBB is working on the development of environmental, social and governance (ESG) disclosure guidelines for banks, and was expected to publish them in 2023. These guidelines will incorporate the insights gathered from the ESG Reporting Survey, distributed to listed companies, insurers, banks and investment firms in early 2022. By integrating ESG criteria into its framework, the CBB aims to enhance the ability of companies and banks to effectively monitor their efficiency, sustainability and risk exposure.
Digital Payments
Bahrain, along with other GCC markets, is actively capitalising on the new opportunities arising in fintech and digital banking. A significant milestone in this endeavour is the release of the first edition of the “Digital Payment Landscape Report” released in 2022. The report highlights the growth observed in digital payments in the kingdom. One of the primary objectives of the ERP is to reduce the volume of currency in circulation by 25% while maintaining a yearly growth rate of 10% in electronic fund transfers.
Bahrain is making significant strides in digital payments, with point-of-sale transaction volumes rising by 49.8% in 2021, according to the report. These transactions also experienced a 34.6% increase in value, reaching $8.5bn. Digital wallet transaction volumes rose by 196.2%, while the corresponding values rose by 111.6%. Looking ahead, US-based Boston Consulting Group (BCG) projects that digital payment revenue in Bahrain will reach $485m by 2030. The kingdom aims to transition into a cashless society over the same period.
The increase in non-cash transactions can be attributed, in part, to the pandemic, which prompted consumers to adopt contactless payments due to health concerns and regulatory guidance. However, the groundwork for the implementation of such services is the result of effective and proactive planning by the CBB. In 2020 and 2021 it introduced the Bahrain Open Banking Framework, enabling consumers to share their financial data across various platforms and providers. The framework has played a crucial role in streamlining digital payments and facilitating other transactions.
In 2012 the CBB implemented real-time banking utilising IBANs – an internationally recognised system of account numbering. The imitative yielded significant benefits, including reduced costs and delays associated with both local and cross-border payments. The use of IBANs represents a significant catalyst for digital payments expansion. Additionally, the adoption of the Arabian Gulf System for Financial Automated Quick Payment Transfer (AFAQ) in 2020 has accelerated digital payment expansion. AFAQ, operated by the Gulf Payments Company, serves as a real-time gross settlement service specifically designed for cross-border payments among GCC countries. Although its primary focus is on businesses and investors for cross-border transactions, the CBB’s Fawri system also serves consumers by offering a user-friendly peer-to-peer payment solution through a mobile app.
Managed by Benefit, Fawri provides a payment solution for immediate and future-dated transactions to individual or multiple recipients. In 2021 it facilitated 9.6m transactions. Fawri+ allows transfers within 30 seconds. The latter hosted 140m transactions that year, equating to an average of 100 transactions per person. Complementing these services, Fawateer, the electronic bill presentment and payment platform, processed 9.1m transactions, both online and offline. These functionalities are integrated into the BenefitPay app, which served as the conduit for 209m transactions in 2021 out of a user base of 861,000 individuals.
Digital transactions are supported by a resilient security framework, encompassing stringent electronic know-your-customer (KYC) protocols. This involves accessing customer information stored by the Information and eGovernment Authority and other relevant government entities. By leveraging a unified digital platform, transactions can be swiftly and securely verified without the need for in-person interactions. As of 2021 the issuance and clearance of cheques has been integrated into the Bahrain Electronic Cheque System.
Fintech Sandbox
The driving force behind fintech innovation is the dedicated regulatory sandbox established by the CBB in 2017. One key component of this initiative is the fintech sandbox, which provides an enabling environment for companies to pioneer new digital financial services without the burden of existing regulatory obligations. As of September 2022 the sandbox had 20 companies, predominantly from the MENA region, with one representative each from Europe and the Americas. One of the participants in the sandbox is OpenNode, a company that is partnering with the CBB to introduce a Bitcoin-based payment processing solution. The sandbox framework plays a pivotal role in positioning Bahrain as a top choice for establishing fintech businesses.
Innovation
The CBB’s innovation efforts continue to attract new businesses to the sector. The bank has implemented several regulations for crowdfunding operators, as outlined in the Crowdfunding Platform Operators Module of the CBB’s rulebook. These guidelines serve as a framework for governing the operations of crowdfunding platforms, with a primary focus on promoting integrity and trust by avoiding conflicts of interest, conducting due diligence of platform operators via KYC and segregating client money from the platforms to ensure safe operations.
Bahrain is also working towards launching a digital dinar via distributed ledger technology (DLT). In June 2022 the CBB announced the successful completion of a test with JPM organ Onyx, which enabled the Arab Banking Corporation (Bank ABC) to initiate real-time payments for Alba to benefit its counterparties in the US by leveraging the coin system, which also made it easier and quicker to make US dollar transfers as a compelling use case for DLT payments.
Banking Structure
The financial services sector is a key pillar of the wider economy, providing employment opportunities to 14,124 people in 2022, twothirds of whom were Bahrainis and the remainder foreigners. As of March 2023 there were 365 financial institutions, including 86 banks, of which 30 were retail banks and 56 were wholesale lenders. Taking a closer look, the sector included 17 branches of foreign banks and 13 locally incorporated lenders, as well as seven bank representative offices and one bank society.
According to the CBB’s March 2023 “Financial Stability Report”, the total assets of the banking sector reached $224.1bn in December 2022. This represents a 3% increase compared to the previous year. Among the different segments, Islamic banking assets experienced the strongest growth, rising by 4.4% to $35.3bn. Retail banks’ assets increased by 2.3% to $101.7bn, while wholesale lenders saw growth of 3.6% to $122.4bn.
Fitch Ratings expects the Islamic banking market share to surpass half of the total domestic banking sector assets in the near to medium term. This projection is attributed to mergers and acquisitions taking place in the industry (see regional analysis), as well as sustained demand for Islamic financial products. Currently, Bahrain holds a 3.3% share of global Islamic banking assets (see analysis).
Mergers & Acquisitions
According to Fitch, the acquisition of Ahli United Bank (AUB), a Bahrain-based conventional bank, by Kuwait Finance House (KFH), Kuwait’s largest Islamic lender, which concluded in October 2022, is expected to deliver a substantial boost to the financial sector. KFH expressed its intention to convert AUB and its subsidiaries into fully sharia-compliant banks, absorbing AUB’s 13% market share of Bahraini banking sector assets by the end of 2022 to become the largest bank in the kingdom. AUB reported a record net profit attributable to its equity shareholders of $203.9m for the fourth quarter of 2022, marking a 30.2% increase compared to the same period of 2021.
In terms of corporate deal-making, Citigroup announced in December 2022 that it had closed the sale of its Bahrain consumer unit to AUB for about $40m. Other acquisitions completed in 2022 include Al Salam Bank’s purchase of Ithmaar Bank’s consumer banking business. Bahrain-headquartered GFH Financial Group increased its stake in investment bank GBCORP from 50.4% to 62.9%, before reporting fourth quarter net profit of $24m, up 0.6% from the previous year. Lastly, Bahrain-listed Al Baraka Banking Group agreed to exit two of its subsidiaries: BTI Bank in Morocco and Itqan Capital in Saudi Arabia.
Performance
According to Fitch Ratings, the kingdom’s Islamic banking market is the seventh largest globally, with total assets valued at $41.6bn, equivalent to 92.4% of GDP. The ratings agency predicts that the recent decision by the CBB to grant a 30% alpha factor discount in the calculation of risk-weighted assets to Islamic banks will fuel further growth. The discount will enhance the capital ratios of Islamic banks, providing them with greater flexibility to expand their operations.
Bahrain has a wide array of Islamic liquidity-management tools available in the market, including Islamic repurchase agreements, remunerative deposits with the CBB, short-term and long-term government sukuk (Islamic bonds), and interbank placements with Islamic and conventional banks. Notably, Bahrain hosts the International Islamic Financial Market, a standard-setting body of the Islamic financial services industry.
Strength in Numbers
In 2021 global sukuk issuance expanded by 7.7% to $188.1bn, with Bahrain, a key market player, issuing both sovereign sukuk and corporate notes through the national oil company, Bapco Energies. Moreover, in April 2023 Bahrain raised $2bn through sovereign bond issuance, comprising $1bn in sukuk with a maturity of more than seven years at 6.25%, and $1bn in conventional bonds with a tenor of 12 years at 7.75%. The issuance drew demand worth $8.8bn, indicating robust market confidence in Bahrain’s fiscal sustainability. Indeed, the kingdom is currently slated to tighten its fiscal deficit from BD494m ($1.3bn) in 2023 to BD76m ($201.6m) in 2024, before reaching a balanced budget and embarking on a extended path of debt repayments.
Looking more closely at domestic lenders, credit distributed to the private sector by retail banks was up 4.7% year-on-year to BD10.7bn ($28.3bn) in December 2022. The deposit base reached BD19bn ($50.4bn), including growth of 3.5% in domestic deposits, which accounted for 76.9% of the total. Personal loans grew by 1.9% to BD5.7bn ($15.1bn), and business credit contracted by 7.3% to reach BD5bn ($13.5bn).
In general, Bahraini banks are benefitting from gradual central bank interest rate hikes, which have tracked US Federal Reserve actions. In May 2023 the central bank increased the key policy interest rate on its one-week deposit facility from 5.75% to 6%. At the same time, the overnight deposit rate was raised from 5.5% to 5.75%, the four-week deposit rate from 6.5% to 6.75%, and the CBB lending rate from 6.75% to 7%.
High oil prices and a general increase in regional economic activity post-pandemic, as well as targeted support from the CBB, have buoyed Bahraini banks’ performance. The CAR of the banking sector stood at 19.5% in December 2022, up from 18.7% in 2021, while the non-performing loan (NPL) ratio decreased from 3.2% to 3%. Return on assets (ROA) remained stable at 1.2% in 2022. Moreover, the return on equity (ROE) rose from 7.8% to 8.4%. Liquidity positions also remained strong, with liquid assets as a proportion of total assets standing at 25.3%.
Among conventional banks, the CAR of retail banks increased from 20.6% in 2021 to 21.5% in 2022, while the NPL ratio declined from 3.9% to 3.3% . Retail banks’ ROA increased from 1.3% to 1.4%, as ROE rose marginally from 10.9% to 11%. Liquidity positions decreased from 33.6% to 32.7%. Conventional wholesale banks’ CAR increased from 17.1% to 17.5% in the same period, and the NPL ratio dropped from 2.8% to 2.3%. Profitability was positive for conventional banks as ROA remained stable at 1.2% and ROE increased from 3.5% to 4.5%. Liquid assets for wholesale banks as a proportion of total assets decreased from 24.7% to 22.9%.
The CAR among Islamic retail banks was marginally higher than conventional counterparts, at 21.1%. Asset quality improved as their non-performing facilities (NPF) ratio decreased from 5% to 4.8% in 2022. ROA for Islamic retail banks increased from 0.6% to 0.9% in 2022 and ROE from 7.3% to 10.6%. Liquid assets available to Islamic retail banks decreased from 19.5% to 17% in 2022. Meanwhile, the CAR of Islamic wholesale banks increased from 15.8% to 16.9%, and the NPF rose from 0.8% to 4.8%. Their profitability improved as ROA increased from 0.7% to 1.1%, and ROE increased from 10% to 10.3% over the same period.
Quick Turnaround
The National Bank of Bahrain, the oldest local bank in the kingdom, reported a 26% increase in net profit in 2022, totalling BD68.1m ($180.6m). Growth was mainly driven by higher income from an expanded portfolio of loans and securities. The bank benefitted from higher market rates and lower provisioning requirements during the fourth quarter.
Gulf International Bank reported an improvement in its financial performance, demonstrating a positive turnaround. The net income attributable to shareholders amounted to $78.7m, indicating a significant recovery compared to $37.9m in 2021. The bank experienced a more than 40% increase in net interest income, totalling $345.8m, through effective balance sheet management, enhanced spreads and the impact of rising interest rates.
Islamic retail bank Ithmaar Bank demonstrated a turnaround by transforming a net loss of BD500,000 ($1.3m) incurred in 2021 into a net profit of BD3.1m ($8.2m) in 2022. The bank aims to transition into an exclusively corporate-focused bank in 2024. In parallel, Bank ABC’s net profit increased to $38.8m in 2022, marking a 29.8% improvement on 2021.
Growth Horizons
Credit ratings agency Moody’s forecast that the sector’s profitability would return to pre-pandemic levels in 2023. A 3.2% expansion in the non-oil sector and increased tourism revenue from Saudi Arabia are expected to drive this recovery. BCG, for its part, predicts a 6.8% compound annual growth rate (CAGR) in retail banking revenue between 2021 and 2026, reflecting increased consumer trust and behavioural changes during the pandemic. Comparatively, the CAGR between 2016 and 2021 was 3.6%. BCG also said that Bahrain’s banking sector can play a decisive role in driving ESG strategies. In line with this, Bapco Energie’s refinancing and upgrade of a $1.6bn murabaha (cost-plus financing) facility to $2.2bn in May 2022, with the inclusion of sustainability-linked criteria, is a milestone. The transaction was billed as the largest sustainability-linked loan facility in the wider region.
The Bahrain Economic Development Board (Bahrain EDB), the country’s investment promotion agency, has undertaken roadshows to attract investors. The Bahrain EDB participated in the Singapore FinTech Festival in November 2022. During the first three quarters of 2022 the Bahrain EDB recorded $72.7m in direct investment in financial services. This investment led to the establishment of nine new companies, including prominent players like Binance, a crypto exchange that processed trades worth nearly $65bn a day.
Outlook
The MENA region is one of the few areas globally where growth capital remains readily accessible. Bahrain is well placed to capitalise on this advantage by strategically deploying funds in the domestic financial services market, aligning with its ongoing sector development plans. Furthermore, the kingdom is in a favourable position to leverage sustained demand for Islamic banking products, presenting a significant opportunity for local banks to expand their operations and assume a more prominent role in the expanding international Islamic banking market.
The CBB has demonstrated strong leadership in the fintech segment, attracting a wave of digital financial services companies. Despite the challenges encountered by volatility in the global fintech and cryptocurrency markets, Bahrain’s well-regulated environment effectively mitigates and minimises risks. The kingdom has sustained the trust of sovereign debt markets, and investors are showing support for its progressive approach towards Bahrain Economic Vision 2030.
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