Braving the storm

Bahraini banks' exposure to foreign investment could soon present a significant challenge.
Braving the storm
By Claire Ferris-Lay
Thu 13 Nov 2008 04:00 AM

Bahrain’s relaxed ownership laws and a firm but flexible regulatory environment have encouraged foreign banks to establish a presence and local banks to flourish. However, the sector’s exposure to foreign investment could soon present a significant challenge.

The Gulf is rapidly discovering that its vast oil wealth and economic growth are not immune to the global slowdown. But the tiny island state of Bahrain, with a population of just 1.2 million, is hoping its diversified economy and strong banking sector will see it through the storm.

“Bahrain has a formidable reputation in terms of regulatory environment [as well as] a wide range of banking services in everything from project finance to personal banking,” says Oliver Cornock, regional editor of the Oxford Business Group.

The kingdom also has a flourishing Islamic banking sector with a total of 29 Shariah-compliant banks, both wholesale and retail.

Yet Bahraini banks have continued to post losses. Ahli United Bank, the country’s largest bank by market value, saw declines of 9 percent to $68.38m in the third quarter compared to the same period in 2007.

Arab Banking Corporation, the country’s third biggest lender, was last month forced to reassess its business model to focus on retail banking after it posted third quarter losses of more than $194m as a result of being directly hit by the US subprime crisis.

“The largest part of Bahrain’s economy is the banking sector, which is bigger than its oil and gas sector and accounts for more than a quarter of its GDP, so any downturn in activity in that sector will have quite an impact on the wider economy,” warns Jane Kinninmont, an editor and economist at the Economist Intelligence Unit in London.

“Bahrain stands at a much higher risk threshold than Saudi Arabia or Qatar,” agrees Raghu Mandagolathur, head of research at Kuwaiti investment bank, Markaz.

As the smallest Gulf Arab state and the Middle East’s smallest producer of oil by volume, Bahrain has long recognised its necessity to create a diverse economy and started to do so as far back as the 1970s. Today banking is one of its core industries, with oil accounting for just 15 percent of its gross domestic product.According to US bank JP Morgan, the island has more than 400 financial institutions, with total assets 17 times its GDP. In August it was reported that the total consolidated balance sheet of the country’s banking sector increased by $17bn to $269.5bn by the end of June 2008, compared to $252.5bn by the end of March.

Bahrain’s relaxed ownership laws — allowing 100 percent foreign ownership — and a firm but flexible regulatory environment in the form of the Central Bank of Bahrain, has encouraged foreign banks to establish a presence and local banks to flourish.

The kingdom also has a flourishing Islamic banking sector with a total of 29 Shariah-compliant banks, both wholesale and retail. They represent almost 7 percent of the total banking system and boast balance sheet assets of $16.4bn at the start of 2008, up 34 percent from the beginning of 2007, according to the Oxford Business Group.

“The new financial hub is a huge investment and I think it does put Bahrain in a very strong position as a leader, if not a leader in terms of regional finance,” says Cornock.

Last year Bahrain was ranked number one in the GCC for inward foreign direct investment, attracting $1.756bn in FDI, according to a World Investment Report.

But while the vast amount of foreign investment was attained during boom times, the country’s dependence on foreign investment could leave it open to potential risks, warns Kinninmont. “It’s quite risky and it does mean they [Bahrain] will have that vulnerability as its very likely FDI will slow quite sharply over the next few years.”

Most Bahraini banks have been spared the immediate fallout from the US subprime crisis, but like other Gulf banks their exposure to the real estate market, which has shown signs of a slowdown, is a concern.

Last week the country’s central bank was in consultations with banks over regulations to curb exposure to the banking sector. The bank’s latest draft puts the maximum share of real estate financing that Bahrain banks can have in their gross financing portfolio at 30 percent. Central Bank governor Rasheed al-Maraj, told reporters that exposure was below the maximum level: “It’s not too much, it’s below that.”Mandagolathur agrees it makes sense for many Gulf banks to reduce their exposure to real estate in the short term given the current economic climate. “[It makes sense to] play it safe by reducing their exposure. All of the banks in the region will drastically reduce their exposure to real estate in the short term given the lack of visibility and clarity in the sector.

“But eventually it will also bounce back because it is one of the best performing sectors in the Gulf region,” he adds.

Despite the sector’s heavy dependence on foreign investment and a number of high-profile and significant losses, the kingdom’s central bank has, unlike many of its Gulf rivals, yet to announce any form of government bailout.

So far central banks from the UAE, Kuwait and Saudi Arabia have announced bailout plans. Last month the UAE said it would guarantee deposits of all local lenders and large foreign banks.

It also set up a $19bn facility to help banks make loans. Saudi Arabia, the world’s largest oil exporter, put $2.7bn into a government-run bank in Riyadh to provide no-fee loans to low- income citizens.

“Bahrain’s central bank hasn’t yet had to step in and that’s a sign in Bahrain’s favour, but it is also still quite early to say what might need to happen,” says Kinninmont, who adds that the tiny country might not be able to fund a bailout even if it wanted too.

“I don’t think [a bailout] is a possibility for the time being,” says Mandagolathur.

Increased pressure is also likely to come in forms other than the subprime mortgage crisis. While the country’s longstanding reputation in banking has served it well, the country is likely to lose out to regional players as Gulf countries seek to develop their own financial hubs. “Now we are in a situation where everywhere is trying to become a financial hub,” says Cornock.

Saudi Arabia’s bid to become a knowledge-based economy is likely to result in increased competition, agrees Kinnonmont. “One of the reasons why Bahrain has so many financial institutions is because its traditionally been a base for companies serving Saudi Arabia, so that’s one of the competitive threats that its going to face now that the Saudi sector has become more liberalised.”

For all the latest banking and finance news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.

Subscribe to our Newsletter

Subscribe to Arabian Business' newsletter to receive the latest breaking news and business stories in Dubai,the UAE and the GCC straight to your inbox.