Diversify or die

Bahraini central banker Khalid Hamad says the watchwords for 2010 will be diversification and consolidation
Diversify or die
By Edward Attwood
Mon 10 Jan 2011 12:48 PM

As the gulf’s de facto banking centre for decades, Bahrain has played a vital role in the development of its neighbouring states. The founder of the UAE, His Highness Sheikh Zayed, was known to keep some of his vast wealth, including payments from international firms working on the country’s natural resources, in accounts based in Manama. With the advent of financial centres in Dubai and Doha, Bahrain’s position has not been diminished, but it has meant that that the country’s banking sector had developed more exposure to outside influences than some other locations in the Gulf.

As a result, some Bahraini financial houses had a rocky recession. Gulf Finance House hit the headlines last year after confirming plans to restructure around $300m worth of debt repayments from 2012. And last year, Awal Bank, the Bahraini subsidiary of Saudi Arabia’s Saad Group filed for Chapter 11 bankruptcy in New York. Likewise, The International Banking Corporation (TIBC), the local division of the Algosaibi group of companies, was also wound up. In what might be seen as a further blow to the sector, at the end of 2010, the Bahrain Economic Development Board (EDB) said that it was revising its Vision 2030 strategy to take into account the relative decline of the financial and construction sectors.

That may come as a surprise to some, particularly given that the EDB’s figures show that financial services grew by six percent in 2010. But many within Bahrain would agree that relative success of the sector in weathering the recession despite its exposure has been down to the prudent policies implemented by the country’s central bank, the Central Bank of Bahrain (CBB). The International Monetary Fund (IMF), no less, has said that the CBB’s existing macroprudential tools have worked well in preventing excesses from building up in the domestic financial system”.

Khalid Hamad is in no doubt as to the preventative effects of the CBB’s policies. As executive director for banking supervision, Hamad knows better than most exactly which banks were affected by the various stages of the credit crunch.

“The direct exposure to the subprime market only really affected about three banks and in late 2007, those banks addressed these issues through putting in more provisions, and by March those issues were dealt with,” Hamad recalls.

“Two banks also managed to increase capital substantially to address any issues in the market.”

After the subprime crisis came the collapse of Lehman Brothers, which left the global banking system in turmoil due to widespread mistrust. Again, Hamad says, Bahraini banks managed their balance sheets and liabilities responsibly. However, the downturn in world markets — the phase the global system is currently dealing with — has been tough for Gulf banks in general. With the drop in stock markets, assets have been devalued, forcing banks to make provisions against those devaluations.

“That has affected the investment banks more than the retail banks, but because the CBB had required a very high capital-adequacy ratio right from 1992, banks had a ratio much higher than 12.5 percent, which is the minimum required,” Hamad adds. “And that has helped them absorb all those shocks, without any bank breaking that ratio.”

Right now, the situation is still concerning. There are a lack of investment opportunities, and retail banks are outperforming investment banks due to their relatively stable deposits. “As you can see from the September figures, some of the retail banks even managed to generate growth in their performance,” Hamad says. “From the credit side, they’ve also booked more provisions from 2009 until September to strengthen their positions and cover unexpected events. The major credit deterioration came from outside, rather than the local markets.”

Provisioning is still the watchword of regional, not just Bahraini banks. The issue was a major feature of Saudi banks’ third-quarter results, with many finance houses being forced to cover potential loan losses from family-owned entities in a pattern that has lasted for well over a year now. At the end of December, the UAE central bank ordered banks to raise their provisions against exposure to the two main troubled Saudi conglomerates to 80 percent, as well as 100 percent provisions on exposure to Awal Bank and TIBC.

With no way to tell which banks are exposed to whom, the global financial system is riddled with mistrust. Like all Gulf bankers, Hamad is keen to stress that the problems are endemic across the world, and not just in the region. But he is convinced that transparency is the only way forward from this point on.

“A bank’s balance sheet doesn’t tell me much — it doesn’t tell me names,” he muses. “It tells me total loans and advances, it tells me non-performing loans, and it tells me the gross negative fair value on your balance sheet. But what it doesn’t tell me is what the impact the financial crisis has had on your counterparty exposures.”

As a result, Hamad says, it is virtually impossible to really be sure where you are placing your money, hampering liquidity even further.

“Is he [the finance house] exposed to Iceland, is he exposed to investment companies in Kuwait, is he exposed to the real estate market in Dubai?” he adds. “There are so many issues that it’s difficult for me to sit here as a banker and say this bank is only exposed to this or that. The only way to resolve it is to be transparent with each other. If you want lines [of credit], ok, let’s meet, show me what you have and I will consider it.”

But the central banker says that levels of transparency in Bahrain are considered higher even that some developed countries in terms of disclosure, with even branches of foreign banks forced to provide information. Elsewhere, and long before the credit crunch, the CBB has been taking a long hard look at policymaking within the country.

In 2006, an internal strategic review came up with a number of issues, including liquidity risk management, which clearly needed closer attention. While a consultation paper on liquidity risk management was later developed, it was not disseminated to the market due to the crisis beginning in 2007.

Another interesting area that the CBB has been looking at is real estate, in which a number of Gulf banks have had a significant interest. The paper, two versions of which have already been exchanged with the industry, aims to regulate all banks wanting to invest in the real estate sector.

“We spotted this issue early, and made arrangements with the [government-run] land registry bureau] to have a mechanism through which every bank that wants to invest and register in land, they need to seek prior approval,” Hamad says. “If a bank wants to enter as a speculator, we will say no. But if they are really coming with a project that will contribute to the economy and the social needs of Bahrainis, then we will entertain that idea.”

Before 2007, the CBB, in conjunction with the government, was also one of the first of the Gulf states to take a closer look at consumer finance. The thinking at that time was that a future crisis was driven by individuals extending themselves beyond their abilities. The result was the creation of a credit reference bureau; by comparison, the UAE’s plans to set up a federal credit bureau have still not been finalised, with the latest word indicating it could happen in the first half of 2011. In addition, Hamad also hails the regulatory framework and compliance the CBB has implemented to guide the banks over the last five years.

“In late 2007, Basel II [the international standard for banking regulation] made it mandatory on all locally incorporated banks to appoint consultants approved by the CBB to conduct a risk management assessment of these banks, based on very detailed questionnaires, covering credit risk management, market risk management, operational risk management, liquidity risk management, reputational risk management, strategic risk management, and interest rate risk in the banking book management,” says Hamad. “These were detailed in a questionnaire that every bank had to submit to a third-party assister. That assister was asked to review answers and test them, to come up with any gaps.”

This process was completed by mid-2009, missing out only the few banks that had been set up in the previous four years or so, which Hamad says the CBB is currently working on right now. During that process, the CBB also carried out a thorough assessment of all banks’ polices to ensure they had prudent limits, and it also started to monitor related party transactions on a monthly basis to ensure that no wrongdoing going on.

“Some board members in the bank might be facing difficulties on a corporate or individual level,” Hamad explains. “They may want to get loans or encourage the bank to invest in them — but all this needs to be done in a prudent way. So we’re looking at loans to staff, exposures to subsidiaries, associates and board members, as well as exposures to anyone related to board members.”

That sort of language will come as music to international investors’ ears. There can be little doubt that the reputation of Gulf finance firms has been dented by a perception that a close-knit hierarchy of prominent individuals – often with links to both family firms and the banks those firms require finance from — have run roughshod over often limpid regulatory regimes.

So what’s the lesson for Bahraini banks as they regroup after the recession? Hamad thinks there are two watchwords for the future: consolidation and diversification.

“For wholesale banks — from what we are seeing or discussing — they are reacting either by capital raising, or sales of assets, or by thinking of consolidation arrangements,” he says. “They are also thinking about changing their business models, because this has been one of the great lessons. The model has not been good enough, and they need to revise them.”

Several finance houses had become overly focused on the real estate sector, and with so many projects put on hold, it has now become incumbent on them to look at other sectors. Hamad says that education, health, SMEs and tourism are all areas that need to be considered as potential investment opportunities, given that Bahrain’s Vision 2030 has earmarked all these sectors as ones that require enhancing. In terms of consolidation, there have been two of note — Al Salam Bank and Bahraini Saudi Bank, and Ithmaar Bank and Shamil Bank. But more is certainly on the cards: the CBB lists 30 retail banks (both foreign and local) on its books, with 76 wholesale banks, and just under 170 insurance organisations.

“I think the time is ripe now for more consolidation in the investment banking sector,” Hamad says. “We are encouraging this, and there may also be opportunities on the retail side. So far we have not seen any resistance, because everyone appreciates there is a need for consolidation.”

Looking forward, Hamad also reveals that better liquidity conditions are encouraging Bahraini banks to look at capital-raising exercises, and more listings could also be on the cards. The CBB has also moved away from management of the Bahrain Stock Exchange, which has now been turned into a closed shareholding company. The move reflects the position of the bourse in other global markets.

“We see some initiatives in terms of sukuk, for example, and I also see that there might be more in terms of privatisation,” he adds. The Alba [Aluminium Bahrain] IPO has attracted a lot of attention. In terms of further IPOs, it’s difficult to list names, but I think the Alba step has been a well-appreciated and courageous step by the government. The potential and appetite is definitely there.”

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.