Playing matchmaker: The central bank continues to encourage mergers, with mixed results

The Central Bank of Bahrain (CBB) has been at the forefront of the global expansion of Islamic finance for decades and, together with Bank Negara Malaysia, is frequently cited as the body most responsible for its current popularity around the globe.

So when, in 2011 the CBB revealed that the bank had urged five Islamic banks to merge in order to strengthen their capital bases, the industry took note. Under the scheme that was revealed by CBB, two mergers would take place in 2012: Al Salam Bank would join forces with Bahrain Islamic Bank, while Capivest, Elaf Bank and Capital Management House would undergo a three-way consolidation.

BACKGROUND: The CBB’s decision to encourage merger activity did not come as a surprise. The regulator had not hidden its desire for merger activity, and in 2009 produced a new module for the CBB Rulebook dealing specifically with mergers and acquisitions, establishing Bahrain as the only GCC jurisdiction with a regulatory framework which addressed consolidation.

Yet more impetus came from beyond Bahrain’s borders. While the balance sheet of the nation’s Islamic banks may not have held the sort of toxic assets that have beleaguered lenders elsewhere, the secondary effects of the US sub-prime mortgage crisis, European sovereign debt issues, a regional decline in real estate prices and the political unrest seen across the Middle East in 2011 have highlighted the need for consolidation in what is considered a fragmented market.

Calls for consolidation in GCC banking sectors are not unusual, and have for years gone largely unanswered. But the revelation that the banks mentioned by the CBB were already at an advanced negotiation stage and would seek shareholder approval in 2012 suggested consolidation would soon become reality.

A MAJOR DEVELOPMENT: The development promised to reshape the sector. Bahrain Islamic Bank, established in 1979, was the first sharia-compliant lender to open for business in the Kingdom. A merger with Al Salam Bank would result in combined assets of BD1.7bn ($4.49bn), making it the largest Islamic bank in Bahrain and the third largest in the domestic market. However, the courtship of the two institutions was to be brief: in July 2011 they appointed KPMG to assist in merger talks and by February 2012 they issued a joint statement to the effect that they had “agreed to end merger talks after they were unable to reach an agreement on the exchange ratio for the shares”.

The cancelled merger highlighted the difficulty of persuading institutional shareholders in the region, often family-centred business groups, of the benefits of consolidation. It has also focused attention on the proposed Capivest, Elaf and Capital Management House merger, which if completed would result in the second-largest investment bank in Bahrain.

A BLESSING IN DISGUISE: Capivest’s CEO, Mohammed Ahmed Abdulmalik, joined the firm in 2010 with the mandate to either merge it or increase its capital. In his view, the economic landscape in the wake of the 2008 liquidity crisis is conducive to market restructuring: “In fact, in many ways the crisis was a blessing in disguise. It encouraged more banks to think about consolidations seriously this time,” he told OBG. “There are separate and unrelated activities involving about eight banks at various stages of the consolidation process.”

Whatever the outcome of the mergers announced by the CBB in 2011, the rationale which underpins the consolidation process remains. Beyond the CBB’s concerns around the question of stability, inefficiencies in the local market, where a lack of outsourcing or shared services in the Islamic banking sector has resulted in a sometimes expensive and unnecessary duplication of staff, increase consolidation’s attractiveness.

There is also a strategic case to be made: while Bahrain’s Islamic banks have made Manama a global centre of Islamic finance, many take the view that in order to compete in the increasingly crowded regional market the creation of large, internationally focused players is necessary. Indeed, for many players the consolidation question is no longer a matter of if, but when.