A recent drive to diversify bodes well for future stability

For the past five years diversification has been a key point of focus within Kuwait’s banking sector. By seeking to generate earnings from a growing number of sources, the country’s banks and other financial players aim to mitigate future risks and ensure long-term stability and profits. Traditionally, domestic commercial banking activities have accounted for most revenue at local banks. As of year-end 2012 this was still the case, according to data from local ratings agency Capital Standards, though a number of banks had worked to reduce their overall exposure to some key commercial asset classes, primarily property and securities, both of which were hit hard during the 2007-08 financial crisis. “We have worked to diversify our assets in recent years and to explore all possible means of funding and to be ready to meet all Basel III needs,” Thunayan Al Ghanim, general manager of the Treasury and Investment Department at Kuwait International Bank (KIB), told OBG.

The current diversification drive was launched in response to the 2007-08 global economic downturn, after which many local institutions found themselves overexposed to a handful of asset classes. In the run-up to the downturn some banks borrowed heavily to invest in equities on the Kuwait Stock Exchange (KSE), and to put money into a variety of large-scale property development projects both at home and abroad. When the crisis swept through the Gulf in 2007-08, these investments were hit hard.

While the situation has improved since mid-to-late 2012 (see overview), both the Central Bank of Kuwait (CBK) and individual financial institutions are eager to ensure that the banking industry is protected against similar shocks in the future.

Policy Changes

Since the end of 2008 the CBK has implemented a number of new laws and regulations aimed at shoring up banks’ risk management departments and, more broadly, improving corporate governance and reporting, all of which have helped support diversification in various ways. Recent pieces of legislation that have had an impact include the March 2009 Financial Stability Law, the February 2010 Capital Markets Law and a raft of new corporate governance-related rules that were put forward in June 2012. Furthermore, in February 2014 the central bank issued instructions for implementing Basel III standards across the banking sector, making Kuwait one of the first countries in the Middle East to do so.

Getting Ready

Under the Basel III guidelines, which are set to be rolled out over a five-year period starting in mid-2014, financial institutions will be required to raise their minimum capital adequacy ratio to 13% by year-end 2016. As a result of heavy provisioning since 2007-08, most of Kuwait’s banking institutions have already surpassed this level. For example, the National Bank of Kuwait (NBK) – the nation’s largest bank by assets – boasted total capital adequacy of 17% at the end of 2012, as per data from Capital Standards, while Kuwait Finance House (KFH) was at 13.9%, Burgan Bank at 18.5%, Boubyan Bank at 24.4% and KIB at an industry-wide high of 25.2%. Additionally, under the new regulations banks will be required to raise minimums and expand buffers in several categories, including conservation capital, counter-cyclical capital and Tier II capital. Finally, Tier III capital, which was allowed under Basel II, must be rescinded under Basel III.

Together, these newly introduced requirements are expected to help enhance stability and improve risk management regimes throughout Kuwait’s banking system, which goes hand-in-hand with the overall diversification efforts. “One of the major lessons of the crisis was that we can no longer sink a majority of our assets into just a handful of asset classes,” Elham Yousry Mahfouz, the deputy CEO of the Commercial Bank of Kuwait, told OBG. “Diversification is the way forward for the industry as a whole, and the CBK’s recent actions, including the introduction of Basel III guidelines, have backed us up on this point.”

Varied Sources

The effort to build up diverse portfolios at Kuwait’s banks has progressed considerably since 2008. On the credit side, for example, personal lending has become a key growth area at most banks, whereas commercial issuance has grown more slowly. As per August 2013 statistics from the Kuwait Projects Company’s Asset Management Company, a local financial services firm, personal facilities accounted for around 38.2% of total loans issued, while lending to real estate and construction firms – which have rebounded somewhat in recent years (see Construction & Real Estate chapters) made up 32.6%. These numbers reflect the fact that many banks remain somewhat wary of overexposure to real estate in particular, but also, more generally, to any individual asset class.

That said, while personal lending has expanded recently, the sector’s credit portfolio as a whole continues to face exposure to the property and capital markets sectors. Personal facilities accounted for 36% of total loans as of the end of the first half of 2012, according to data from Capital Standards, but one-third of these loans were reportedly extended for investment in securities, and 32% of total loans in the same period went towards real estate and construction projects. Additionally, credit issuance during this period also went toward trade (9% of total loans during this period), non-banking financial institutions (8%), industry (7%) and the oil and gas sector (1%), with the remainder (7%) going towards other smaller sectors.

Looking Elsewhere

In recent years many local banks have entered the Islamic financial services (IFS) segment, in an effort to diversify their business activities and to tap into new markets. Indeed, the IFS industry as a whole has grown rapidly across the Gulf. In 2007 KIB began to operate according to Islamic principles, for example. “Our business mode is dynamic and reacts in a proactive manner to changes in the market. As such, we have realigned our efforts in training our employees, so as to be prepared and have the latest knowledge tools in assisting their work,” said KIB’s Al Ghanim. “In addition, we have also started to attract new investments from international partners.” Three years after KIB made the switch to Islamic operations, in 2010 Ahli United Bank-Kuwait, another local institution, made the same transition.

As of the end of 2012 five of the nation’s 10 domestic banks were sharia-compliant, and Kuwait was home to the fifth-largest Islamic financial sector in the world by total assets, according to data published by the Islamic Corporation for the Development of the Private Sector, a global agency based in Jeddah (see Islamic Financial Services chapter). In early April 2013 the Commercial Bank of Kuwait announced that it planned to convert to sharia-compliant operations, pending a regulatory review and shareholder confirmation.

Far Afield

Additionally, since 2009 many banks have worked to expand their business activities outside of Kuwait, in an effort to tap into more robust markets elsewhere. Indeed, while personal lending and IFS have provided some new sources of revenue for local institutions in recent years, in general growth rates remain somewhat slow at home. Further, the local operating environment has become more complex as a result of new legislation put in place by the KSE and other regulatory entities since the downturn. As a result of heavy provisioning over the past half-decade, many local banks are sitting on a large amount of cash, which they have not been able to put to good use at home due to a widespread lack of new investment opportunities.

Against this backdrop, many of Kuwait’s banks have invested abroad in recent years. KFH and NBK, both of which are among the oldest banks in the Gulf and have been well diversified for decades, have increasingly relied on their international operations for revenues. Around 50% of KFH’s total revenues have originated outside Kuwait in recent years, according to the bank. Similarly, in 2012 more than 31% of NBK’s total assets came from outside the institution’s home market. NBK has been particularly active in terms of diversifying its earnings. In 2012 the bank increased its stake in Boubyan Bank – a local Islamic institution – to just over 58%, for example, after acquiring the bank in the wake of the downturn.

“Our regional and international strategy remains on track,” Ibrahim Dabdoub, NBK’s CEO, told local press in early 2014. “In 2013 NBK Group’s international banking profits grew by 9.5% year-on-year, confirming the strength of NBK’s international operations. Moreover, our expansion into Islamic banking through the acquisition of 58.4% of Boubyan Bank continues to pay off as Boubyan’s contribution to the group’s profitability and balance sheet increases over time.”

In December 2012 Burgan Bank – which is controlled by the Kuwait Projects Company – acquired a 99.26% stake in Eurobank Tekfen, a leading Turkish bank, in an effort to diversify its holdings.

Since the $349m deal went through, Eurobank Tekfen has been rebranded as Burgan Bank Turkey. Burgan Bank also boasts subsidiaries in Algeria (Gulf Bank Algeria), Iraq and Lebanon (Bank of Baghdad), Jordan (Jordan Kuwait Bank) and Tunisia (Tunis International Bank). Other Kuwaiti financial institutions are similarly working to build up their international exposure.