Kuwait's Islamic banking sector grew rapidily over past decade

In April 2014 the Commercial Bank of Kuwait (CMBK) received approval from 85% of its shareholders to convert the bank to a full-fledged sharia-compliant lender, making it the most recent financial services provider to begin exploring a possible conversion. Indeed, Ahli United Bank Kuwait (AUB) went through a similar process in 2010. When CMBK completes the transition to sharia compliance – potentially before the end of 2015 – Kuwait’s banking sector will be predominantly composed of sharia-compliant institutions. As of the end of 2014 five of the country’s 11 banks operated according to sharia principles; the conversion of CMBK will bring that number to six.

GATHERING SPEED: This move by CMBK is representative of an established trend in Kuwait’s banking sector in recent years. Since 2010, sharia-compliant banking has taken off in the country, and according to data from the IMF, Kuwait had the fifth-largest share of Islamic banking assets in the world as of the end of June 2014. In the same period sharia-compliant banks held 39% of all assets in the domestic banking system, up from 23% at the end of 2005. CMBK is the third bank to initiate a conversion from conventional to sharia-compliant services since 2003, when Boubyan Bank made the switch. Additionally, a handful of new Islamic lenders have set up shop in the country over the course of the past decade. Today the Islamic sector comprises Kuwait Finance House (KFH), which is the second-largest Islamic financial institution in the world; Boubyan Bank; Kuwait International Bank; AUB; and Warba Bank. The segment has posted solid growth in recent years, growing 8.7% in the first nine months of 2013, for example, as compared to 7.1% growth among the banking sector as a whole in the same period. Should it go through, the conversion of CMBK is expected to push sharia-compliant banking assets to 45-50% of the sector total.

A REGIONAL BELLWETHER: The rapid expansion of the Islamic banking segment in Kuwait over the course of the past decade is indicative of the sector’s trajectory throughout the Gulf in the same period, not to mention a broad swathe of the rest of the world. According to data from EY, global Islamic banking assets posted yearly growth of 17.6% between 2009 and 2013, and the segment is expected to continue to grow annually at a rate of 19.7% through 2018. As of June 2013, Kuwait-based institutions housed an estimated 6% of global Islamic banking assets, according to IMF data. As of the end of June 2014, banks accounted for more than 84% of all financial system assets in Kuwait, and the country had the third-largest share of Islamic funds in the world, as per IMF data.

TRAILBLAZER: Kuwait’s reputation as a centre for sharia-compliant banking dates back to the early 1970s, when Kuwait played a key organising role in establishing what is now known as the Organisation of Islamic Cooperation. Under this body the government of Kuwait organised and hosted a number of international conferences on the topic of sharia-compliant finance throughout the 1970s, in the process paving the way for a host of majority-Muslim nations to invest in their financial sectors during this period. In March 1977 the government introduced Law No. 72, which formally established KFH as a state-owned firm and the sole Islamic bank in the nation at the time and for the subsequent few decades.

As one of the region’s flagship sharia-compliant banks, the government gave KFH a considerable amount of regulatory leeway to ensure that it could compete effectively with other new similar institutions in the Gulf and elsewhere. KFH’s key competitors during this period included the UAE’s Dubai Islamic Bank (DIB), launched in 1975; Bahrain Islamic Bank (BIB), established in 1979; and the Islamic Development Bank (IDB), set up by Saudi Arabia in Jeddah in 1973. KFH and these three other banks had more than 20 years of first-mover advantage in the Gulf – in Kuwait the CBK did not allow any other sharia-compliant institutions to set up shop until the early 2000s. It is perhaps not surprising, then, that KFH, DIB, BIB and IDB continue to account for a considerable percentage of Islamic assets both in the Gulf and around the world. As of end-June 2014, KFH accounted for 70% of total Islamic banking assets and 26% of Kuwait’s total banking assets, both conventional and Islamic.

STATE FACILITATION: The government set out to develop the sharia-compliant banking sector further in the early 2000s, when the state amended the 1968 CBK Law prohibiting Islamic banks – other than KFH – from operating in the country. Consequently, Boubyan Bank received a licence to operate in 2003 and opened its doors in 2004. In 2007 Kuwait International Bank (KIB), which had operated as a conventional lender until then, shifted to a sharia-compliant model. Finally, in 2010 both AUB and Warba Bank were established by local investors and, in the case of Warba, with considerable government support.

The government of Kuwait continues to play an important role in the Islamic banking segment. The state is a majority shareholder – via a range of stateowned firms – in KFH and Warba, and government enterprises have stakes in Boubyan and AUB, for example. Key government players in this regard include the Kuwait Investment Authority, the state’s sovereign wealth fund, and the Kuwait Pension Fund, which manages a large portfolio on behalf of state employees.

Like their conventional counterparts, Islamic banks operating in Kuwait are regulated by the CBK, albeit under a 2003 law that served as an amendment to the pre-existing banking law. In general, sharia-compliant institutions are required to operate according to the same rules that are applied to the conventional financial system, with the proviso that the former must be given some latitude to develop business models and risk-sharing agreements that are compatible with sharia principles (see overview). For example, both conventional and Islamic banks are required to hold paid-up capital of KD75m ($258.4m) for local institutions and KD15m ($51.7m) for branches of foreign banks. However, Islamic banks are allowed to adjust internal management and organisational practices to suit the requirements of sharia-compliant banking.

RECENT PERFORMANCE: According to data from the IMF, in recent years Kuwait’s Islamic banking industry as a whole posted stronger asset growth than the banking industry average, due mainly to rapid growth in deposits. As of the end of June 2014 more than 60% of total Islamic banking assets in the country were funded by customer deposits, with a significant percentage of the remainder (10-22%, according to IMF data) coming from other financial institutions.

At year-end 2013, KFH had 70% market share in the Islamic banking segment and around 26% in the banking sector as a whole in terms of assets, according to a report put out at the end of 2014 by the IMF. AUB was the second-largest Islamic institution, with 14% of sharia-compliant banking assets and 5% of total sector assets. Boubyan Bank, owned by the market leader National Bank of Kuwait, was the third-largest shariacompliant bank, with 9% of Islamic banking assets and 4% of total assets. Finally, KIB and Warba occupied the fourth and fifth spots, respectively, with 5% and 2% of Islamic banking assets and 2% and 1% of total assets. Assuming that CMBK retains its current position in the market, and provided that the bank’s transition to sharia-compliant status goes smoothly, it will become Kuwait’s second-largest Islamic bank.

CHALLENGES: Islamic banks in Kuwait face a range of challenges. Some of these issues are the same as those confronting the conventional sector, including market, credit and operational risks. A reliance on oil revenues in the economy at large and real estate and equity throughout the financial industry is considered a key issue for all banks operating in Kuwait. At the same time, the Islamic segment is prone to a handful of distinctive risks. For example, the sharia-compliant financial sector as a whole lacks depth in Kuwait and to a lesser extent throughout the region, which makes it hard for some Islamic banks to manage liquidity. Sharia provisions require that monetary instruments be linked directly to real economic activity, so that many banks have substantial non-financial holdings across a range of sectors, often in the frame of a conglomerate corporate structure. This has the potential to be exposed to risks not faced by conventional banks, which are generally more restricted when it comes to investments in non-financial equity.

Additionally, sharia-compliant banks often face risks related to the complexity of their corporate structure and operations, particularly in regard to risk management and, in the case of disputes, resolution. As the IMF pointed out in its mid-2014 report on the sector, KFH “is systemically important with extensive crosssector and cross-border operations, some of which are in offshore centres reputed for lax supervision”. Unlike their conventional counterparts, Islamic banks are required to ensure that all of their products and operations adhere to sharia legal provisions, as interpreted by sharia scholars. However, maintaining an independent and qualified board of scholars is expensive and can also potentially entail reputational risk.