Bahrain's banking sector remains stable despite fluctuations in the regional market

As Bahrain’s banking sector completes its third full year of operation in a lower oil price environment, profitability and asset growth in the industry has turned flat. However, thanks to a robust regulatory framework, there has been no significant deterioration in asset quality, and there is sufficient liquidity in the system to allow banks to pursue lending opportunities. The sector has also seen some interesting regulatory changes over the past year, aimed at maintaining the kingdom’s position as a regional leader.

REGIONAL HUB: Bahrain’s reputation as a regional financial hub rests in part on the early flourishing of its banking industry. Bahrain’s first modern bank was established nearly 100 years ago following an agreement between the kingdom’s ruler at the time, Sheikh Isa bin Ali Al Khalifa, and the UK-owned and Indian-headquartered Oriental Bank. The arrival of the new institution in 1920 heralded the end of an era of informal banking, wherein local traders rented space in their office safes to pearl traders and other merchants. Formalisation provided a stable platform for banking expansion, a trend that was at first driven by the foreign institutions that played a pioneering role in the domestic market. However, in 1957 the National Bank of Bahrain (NBB) entered the arena to become the first local lender in Bahrain, and from that point domestic and regional banking institutions began to play a more prominent role in the industry.

Bahrain’s status as a financial centre received another boost in the 1970s, when civil war in Lebanon resulted in a many of Beirut’s banking institutions moving to Manama, bringing with them the collective expertise that reinforced Bahrain’s reputation as a financial centre in the Gulf. More recently, however, the emergence of other commercial hubs in the region, such as Doha and Dubai, has heightened competition for regional assets. Despite facing competition from the new regulatory frameworks being established across the GCC, Bahrain continues to enjoy a number of comparative advantages, most notably a large, highly skilled pool of financial workers, a regulatory structure that is both advanced and internationally well regarded, and a physical connection to Saudi Arabia, by far the largest economy in the Gulf.

SECTOR STRUCTURE: Today, Bahrain’s banking arena is a vibrant mix of local, regional and international institutions, competing for business both within the kingdom and beyond. The sector is divided in regulatory terms into retail and wholesale segments, which can be defined as either Islamic or conventional, with numerous institutions holding multiple licence types.

As of February 2018 the Central Bank of Bahrain (CBB) register featured 23 conventional retail banks, one more than the previous year. The new arrival to the retail segment is Gulf International Bank (GIB), which in June 2017 announced that it had been granted a retail banking licence by the regulator, having been permitted to operate in Bahrain as a wholesale institution since 1976. Eight other retail institutions are locally incorporated and 15 are headquartered abroad.

Domestic retail activity is dominated by the three players with the largest branch networks: National Bank of Bahrain, with 28 branches; BBK, formerly known as the Bank of Bahrain and Kuwait, with 24 branches; and Ahli United Bank (AUB), with 21 branches.

Other retail banks operating in the kingdom, such as BNP Paribas, HSBC and Citibank, have networks of between two and six branches or, in some cases, conduct their business from a single head office.

Looking to the wholesale segment, much of Bahrain’s reputation as a financial hub rests on the presence of a large number of licensed institutions that have elected to direct their regional operations from Manama. As of February 2018 the CBB listed 56 conventional wholesale banks, including locally incorporated players such as Bank ABC – formerly the Arab Banking Corporation – GIB, Investcorp, TAIB Bank and the International Banking Corporation; regional banks, such as Jordan’s Arab Bank and Saudi Arabia’s Arab Investment Company; and global operators, such as US-based JP Morgan, Pakistan’s Allied Bank, India’s Bank of Baroda, the Philippines’ Allied Banking Corporation, and Turkey’s Finansbank, Denizbank and Türk Economi Bankası.

ISLAMIC BANKING: As well as its conventional banking segment, Bahrain is home to a rapidly expanding Islamic banking industry. Since its inception in the 1980s, the demand for sharia-compliant financing has seen this segment grow to claim a market share of approximately 30%, according to global financial services firm EY. As of February 2018 six Islamic banks were licensed to carry out retail banking activity in the kingdom, all of which were locally incorporated. Ithmaar Bank, with 16 branches, is the most visible in the market, followed by Khaleeji Commercial Bank with 11 branches. A further 18 Islamic banks operate with wholesale licences, and all but three of them – Kuveyt Türk Katılım Bankası, Türkiye Finans Katılım Bankası and the sector’s most recent arrival, BOK International of Sudan – are locally incorporated. These institutions have benefitted from the kingdom’s history as a trendsetter in the global Islamic financial services market, a status that was cemented in 1990, when a number of regional Islamic financial institutions chose Manama as the home of a new standards-setting body, the Accounting and Auditing Organisation for Islamic Institutions.

THE BIG FIVE: Bahrain’s “big five” locally incorporated banking institutions reflect the sector’s diversity, being made up of both conventional and Islamic banks that operate across varied geographies. The largest of them, with assets of $33.2bn as of the end of 2017, is the AUB Group, the flagship of which is AUB. The bank was established as a result of the 2000 merger between The United Bank of Kuwait and Al Ahli Commercial Bank, and operates in the domestic market under a retail licence. Its network of subsidiaries and associated companies provide corporate, private and Islamic banking across a number of countries, including the UK, Egypt, Kuwait and Iraq. In addition to conventional products and services, the bank provides sharia-compliant financing through the Al Hilal brand name. The group has made public its desire to expand within the GCC and MENA region by acquiring complementary banking platforms, and in 2017 local and international press reported that the bank was at an advanced stage of discussions with Kuwait Finance House regarding a possible merger. Such a development would result in the creation of the sixth-largest bank in the GCC with assets of nearly $90bn (see analysis). Other recent advances by AUB include the launch of AUB Limited – a new wholly owned subsidiary in the Dubai International Financial Centre – increasing the paid-up capital in its Egyptian subsidiary and the full conversion of its Libyan affiliate to a sharia-compliant bank, despite the challenging operating environment of the country.

BANK ABC: The nation’s second-largest lender, with total assets of $29.5bn as of the last quarter of 2017, entered the market in 1980. Bank ABC has since expanded its presence across more than 18 markets in the GCC, MENA, Europe, the Americas and Asia, including Algeria, Bahrain, Brazil, France, Germany, Iran, Iraq, Egypt, Lebanon, Italy, Jordan, Singapore, Sweden, Tunisia, Turkey, Libya, the UAE, the UK, Grand Cayman, Russia and the US. In the domestic market, the bank is licensed as a conventional wholesale institution, and it has built its reputation as a market leader in trade finance, Treasury, project and structured finance, syndications, corporate and institutional banking, and Islamic banking, which it conducts through its sharia-compliant arm, Bank ABC Islamic. The bank is also listed on the Bahrain Bourse, with its principal shareholders being the Central Bank of Libya and the Kuwait Investment Authority. In the first quarter of 2017 Bank ABC announced details of a new management structure, with which it aims to accelerate the implementation of its expansion strategy. This effort includes further integrating the group’s business units, strengthening the management and structure of the wholesale banking business, and recalibrating its senior management team.

GIB: An expansion of its assets over the past year has nudged GIB into third place in the 2017 rankings, with the Manama-based lender reporting total assets of $25.5bn in the fourth quarter of 2017. The bank’s traditional strength has been its corporate balance sheet, derived from its business in Saudi Arabia. Despite its headquarters being in Manama, the fact that Saudi Arabia’s Public Investment Fund maintains a 97.2% stake in the institution has helped it make significant inroads in the market of Bahrain’s larger neighbour. The governments of the other five GCC members own the remaining shares in GIB. GIB’s principal subsidiaries are GIB UK (GIBUK), which focuses on asset management and investment banking, and the Riyadh-based GIB Capital. The bank also operates branches in London, New York, Abu Dhabi, Dhahran, Riyadh and Jeddah, as well as a representative office in Dubai. Since 2010 GIB has begun to expand from its corporate and investment banking base, implementing a new strategy aimed at creating a universal GCC institution, operating across the core areas of corporate banking, investment banking, asset management and retail banking. In 2015 it was granted a retail banking licence in Saudi Arabia, and in 2017 the CBB granted the bank permission to carry out retail operations in Bahrain. As part of its retail rollout, GIB has established a new retail banking arm called Meem, which combines online and mobile banking with more modern physical locations, known as nano stores, to facilitate customer acquisition without the major expenditure associated with a traditional brick-and-mortar branch network.

AL BARAKA: Al Baraka Banking Group, with total assets of $25.4bn at the end of 2017, is the fourth-largest bank in Bahrain, as well as the biggest locally incorporated sharia-compliant institution. Licensed as a wholesale operator in the kingdom, it is also a leading international Islamic banking group, operating subsidiary banking units in 15 countries. These subsidiaries include Jordan Islamic Bank, Al Baraka Bank Pakistan, Banque Al Baraka d’Algérie, Al Baraka Bank South Africa, Al Baraka Bank Lebanon, Al Baraka Bank Tunisia, Al Baraka Bank Egypt, Al Baraka Turk Participation Bank, Al Baraka Bank Syria, Al Baraka Bank Sudan and representative offices in Indonesia and Libya. Through this network Al Baraka offers retail, corporate, Treasury and investment banking services. While components of the group date back to 1978, its present structure was established in 2002, prior to its flotation in 2006. Since that time it has sought opportunities in key markets that are non-correlative and therefore represent, according to the bank’s strategy statement, a natural risk diversification. The bank announced in 2015 that it plans to almost double its assets to $46bn by 2020, a target it aims to meet by expanding into markets such as Morocco, Indonesia and China. In January 2017 Al Baraka announced that Bank Al Maghrib, the central bank of Morocco, had granted it permission to commence operations in the country. Al Baraka Morocco is to be formed in partnership with the Moroccan Bank for Foreign Commerce of Africa, one of the oldest and largest private banks in the country. The development will grant Al Baraka a presence in all of the countries of the Maghreb, a region in which it has been particularly active since the beginning of 2017. In April of that year the bank raised the capital of its Algerian subsidiary to BD15bn ($39.7bn) from BD10bn ($26.5bn), and in July 2017 it signed an agreement with the Libyan Foreign Bank to enhance its operations in that country.

BBK: With assets of BD3.8bn ($10.1bn) as of the end of 2017, BBK rounds out the top-five locally incorporated lenders. Established in 1971, the bank operates in the domestic market under a retail licence and is known in Bahrain for its developing the so-called financial mall model, which saw it establish a number of retail-focused centres offering services such as credit card partners, telecommunications operators, personal finance advisors and insurance providers under one roof. Along with these retail-focused activities, the bank offers lending, Treasury and investment services to the corporate sector in Bahrain, as well as the external markets in which it has established operations. These include Kuwait, India, Dubai and, most recently, Turkey. Its Istanbul representative office, officially inaugurated in January 2017, will allow the bank to work with existing and prospective clients in the country, monitor local market developments and have direct liaison with the Turkish authorities. The bank has also begun to broaden its product range and build crossover business by establishing subsidiaries in the areas of financial services, Islamic investment, mortgages and credit cards. In January 2017 BBK announced a number of new executive appointments as part of a wider reorganisation plan, including a new deputy chief executive, as well as heads of wholesale, retail, IT, financial planning and control, and Treasury and investment.

NBB: With assets totalling $7.8bn as of December 2017, NBB does not quite make Bahrain’s top-five banks. However, the kingdom’s oldest locally incorporated bank is nonetheless an important presence in the domestic market. Operating under a conventional retail licence, it maintains the largest branch network in Bahrain, and it has become an important local institution through personal loan and credit card services.

It is also a key player in the domestic commercial sphere, and through its financing of large projects has played an important role in the development of Bahrain’s infrastructure. Its ownership structure includes some of Bahrain’s most important institutions, including the Mumtalakat Holding Company, the nation’s investment arm, which retains a 44.18% stake in the company. The bank is also the biggest shareholder in Bahrain Islamic Bank, which is undertaking a five-year plan to boost growth. This will see it dispose of non-core investments and seek to establish an annual revenue expansion of between 20% and 25%. In 2017 NBB appointed a new CEO, Jean-Christophe Durand, who came to the bank from BNP Paribas, where he was head of corporate and institutional banking for the Middle East and Africa. The change in management has been accompanied by a review of the bank’s branch network, which is expected to be concluded before the end of 2018. According to the new CEO, the redesigned network may see branches close in some areas and new facilities established in others. The bank is also seeking to develop its technological capabilities, investing in a new online banking platform and rebranding itself to target affluent millennial customers.

PERFORMANCE: The geographic diversity seen on the balance sheets of Bahrain’s banks has enabled them show strong performance during even the most challenging periods. This was the case during the political disturbance of 2011, when aggregate asset growth for the banking sector reached 2.6%, lending was up 14.9% and deposits registered a 10.1% rise, according to CBB data. The retail segment has shown particularly robust growth over the past decade, its assets expanding from BD18.6bn ($49.3bn) in 2007 to reach BD31.5bn ($83.5bn) in November 2016. Since 2014 this expansion has been driven by domestic asset growth, which accounted for approximately 57.8% of the total as of the third quarter of 2017.

The wholesale segment, despite maintaining profitability throughout this period, has been more adversely affected by the changing economic landscape; its aggregate assets declined from $156.7bn in 2010 to $105.7bn in November 2016. This period saw an interesting shift in the geographic classification of wholesale lenders’ assets, with credit extended to the European market remaining steady between 2007 and 2015, at between 36.5% and 33.8% of the total. The share of wholesale assets of the Americas (primarily the US) fell significantly over the same period, from 12.7% of the total to just 8.7%. Conversely, Asian assets more than doubled, from 4.4% to 11%.

Approximately 8% of wholesale banks’ assets are derived from Bahrain, and therefore their balance sheets have been protected from the slowdown in the domestic economy. Nevertheless, the exposure of Bahrain’s lending institutions to regional markets, which are adjusting to a new oil price scenario, has made the years since 2014 challenging ones for the sector. The overall forecast could see growth in particular segments, however. “The wholesale banking segment is expected to grow, as the size of the loan market has grown consistently across the GCC,” Mohamed Asem Abdelkhalek, country manager of Arab Bank Bahrain, told OBG. “This is due to organic expansion and budget deficits as well as the increased working capital requirements. We expect to see particular segment growth in critical areas such as pharmaceuticals and fast-moving consumer goods,” he added.

Even against a backdrop of tightening fiscal policies and slowing private sector activity, the performance of the Bahraini banking sector has been an encouraging one. Aggregate assets of the kingdom’s five largest banks grew from $110.9bn at the close of 2014 to $114.5bn at the end of 2015, a rise of around 3.2%. The full-year results for 2016 demonstrated the impact of lower oil prices on balance sheets and income statements, but the declines in performance were relatively modest. The aggregate assets of the big five contracted by 2.6% over the year. These trends undermined the ability of banks to turn a profit in 2016, and the year ended with aggregate net income down 3.4%. In 2017 the sector’s performance metrics stabilised, showing asset growth of 5.2% and net profit growth of 12%, according to financial statements for this period.

SECTOR STABILITY: Despite a slowdown in profit growth, Bahrain’s banks have shown their ability to defend their margins during a challenging period, and in 2017 Bahrain’s five biggest lenders posted a combined net profit of $1.3bn. The more pertinent questions for most market observers have been related to asset quality and financial soundness. To date, the key financial stability indicators of the domestic banking system have shown the sector’s strength in the face of limited credit demand and economic headwinds. “We can see strong resilience in the sector. Reforms on subsidies should also help, as well as the commitment of the GCC fund,” Ali Moosa, head of Treasury services for JP Morgan Chase Bank MENA & Turkey, told OBG. “At the same time, the state’s debt build up is a key challenge. Even though the budget deficit fell on the previous year it is still in the double digits, which makes it even tougher to introduce taxes or reduce subsidies.”

The level of non-performing loans (NPLs) increased modestly in 2016 and 2017, from 5.2% of gross loans in March 2016 to 5.5% in September 2016, to 5.9% in March 2017, according to the CBB. This compares relatively well to the EU’s NPL ratio of 4.8%. In regional terms, Bahrain’s NPL level is lower than that of the UAE (which stood at more than 6% at the close of 2016), but considerably higher than that of its neighbour Saudi Arabia (which stood at 1.2% at the end of 2016). Bahrain’s banks have significant buffers with which to defend themselves against any further deterioration in asset quality. The sector’s capital adequacy ratio (CAR) stood at 18.7% in March 2017 – well in excess of the minimum required by the regulator.

Liquidity in the banking sector was also at a comfortable level as of the end of 2017. The Bahraini Dinar Interbank Offered Rate (BHIBOR), the daily reference rate based on the interest at which banks borrow funds from each other in the wholesale banking market, climbed modestly from 1.6% in January 2017 to reach 2.7% by December. This gain reflects a slight tightening of liquidity due to a contraction in deposit growth as the government has drawn down reserves and corporate growth has slowed. However, the upward trend in BHIBOR is mild in the context of Bahrain’s recent economic history: the kingdom’s all-time high interbank rate of 5.28% came in 2007, as the effects of the global credit crunch began to be felt in the domestic market.

REGULATION: The ability of the domestic banking sector to meet the political and economic challenges that have faced the kingdom in recent years is largely due to a robust regulatory framework. The CBB is one of the industry’s chief assets, having gained a reputation both as a regulatory pioneer and a sound prudential supervisor. The most important components of the regulatory framework are the CBB and Financial Institutions Law 2006 (CBB Law), the Anti-Money Laundering Law of 2001 and the recently revised Corporate Governance Code. The CBB also possesses a flexible regulatory tool in the form of the CBB Rulebook, the first two volumes of which are devoted to conventional and Islamic banks, respectively. Since the onset of the global economic crisis, the CBB has adopted a conservative stance with regard to key financial stability ratios. Locally licensed lenders are required to maintain a minimum CAR of 12%, which is above the Basel III capital requirement of 10.5%. A further line of defence comes from a 0.5% capital conservation buffer, made up of core or Tier-1 capital. The CBB has a good record of consulting with the banking industry before implementing new regulations – a duty it is bound to by the CBB Law, unless the regulation in question can be shown to be urgently required. In the decade to 2017 the formal and informal channels of communication between banks and the regulator have been focused on implementation of Basel II and Basel III, as the CBB has sought to keep pace with the changes in the global regulatory landscape.

The first phase of Basel III’s liquidity coverage ratio was introduced to the sector in 2015, and the industry will reach full compliance in 2019. The regulation aims to ensure that banks have sufficient liquid assets to overcome a stress scenario for 30 days. Other Basel-related regulatory developments in recent years include establishing the sector’s systemically important domestic banks, as well as the finalisation of public disclosure rules for conventional banks.

ISLAMIC RULES: The single-biggest regulatory change in 2017 was not related to Basel, but to the kingdom’s rapidly expanding Islamic banking segment. In September 2017 the CBB released the details of a landmark sharia-governance module, which it describes as a “major attempt to establish industry-leading sharia-governance principles and practices in Bahrain”. The new sharia framework is to be applied to Islamic retail and wholesale banks, and will come into effect on June 30, 2018. From that date all Islamic banks will be required to undergo an independent external sharia compliance audit, a development that brings to an end the era when questions of sharia compliance were largely self-regulated via proprietary sharia boards. These internal boards will from 2018 be compelled to make their advice on products and services available to the public by publishing them both online and in the respective bank’s annual report – an important advance in governance and transparency.

The announcement of the new framework comes at a time when regulators across the GCC are evaluating the merits of overhauling self-regulated sharia compliance. As the financial products and services being offered by Islamic institutions have become more complex, support for centralised sharia authorities like those in Indonesia and Pakistan has grown. Some GCC regulators have already begun to develop a centralised sharia board, but Bahrain’s adoption of a system based on external sharia audits might be a useful model for those looking for a regulatory compromise between central control and a self-regulated industry (see IFS chapter).

TECHNOLOGY: The CBB has also sought to maintain its reputation as a regulatory pioneer in other areas. Technology has for some time represented a front line where regulatory jurisdictions seek to gain advantage, and Bahrain has made some significant advances in this area. In 2017 the CBB announced the launch of the first electronic wallet in the kingdom, a joint initiative with BENEFIT, a body established in 1997 by 17 commercial banks to provide ancillary services for the financial industry. The electronic wallet allows for instant payments via smart phones, and will also make it possible for retailers and institutions to collect payments for online and in-store purchases electronically through debit, credit and prepaid cards and online bank accounts. In July 2017 AFS, a provider of electronic payments outsourcing services in the MENA region, announced that it was launching its version of a mobile wallet in the kingdom. The same month saw the debut of MaxWallet, a digital wallet created by Bahrain-based Credimax in collaboration with Mastercard. Using the new platform, customers are able to pay for face-to-face purchases via their smartphones.

However, some players are sceptical about how well the country’s local banks will fare when it comes to adapting to new technologies.“There are too many local banks for the current market and keeping up with the digital transformation will be difficult for many,” Jacques Michel, head of Middle East and Africa at BNP Paribas, told OBG. “So we expect there to be some consolidation going forward,” he added.

Nevertheless, these recent developments are strengthening Bahrain’s status as a fintech hub, which is now a key priority for the CBB. In June 2017 the regulator unveiled its new regulatory sandbox for fintech development, the first of its type in the region. The new facility allows both domestic and foreign firms to test new products on a limited sample of customers for defined periods, utilising a test-and-learn approach that has been pioneered by a small number of regulators, including the UK’s Financial Conduct Authority. This development places Bahrain at the forefront of regulatory development in the region, and the new products and services that emerge from it may provide useful tools for domestic banks in areas ranging from customer acquisition to online trading (see analysis).

OUTLOOK: After more than 100 years of operations, Bahrain’s banking sector has demonstrated its ability to withstand external shocks – the latest being oil price volatility, as well as the internal pressures generated by the political unrest in the region in 2011. The relatively small size of the domestic bankable population and fierce competition in the local market means that expansion in the region and beyond remains a strategic goal for many lenders, though this task is made more challenging by the fiscal austerity measures being taken by governments in the GCC. Bahrain’s own cost-cutting measures are having a similarly constrictive effect on credit growth. However, in this regard, the macroeconomic outlook of the kingdom should provide some reassurance. Bahrain’s Economic Development Board expects real GDP growth will reach 3.3% in 2018, and with a raft of large infrastructure projects planned in the near term, the economy – and by extension, opportunities for lending – is set to continue expanding.