Favourable regulations to support Bahraini banking sector growth

Growth in the banking sector has maintained an upward trajectory in recent years, with banking assets growing and investors taking note of the favourable and robust regulatory environment. This, combined with the sector’s profitability, high penetration rates and investment in financial technology (fintech), has strengthened Bahrain’s position as a regional leader in banking.

Sector History

Bahrain’s first local bank, the National Bank of Bahrain, was established in 1957. When the Lebanese civil war broke out in 1975, many of the Middle East’s regional financial institutions moved their headquarters from Beirut to Manama, which became the region’s premier financial centre. Since the 2000s some banks have shifted to Dubai.

However, Bahrain’s proximity to Saudi Arabia — the GCC’s largest economy — as well as the availability of an experienced banking workforce, ease of recruiting expatriates and respect for the sector regulator, the Central Bank of Bahrain (CBB), have seen it maintain a role as a regional hub for financial services.

Structure & Oversight

The market is divided between locally focused retail banks and, in keeping with Bahrain’s nature as a financial centre, a regionally focused wholesale banking sector. Within the conventional segment, 23 banks have retail licences and 54 are licensed to conduct wholesale activities, with a certain degree of overlap between the two. In addition to this, there are 21 Islamic banks, of which six are retail and 15 wholesale institutions.

The sector is regulated by the CBB. Recent major regulatory changes include the implementation of the International Accounting Standards Board’s latest version of the International Financial Reporting Standard (IFRS), the IFRS 9, at the beginning of 2018, although some local institutions had begun implementing it a year earlier. The new standard mandates banks to provision for likely losses in addition to loans that have already gone bad. “IFRS 9 is more than an accounting treatment. It represents a significant change in how banks do business,” Khalid Hamad, director of banking supervision at the CBB, told OBG. However, while increased provisioning under the framework may have an impact on some banks’ profitability, the CBB had taken steps to mitigate its impact, Hamad said. “Early on we asked banks to create more provisions against their loan portfolio, and banks themselves had already geared up for the implementation and changed their approach to selling and pricing loans, so not many have been affected,” he told OBG.

Performance

Total aggregated banking assets were at $192.7bn as of the third quarter of 2018 according to the CBB, up from $187.4bn at the end of 2017 and $186.1bn in 2016. Domestic assets were worth $59.8bn and foreign assets $135.8bn. As of August 2018 total assets of retail banks stood at BD31.9bn ($84.5bn) including BD18.3bn ($48.5bn) of domestic assets. Assets of wholesale banks stood at $107.4bn. Of the wholesale assets, $11.1bn was domestic assets and $96.4bn were foreign assets.

The banking sector’s return on assets stood at 0.9% as of September 2017 according to latest available CBB data, up from 0.7% a year earlier. Return on equity was also up, hitting 5.7% from 4.5% in September 2016. A report by consultancy KPMG found that profits at Bahraini banks grew by 6.4% in 2017.

While profitability is positive, the sector is also facing challenges linked to domestic macroeconomic headwinds. In August 2018 sovereign credit ratings agency Moody’s downgraded four local banks, maintaining a negative outlook for all of them. The bank cited its downgrade of the country’s sovereign credit rating several days prior as the principal factor behind the decision, highlighting the banks’ exposure to sovereign credit and the government’s reduced capacity to support banks should they encounter difficulties. The credit ratings agency, however, also pointed out that the sector appeared to remain resilient, thanks in part to solid profitability and healthy liquidity buffers.

Domestic Banks

As of October 2018 eight of the 23 conventional retail banks on the CBB’s register were locally incorporated. Of those, two were specialised government-backed institutions: the Bahrain Development Bank (BDB), which principally focuses on financing local small and medium-sized enterprises (SMEs); and Eskan Bank, which provides government-backed mortgages and acts as a real estate developer.

The largest local bank by assets is retail bank Ahli United Bank, with $34.4bn as of the end of June 2018. The largest individual shareholder in the bank, which has 22 domestic branches, is Kuwait’s Public Institution for Social Security, with an 18.6% share, followed by Bahrain’s Social Insurance Organisation with 10.1%. The second-largest locally incorporated bank by assets is wholesale-licensee Arab Banking Corporation with $27.9bn, 59.4% of which is held by Central Bank of Libya. Saudi government-owned Gulf International Bank ranks third, with eight branches and assets of $27.4bn. Sharia-compliant Al Baraka Bank followed, with $24.6bn in assets, and BBK (formerly the Bank of Bahrain and Kuwait), with BD3.6bn ($9.5bn). The local and regional footprint of the kingdom’s largest bank, Ahli United, is set to expand further following reports in July 2018 that, in keeping with a wider recent regional trend towards banking consolidation, it was in renewed talks with Kuwait Finance House regarding a possible merger. Tie-up negotiations between the two had been put on hold six months before that.

Additional local mergers and acquisitions (M&As) are in the pipeline. In August 2018 it was reported that the National Bank of Bahrain was in talks to acquire a 14.4% stake in Bahrain Islamic Bank from the Jeddah-based Islamic Development Bank, and industry figures say that further mergers may be in the cards.

“Restrictions on correspondent banking globally are putting pressure on the small banks in the region to merge so they can more easily work with international banks,” Waheed Al Qassim, CEO of the Bahrain Association of Banks, told OBG. The CBB’s Hamad echoed this sentiment, adding that the institution was very much continuing to encourage consolidation in the sector. “There is no space for smaller players anymore as they cannot absorb the costs of new standards such as Basel III or become sufficiently resilient. To do so, banks need more capital and the only way to obtain it is through M&As” he added. “Some smaller banks want to maintain a separate identity for reasons of prestige, but they are going to eventually realise that it is not sustainable.”

Credit & Loans

Despite the economy having faced oil price-related headwinds in recent years, bank lending continues to grow. The value of credit to non-bank residents stood at BD9.2bn ($24.4bn) at the end of the second quarter of 2018, up from BD8.7bn ($23.1bn) at the end of 2017 and BD8.3bn ($22bn) in mid-2017. According to the latest CBB data, the construction and real estate sectors accounted for the largest share of lending to businesses at 35.4% of the total, or BD1.6bn ($4.2bn), as of November 2017. The non-performing loan (NPL) rate stood at 5.7% in September 2017, down from 5.9% six months earlier. “NPLs reached as high as 6.5% by the end of 2017 as asset quality was visibly affected by the economic slowdown arising from low oil prices,” Mohamed Abdelkhalek, country general manager for Arab Bank Bahrain, told OBG. “This is driving banks to be more selective and target strategic projects that are most likely to receive funding.”

Banking liquidity is on the rise in Bahrain. The liquid asset ratio stood at 25.7% as of September 2017, the most recent CBB data available, up from 24.3% a year earlier, while the loan-to-deposit ratio fell over the same period from 65.2% to 64.7%. The Basel III framework’s liquidity coverage ratio, which requires banks to maintain enough liquid assets to survive a 30-day stress test, will be fully implemented in 2019.

Basel III

Most elements of Basel III are already in place, and in some cases local rules are even stricter than international ones, such as the requirement for banks to maintain a capital adequacy ratio of at least 12.5%, above the framework’s stipulated 10.5%. In addition, banks must maintain a capital conservation buffer of 0.5% of Tier-1 or core capital, while the four banks rated as systemically important must maintain a buffer of 1.5%. Full implementation of the liquidity coverage ratio, which began in 2015, is set for 2019.

Financial Inclusion

Bahrain performs well in measures of financial inclusion, with a banking penetration rate of 82.6% in 2017, up from 64.5% in 2011 and well above the MENA average of 47.1%. Several institutions and initiatives are positioned to further boost inclusion in segments that struggle to access loans. The Mazaya government mortgage subsidy programme is helping to boost access to housing finance. The BDB, which is focused on expanding the credit access of local SMEs, is also working to bolster inclusion. Sanjeev Paul, the bank’s CEO, told OBG that the BDB will expand its loan portfolio in the near term to help local entrepreneurs solve various challenges, such as the planned introduction of value-added tax. “We are well capitalised, with a capital adequacy ratio above 30%, and support is available from various funding agencies, so growing our balance sheet is not a problem,” he said.

In 2016, as part of its Global Accelerator Network, the BDB also launched the entrepreneurial funding programme Seed Fuel - Rowad. “Rowad is a pioneer accelerator programme providing seed and early-stage start-ups with up to BD25,000 ($66,200) in equity investment funding, as well as coaching, mentoring, training and access to investors and networks,” Paul told OBG. “We have made seven equity investments over the last two years under this programme, two of which received follow-on investment from other sources.”

Fintech

Work is under way to transform Bahrain into a regional fintech hub, as part of an effort to compete as a regional financial centre. A key element of this work is the launch in February 2018 of Bahrain Fintech Bay, a joint venture managed by the Economic Development Board and international incubator Fintech Consortium. The project is home to 30 early-stage fintech firms and has plans to double that figure in the near term.

BDB also launched a venture capital fund, the Al Waha Fund of Funds, in May 2018, with a view to investing in portfolios with assets in fintech ventures and other MENA start-ups. The fund closed a $100m funding round in late June. The bank is the general partner in the project, with various local players, among them the kingdom’s sovereign wealth fund Mumtalakat and telecoms operator Batelco, serving as limited partners.

Outlook

Despite recent economic challenges, the outlook for Bahrain’s banking sector is positive. Hamid Saeed, country head of global banking in the corporate and institutional banking department at Standard Chartered Bahrain, told OBG that some large infrastructure and industrial projects that have been on hold, such as the new Alba aluminium smelting line, were restarting and boosting capital demand. “The market is not very aggressive at the moment and banks are being selective on deploying credit,” Saeed told OBG. “However, deal sizes for these projects are substantial so there is plenty of business to go around for the sector,” though he noted that the rising cost of funds remained a concern.