Kuwait's Islamic finance sector positioned for growth

One of the world’s largest Islamic finance markets, Kuwait has a wide range of banking, sukuk (Islamic bonds) and takaful (Islamic insurance) entities and products on offer, with recent headwinds such as the Covid-19 pandemic proving little obstacle to the sharia-compliant sector’s continuing robust growth.

Indeed, the country’s Islamic banks have been expanding faster than its conventional ones in recent years, with a new merger making an Islamic banking provider an even bigger player in the local market. At the same time, sukuk issuance continues to bolster the country’s capital markets, while takaful products compete for market share with well-established conventional players.

Increasingly, Islamic financial technology (fintech) is also playing a role, with Kuwait home to many innovative fintech outfits benefitting from a central bank-supported drive towards digitalisation.

Structure & Oversight

The banking sector is supervised by the Central Bank of Kuwait (CBK), which is headed by the governor and the CBK board, on which representatives from the private sector and two key government ministries, the Ministry of Finance and the Ministry of Commerce and Industry (MoCI), also sit. As of November 2022 the CBK governor was Basel Al Haroon.

In October 2020 the CBK approved the establishment of the Higher Committee of Sharia Supervision (HCSS) under its auspices. The HCSS is charged with overseeing the Islamic finance sector, and monitors and advises the CBK board on the central bank’s operations in Islamic finance. It also acts as an arbiter in disputes between or within individual bank and other financial institutions’ sharia boards – institutions that have been obligatory for Islamic banks since 2003. Essa Shaqra was appointed chair of the committee upon its foundation. The HCSS also has the power to approve candidates for the sharia boards of Kuwaiti Islamic finance institutions.

A strict separation between conventional and Islamic banks is observed, with no Islamic windows permitted in conventional banks. There are, however, often other links between the two, with the Islamic lender Boubyan Bank, for example, a subsidiary of the conventional National Bank of Kuwait (NBK).

Currently, the CBK operates an interest rate ceiling that still impacts the sector, as Islamic banks tend to follow prevailing market rates to stay competitive in their own product pricing. This may be relaxed in the future to enable more accurate pricing of risk.

Capital Markets & Takaful

A further key body for many finance institutions involved in the sukuk and equities markets is the Capital Markets Authority (CMA). Headed by a board of commissioners, the CMA supervises and promotes the development of the country’s capital markets. Within its structure is the Advisory Council for Sharia Supervision, which examines Islamic finance activities and products, and advises the council as to their compliance.

On the takaful side, the key authority is the Insurance Regulatory Unit (IRU), which was headed by Muhammed Sulaiman Al Otaibi as of November 2022. The IRU was established under a 2019 insurance law, which repealed the previous regulation from 1961. Only companies licensed by the IRU can issue policies, with the IRU itself supervised by the MoCI.

As with banks and other financial sector institutions, the 2019 law states that insurance companies can either undertake conventional activities or they can undertake sharia-compliant takaful activities, but not both. The law also saw regulations issued for all manner of other insurance entities, such as brokers, agents, actuaries and adjusters, and also covers reinsurance activities.

In 2021 a further regulation, Decision No. 21, provided the executive regulations for the 2019 law, with takaful operators expecting further measures ahead as the CBK and the government move towards a more consolidated, financially robust industry. Conventional and takaful companies and other industry-related individuals have been given a September 30, 2022 deadline by the IRU to regularise their status and renew their operating licences in line with the new regulations. Licences can now be renewed every three years. At the same time, insurance activities – conventional or takaful – are not currently on the negative list for foreign investors, meaning that they can establish wholly owned subsidiaries, licensed branches or licensed representative offices in Kuwait.

Elsewhere, the Kuwait Insurance Federation (KIF) is made up of the country’s takaful and conventional insurers, and promotes the sector and its interests to the government and the general public.

Islamic Banking

Among the major players in the local banking sector is Kuwait Finance House (KFH), which completed its acquisition of Bahrain-based Ahli United Bank (AUB) in October 2022. KFH’s interim results for the second quarter of 2022 showed assets at KD22.8bn ($75bn), up from KD21.6bn ($71.1bn) in the second quarter of 2021. Total assets for the banks in the second quarter of 2022 were an estimated $331bn, giving KFH a 22.7% share of the sector. In July 2022 the long-delayed merger deal with AUB was greenlit for a reported $11.6bn. The merger created the Gulf’s seventh-largest bank and the world’s second-largest Islamic bank by assets, with some $115bn.

Another large Islamic lender is Boubyan Bank, and in 2022 its interim second quarter results showed total assets of KD7.6bn ($25.1bn), up from KD6.9bn ($22.8bn) at the same time the previous year, giving it a 7.6% share of total banking assets based on 2022 figures. Other local Islamic banks are Kuwait International Bank (KIB), Al Ahli Bank of Kuwait (ABK) and Warba Bank. In June 2022 ABK announced a merger with the conventional Gulf Bank, with the latter converting to Islamic banking.

For the first half of 2022 credit ratings agency Fitch calculated the adjusted share of the Islamic banking sector in total banking assets at 45.5%, with Islamic banking assets having grown by 8.5% – a figure in line with conventional banking asset growth.

As of the second quarter of 2022 Kuwait’s non-banking finance sector was home to 18 Islamic investment companies and one Islamic finance company – around half of the total number of such entities registered with the CBK.

Takaful Activity

Islamic banks also play a major role in the takaful industry, with KFH backing KFH Takaful, Boubyan Bank backing Boubyan Takaful and KIB backing KIB Takaful, formerly Ritaj. Gulf Insurance Group (GIG), Kuwait’s largest insurance firm, undertakes its takaful operations via Gulf Takaful, given the restriction on insurance companies undertaking both Islamic and conventional business. Other players include Wethaq Takaful, which became the first local takaful company to offer products in 2000; First Takaful; Arab Islamic Takaful; Kuwait International Takaful; Al Khaleej Takaful; and National Takaful.

Several smaller outfits are also present in the market, with two of the six insurance companies listed on the country’s stock exchange, Boursa Kuwait, in September 2022 being takaful operators. They were First Takaful and Wethaq Takaful, illustrating the small size and private ownership structure of many takaful entities. Wethaq Takaful reported total assets of KD12.4m ($40.1m) at the end of 2021, while First Takaful had KD13.3m ($43.8m). In contrast, GIG recorded total assets of KD1.3bn ($4.4bn) at the end of the second quarter of 2022, up from KD800m ($2.6bn) at the end of the second quarter of 2021.

The main business for takaful companies is nonlife, with medical and motor the leading lines of cover, while marine, travel, fire and group policies are also prevalent. Regarding motor, as part of its regulatory strengthening of the sector, the IRU worked with the Traffic Operations Sector to issue new approvals for companies to operate in the motor space in January 2021, with periodic updates being made to the list since. As for medical, in 2020 Kuwait made health insurance mandatory for the 2m expatriates working in the country, as well as their families, while expats over 60 years of age must hold private health insurance to renew their visas. This can be obtained from an approved list of insurers published by the IRU; five of the 11 companies listed in February 2022 were takaful providers.

Structuring Sukuk

Sharia-compliant debt issuance is governed by a 2015 regulation, introduced to provide a formal structure to sukuk that had previously been absent. The regulation covers the creation of segregated portfolio companies (SPCs), governance, minimum capital requirements for issuers, and prerequisites for obtaining CMA and CBK approval for sukuk to be issued. In recent years leading issuers have used the SPC format for their activities, with NBK SPC, KFH Sukuk SPC and Burgan Senior SPC all major examples. Other active sharia-compliant debt issuers include Boubyan Sukuk, KIB Sukuk and Warba Sukuk. Listings of sukuk have yet to take place on Boursa Kuwait, which still lacks a developed bond market.

The CBK regularly issues bonds and related tawarruq (reverse cost-plus financing) papers, which carry a return rate and a repayment term. Some 14 of these were issued in the first nine months of 2022, with three-, six- or 12-month maturities. The most recent totalled KD240m ($790m) with a six-month tenor and 3.8% rate of return.

The 2015 regulations have assisted in the development of the corporate sukuk market, but sovereign issues await the implementation of a full legal framework. A new comprehensive debt law should assist with such a development, and many analysts and investors are watching to see how the new government performs in this regard, given strong global appetite for sukuk issuances.

This was illustrated in 2020-21 when the CBK chaired the International Islamic Liquidity Management Corporation (IILM), a multilateral organisation based in Kuala Lumpur and designed to ensure continued cross-border Islamic liquidity flows. During the CBK’s chair the IILM saw the highest number of sukuk offerings in its history at 35, for a total value of $12bn and $3.5bn in recorded assets.

Post-pandemic Performance

Like many of its peers in the conventional segment, the sharia-compliant banking industry was hit by the fallout from the Covid-19 pandemic. The authorities responded rapidly to the crisis, with the CBK cutting the discount rate to a historic low of 1.5%, reducing the minimum capital adequacy ratio from 13% to 10.5%, and the risk rating for small and medium-sized enterprises (SMEs) from 75% to 25%. Financial concentration limits were also relaxed, filing times were extended and loan repayment terms for SMEs were deferred for six months, while losses could be extended out to 2024. The liquidity ratio was lowered from 18% to 15%, and the liquidity coverage ratio from 100% to 80%. Direct fiscal support to Kuwaiti citizens and businesses was estimated at around 1.5% of GDP in 2020-21.

Despite the pandemic, the country’s insurance sector grew in 2020-21, with direct premium up 4.3% to reach KD550m ($1.8bn), according to the KIF. Takaful companies, however, faced headwinds stemming from global uncertainty. Measures to combat the pandemic led to branch closures and a decline in new business – Wethaq, for example, reported closing for 71 days and a decrease of around 32% in underwritten premium in 2020.

First Takaful recorded a loss of KD5.7m ($18.8m) in 2020 after a profit of KD841,000 ($2.8m) in 2019, mainly due to foreign exchange losses incurred by the sale of its stake in Turkey’s Neova Sigorta, according to the company’s 2020 annual report. In 2021 it went back into the black, recording a profit of KD64,400 ($212,000), although provisional results from the first half of 2022 indicated a loss of approximately KD60,000 ($197,000).

Wethaq also posted a loss in 2020, at KD1.3m ($4.2m), but returned to profitability in 2021, recording a profit of KD262,000 ($862,000). This continued into the first half of 2022, with unaudited results showing net profit of KD58,900 ($194,000).

These results show the conditions faced by Kuwait’s takaful operators in a crowded, competitive market. Fully owned subsidiaries of larger financial operations such as KFH Takaful, Boubyan Takaful and KIB Takaful have more resources. As such, analysts expect further consolidation and restructuring, particularly as the IRU strengthens the regulatory framework for insurance companies.

Growth Trends

The banking sector in general was able to withstand the pandemic, with Islamic banks also capitalising on their risk-sharing and prudent approach in the years leading up to 2020. KFH stated in its June 2022 interim results that operating income for the second quarter of 2022 was KD230m ($755m), up from KD197m ($648m) in the second quarter of 2021, while net profit had risen from KD74.7m ($246m) to KD90.6m ($298m). Boubyan Bank reported operating income of KD52.6m ($173m) for the second quarter of 2022, up from KD47.5m ($156m) in the second quarter of 2021, and net profit rose from KD8.8m ($28.9m) to KD14m ($46.1m). Results for KIB showed net profit growth of 43% between the first half of 2021 and the first half of 2022, from KD2.2m ($7.2m) to KD3.2m ($10.5m), along with financing income growth of 15%, from KD39.9m ($131m) to KD45.8m ($151m), over the same period. Warba Bank reported a slight increase in net operating income in the second quarter of 2022 compared to the second quarter of 2021 – KD20.9m ($68.8m) versus KD20.6m ($67.8m) – but overall profit rose substantially, from KD3.3m ($10.8m) to KD5.1m ($16.8m).

The sector outlook suggests that income and profitability will continue to rise in 2022-23, as economic growth picks up on the back of high oil prices. At the same time, global political and security uncertainties may see a continued cautious approach from the country’s well-capitalised Islamic banks.

Sukuk Issuance

Sukuk issuance began to rise in the wake of the 2015 regulations, particularly as the economy faced low oil prices post-2014 and debt instruments became a favoured way to raise capital. The market had begun to slow pre-pandemic but picked up again in 2020-21.

In 2020 Warba Bank’s special-purpose Islamic finance vehicle, Warba Sukuk, issued a KD150m ($494m) Series 2 of its trust certificates on the Dublin stock exchange, and in November 2021 Warba Tier-1 Sukuk issued $250m of Tier-1 capital certificates on the same exchange.

The year 2021 also saw Kuwait’s largest-ever issuance, a $750m AT1 mudaraba (profit sharing) sukuk from KFH. The issuance received $2bn in orders and had an annual yield of 3.6%. In April 2021 Boubyan Bank also closed its first senior, unsecured Tier-1 sukuk, a $500m facility also listed on the Dublin exchange. Overall, sukuk issuance in Kuwait rose from $800m in 2019 to $1.5bn in 2020 and $2.1bn in 2021, demonstrating the continuing local and regional appetite for these instruments.

KFH’s investment arm, KFH Capital, has also organised sukuk issuances for other players. In 2022 it helped arrange a $750m sukuk for Dubai Islamic Bank and a $3bn issuance on behalf of the Turkish government. These issuances were also listed in the Irish capital, with the Dubai Islamic Bank sukuk listed on Nasdaq Dubai as well.

Fintech

Efforts by the CBK to create a regulatory framework for fintech have also impacted the Islamic sector. While the value of the Kuwaiti Islamic fintech market was estimated at around $2bn in 2020, it is expected to grow to $7bn by 2025, according to the “Global Islamic Fintech 2021” report.

The CBK launched regulations for the electronic payment of funds and a regulatory sandbox for fintech in 2018, and set up a dedicated fintech unit in 2019. A cybersecurity framework was launched the following year, along with the Kuwait Automated Settlement System for Inter-Participant Payments, boosting payment security and monitoring, as well as instantaneous settlement of bank balances. In February 2022 the CBK launched new digital bank guidelines and opened applications for licences, with approvals set to be granted by the end of 2022.

This has cleared the way for Islamic finance institutions to begin partnering with a variety of fintech outfits that have developed technology for sharia-compliant products. KFH and KIB have partnered with ProgressSoft, Mobiquity and Aion Digital. As a result, KFH was able to launch an electronic forms solution, digitising banking forms.

In June 2021 Boubyan Bank launched the world’s first digital Islamic bank, Nomo, in the UK. In addition, KFH’s recently approved acquisition of AUB is reportedly set to transform the Kuwaiti subsidiary of AUB into a digital bank, creating the country’s first local digital Islamic lender.

Digitalisation is proceeding across the broader Islamic financial services sector, with takaful companies also introducing more tech-based systems. The pandemic has accelerated this trend, as remote work replaced many face-to-face interactions. The years ahead are set to see further growth among local Islamic fintech companies, as well as in the adoption of digital solutions by local institutions.

Outlook

The KFH-AUB deal paves the way for an Islamic bank to become among largest in the country and one of the biggest internationally. Indeed, the Islamic banking segment looks set to secure a major share of the country’s banking services for many years to come. As the economy experiences growth on the back of strong oil prices and capital expenditure, there is ample potential for new business.

This holds true for the takaful sector, though the number of small outfits currently in the market makes for a competitive environment in which larger providers are likely to issue most of the new policies. Strengthening regulation in the sector for both conventional and Islamic insurers will limit risk and reduce the number of takaful providers, with restructuring and consolidation expected.

Sukuk issuances also look set for further growth, as Islamic debt instruments continue to be in high demand globally – often as regulatory requirements. The sukuk market could benefit from a comprehensive regulatory framework and the issuance of sovereign debt, while the outcome of the September 2022 elections offers the potential for progress in areas such as a new debt law.

While there is continuing uncertainty over the future course of the pandemic and global conflicts, the country’s Islamic finance sector provides some solid foundations for growth and resilience, with the merits of its risk-sharing model increasingly evident.