How Bahrain aims to leverage innovation to boost financial services

Bahrain is home to one of the region’s most vibrant financial sectors, with financial services rivalling oil and gas in terms of economic importance: indeed, by late 2021 the financial sector had overtaken hydrocarbons as the largest contributor to the economy. The country’s Islamic finance sector is also strong, with Bahrain ranking fourth out of 135 countries and second in the MENA region in terms of Islamic financial development in a 2021 report by financial analysis firm Refinitiv. Through initiatives such as the launch of the region’s first cross-border innovation centre in 2020, the kingdom is working to establish itself as a global financial technology (fintech) centre.

However, with the economy impacted by a string of external headwinds in recent years, the financial sector faced some notable challenges. Protracted low oil and gas prices on international markets, the Covid-19 pandemic, and regional and international political and security uncertainties have forced leading players to innovate and adjust. This has put the sector in a position to reap the benefits of the post-pandemic economic recovery, with ongoing progress in digitalisation, productivity and efficiency setting the stage for future expansion.

Structure & Oversight

In 2006 the Central Bank of Bahrain (CBB) became the unified regulatory body for the kingdom’s financial services industry, replacing the Bahrain Monetary Agency. Under Article 4 of its founding law, the CBB is responsible for licensing, supervising and regulating all entities undertaking financial services in the kingdom. In addition, it regulates the capital markets, provides banking services to the government, manages reserves of gold and foreign exchange, and issues the national currency – the Bahraini dinar.

In 2015 the CBB established a centralised Sharia Supervisory Board (SSB), the first such institution in the GCC. The SSB launched a sharia governance framework in 2018 and today oversees compliance in the Islamic banking and insurance segments. Individual Islamic financial institutions also have their own dedicated sharia compliance boards.

Banks may undertake both conventional and Islamic banking, provided the latter is undertaken via a dedicated Islamic unit. Such units and standalone Islamic banks are required to meet the standards of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), which is headquartered in Bahrain, along with the International Islamic Finance Market. Since April 2020 AAOIFI standards have also applied to all branches of foreign Islamic banks operating in the kingdom.

Elsewhere, the Bahrain Association of Banks, established in 1979, is the key body advocating for and promoting the banking sector.

Banking Standards

Since 2015 the CBB has enforced Basel III standards for capital and liquidity for banks in the kingdom, though the CBB has gone beyond Basel III requirements in many key areas. Local banks, for example, must maintain a minimum capital adequacy ratio (CAR) of 12.5% of riskweighted assets, rather than the 8% required under Basel III. Since June 2019 the CBB has also required all locally incorporated banks to report Basel III ratios on leverage and liquidity on a quarterly basis. Locally incorporated banks must also report their net stable funding ratio as of December of the reporting year.

The CBB and Bahrain’s banks are working to meet the standards outlined in Basel IV. Due to the pandemic, however, the original January 1, 2022 deadline for global implementation of the updated standards was postponed to January 1, 2023. Among other changes, the new rules require bank credit ratings to exclude implicit sovereign support, likely leading to some adjustments among some banks in the GCC, which often have sovereign connections.

March 2022 marked another important deadline, when the kingdom’s financial services entities had to be in full compliance with CBB regulations on cyberrisk management. Banks were required to complete a full gap survey, with non-compliant banks, insurers and other financial services outfits facing immediate CBB action. The move highlights the fact that cybersecurity is among the authorities’ top priorities – one made even more pressing by the accelerated move to online services during the pandemic.

Plans & Programmes

Since 2008 the country has followed the Bahrain Economic Vision 2030 longterm development plan. This plan seeks to enhance diversification in the economy away from oil and gas.

More recently, in 2021 the government announced its revised Fiscal Balance Programme (FBP) as part of a wide-ranging Economic Recovery Plan. The plan includes six sector-specific strategies running through to 2026. Among these is financial services, with the CBB overseeing the Financial Services Development Strategy 2022-26. The framework outlines five priorities: job creation, legislation and policies, financial markets, financial services and fintech, and insurance. A series of key performance indicators were established, including steps to ensure that 3000 trainees are educated in financial services each year, and a requirement that at least 20% of retail banks’ lending portfolios be allotted to small and medium-sized enterprises (SMEs) by 2025. Other objectives include a 25% drop in cash circulation and the inclusion of five companies on the Bahrain Investment Market, the alternative equity board for small firms and start-ups (see Capital Markets chapter).

Strength in Numbers

As of June 2022 the CBB had responsibility for 362 financial institutions. Together, these entities employ around 13,700 individuals, making the sector the country’s largest employer. In 2021, 69% of workers in the sector were Bahraini nationals, while 31% were foreigners, according to the central bank.

CBB data for June 2022 shows that 87 of the 362 financial institutions were banks, of which 30 were retail and 57 wholesale. Among the banks were 17 branches of foreign banks and eight representative offices. Of the total, 14 were Islamic. At end-2020 the market share of the sharia-compliant segment was 37.1% of domestic banking system assets and 17.2% of total banking system assets, according to international credit ratings agency Fitch. The banking sector is also the financial industry’s largest segment, accounting for approximately 85% of total assets.

The insurance sector, for its part, comprised 21 locally incorporated entities and 10 branches of overseas insurers as of June 2021, with the 21 domestic companies consisting of 12 conventional insurers, five takaful (Islamic insurance), two reinsurance, one re-takaful (Islamic reinsurance) and one captive firm, according to the CBB. Meanwhile, overseas branches consisted of nine conventional insurers and one reinsurer. There were also numerous agents, brokers and other ancillary services active in the market. A variety of microfinance institutions, money changers, financing companies, trust and ancillary service providers, asset managers and funds are also active in the sector, demonstrating the depth, vibrancy and range of the industry.

While oil and gas has traditionally been the main driver of the economy – accounting for 17.8% of GDP in 2019, compared to 16.5% for financial services – by late 2021 the financial sector had overtaken oil and gas as the largest contributor to GDP: financial services accounted for 17.9% of real GDP in the fourth quarter of 2021, compared to 17.4% for petroleum and natural gas, according to the most recent figures from the Ministry of Finance and National Economy.

Banking Players

The biggest bank in Bahrain is Ahli United Bank (AUB), ranking 28th out of 500 banks in the Middle East and Africa in 2021 in terms of total assets, according to financial services research firm Asian Banker. A planned merger with Kuwait Finance House would have created the GCC’s sixth-largest bank with over $100bn in combined assets. However, in December 2020 the proposed consolidation was indefinitely suspended due to uncertainties associated with the Covid-19 pandemic.

Other top-40 banks include the Arab Banking Corporation (Bank ABC), which ranked 35th and is majority owned by the Central Bank of Libya, with the Kuwait Investment Authority holding a 29.7% stake; Gulf International Bank, in 37th place, 97.2% owned by Saudi Arabia’s Public Investment Fund; and Al Baraka Banking Group, in 39th place.

Key conventional banks are the Bank of Bahrain and Kuwait, and the National Bank of Bahrain (NBB). The latter bank is the largest domestically focused bank in the country, with some 20% of total domestic assets at the end of the first quarter of 2021. The government holds 55% of NBB’s shares via Mumtalakat, the country’s sovereign wealth fund. Key local Islamic banks include Bahrain Islamic Bank, 78.8% owned by NBB, and Ithmaar Bank. The most popular type of Islamic banking instrument is murabaha (cost-plus financing), which accounted for 51% of total facilities in retail and 65.3% in wholesale in the second quarter of 2021. Ijara (leasing) was the second-most-popular Islamic offering in retail, with 28.6% of total facilities.

Insurance & Takaful Providers

In 2020 the top-five insurance and takaful firms in terms of turnover were GIG Bahrain, with BD85,430 ($227,000) in turnover and accounting for around 31% of the market; Bahrain National Insurance – the insurance arm of Bahrain National Holding – with BD36,700 ($97,300); Solidarity Bahrain – the local subsidiary of Solidarity Group Holding, the world’s largest takaful group – with BD30,204 ($80,100); GIG Takaful International, with BD22,859 ($60,600); and the T’azur Company, with BD19,072 ($50,600). In January 2022 Solidarity Bahrain completed a successful merger with the domestic takaful business arm of T’azur.

As of mid-2021 medical was the largest line of business, comprising 32% of total gross premium, followed by motor (24%) and life insurance (21%). Other lines include fire, property and liability, which took a 12% share; engineering (3%); marine and aviation (2%); miscellaneous losses (2%); and other (4%).

Performance

Backed by a $10bn support package from Bahrain’s GCC neighbours, the first FBP was launched in 2018 in response to a protracted period of low oil and gas prices, which negatively affected government revenue and created a growing budget deficit. The government then began a programme of fiscal austerity, achieving some success in reducing the deficit, which fell from 14% of GDP in 2017 to 11.7% in 2018 and 9% by the end of 2019. However, with many of Bahrain’s key economic sectors in areas of high person-to-person contact – such as hospitality, travel, retail and transport – pandemic-related shutdowns and closed borders significantly impacted many businesses in 2020 and early 2021.

At the same time, 2020 saw a major decline in economic activity worldwide, reducing demand for oil and gas, and slowing trade. This was reflected in Bahrain’s fiscal deficit reversing course to expand to an estimated 17.6% of GDP in 2020, while GDP shrank by 4.9%, according to the IMF.

Pandemic Response

The pandemic period proved to be challenging, with both public and private customers negatively affected. Recognising this, the government and the CBB moved quickly to help mitigate the impact. In March 2020 the CBB reduced retail banks’ reserve requirements from 5% to 3%. It also cut overnight lending rates from 4% to 2.45%, one-week deposit facility rates from 2.25% to 1.75%, overnight deposit rates from 2% to 1.5%, and one-month deposit rates from 2.45% to 2.2%. Local currency deposit and lending rates were cut by 75 basis points, although in April 2020 the onemonth deposit rate and overnight lending rate were increased slightly, to 2% and 2.25%, respectively.

The CBB introduced a requirement for banks to defer loan and financing repayment instalments, initially by six months, but with payment holidays then extended to the end of 2021. A stress test was carried out to evaluate the impact on the banks, which were required to closely monitor the developing implications of such a move on non-performing loans (NPLs) and other banking metrics.

Meanwhile, helping ensure liquidity in the wider economy, the government made two major interventions: an $11.3bn package in March 2020, followed by a $1.3bn package in June 2021. As part of these efforts, banks received liquidity allocations of $610m and $642.5m, respectively, in the form of a 0% concessionary repo facility for eligible banks, with a maturity period of up to six months.

These measures helped many Bahraini businesses and financial services entities weather the storm, averting a major economic downturn. This was evident in financial soundness indicators, which remained healthy, even as they witnessed slight declines. The CAR, for example, fell from 19.5% to 18.5% during the first half of 2020, with the core Tier-1 capital ratio dropping from 18.1% to 17.1%. In the second quarter of 2021 these ratios recovered to 18.8% and 17.6%, respectively.

Meanwhile, assisted by prudent banking policies and mandated payment holidays, the NPL ratio declined from 4.8% in December 2019 to 4.5% in June 2020. It then dropped further to 4.3% at the end of 2020 and 3.8% in the second quarter of 2021.

Profitability

Profitability remained roughly stable between the first half of 2019 and same period in 2020, although return on assets (ROA) and return on equity (ROE) both fell, from 0.6% to 0.4% and 4.8% to 1.5%, respectively. Liquidity also saw a slight drop, with the overall sector liquid asset ratio (LAR) declining from 25.5% in the fourth quarter of 2019 to 24.6% in the second quarter of 2020. However, in the second quarter of 2021 ROA and ROE rose again, to 0.6% and 4%, respectively, by which time the LAR had also recovered to 26.5%. This was notable given the stresses under which the banking system and wider economy had been placed. Throughout the pandemic, banks maintained CARs well above the requirements established by both the CBB and Basel III.

The banking system’s total domestic assets grew from BD68.5bn ($181.7bn) at the end of 2019 to BD71.5bn ($189.7bn) at the end of 2020 and BD76.1bn ($201.8bn) by the end of 2021. As a percentage of GDP, total domestic assets rose from 178.1% at the end of 2019 to 197% in the first quarter of 2022.

At the same time, total foreign liabilities were up, from 370.6% of GDP in the second half of 2019 to 410.3% by end-2020 and 429.5% by end-2021. However, they fell to 381.4% in the first quarter of 2022. This displays a fairly high reliance on external financing – common in a large banking sector in a relatively small market – with foreign currency assets accounting for around 53% of total holdings and 52.4% of total liabilities in 2021, according to Fitch. The US dollar peg and support from the CBB and Bahrain’s sovereign wealth fund have historically mitigated this risk. Substantial support packages from GCC partners, such as the $10bn facility aligned with the 2018 FBP, have also eased market concerns. This support is expected to continue in the coming years.

While conventional banks saw the capital positions of retail and wholesale lenders erode, Islamic banks experienced an increase among both retail and wholesale players from the end of 2019 to the second quarter of 2020. Conventional retail then reversed this trend between the second quarter of 2020 and the second quarter of 2021, although capital positions continued to weaken for conventional wholesale banks – a pattern seen in the Islamic sector.

In terms of financial soundness indicators, between the second quarter of 2020 and the same period in 2021 the Islamic segment saw NPLs drop in retail, but increase in wholesale. The segment’s ROA and ROE rose during this period, from 0.2% to 0.3% and 2.1% to 3.9%, respectively. NPLs for conventional banks were down, while ROA was up for retail and wholesale, from 0.6% to 0.7%. ROE fell for retail, from 6% to 5.8%, but rose for wholesale, from -2.3% to 1.7%. As of the first quarter of 2022 the sector had an NPL ratio of 3.5%, while ROA and ROE were 1.1% and 7.8%, respectively, according to the central bank.

After the first half of 2019 credit saw growth slow to reach a low of around 2% at the turn of the year, it rose to 6.8% for 2020 before falling to 5.4% in the first half of 2021 due to renewed pandemic restrictions, and again to 4.7% at the close of the year. In a September 2021 report Fitch predicted overall annualised credit growth of 7% in 2022, highlighting consumer demand as the main driver behind this performance, with consumers returning to retail and hospitality, in particular, driving up point-ofsale purchases. The banking sector has largely been able to navigate the pandemic. In fact, some banks have reported that the crisis had a positive effect by encouraging a rapid rethink of many practices, including facilitating a quick shift towards digital tools as interactions moved online. By the first quarter of 2022 credit growth had recovered slightly, to 4.9%.

Insurance

Similar to banking, the insurance sector was able to weather the wider effects of the pandemic and achieve expansion. While the initial stage of the pandemic and the various restrictions introduced to stem the spread of the virus slowed activity, a gradual return to growth followed. Moreover, the pandemic triggered interest in insurance products – and not only in medical and health.

Total gross premium rose from BD134.6m ($357m) in June 2020 to BD143.7m ($381.2m) in June 2021. Most of this expansion was seen in the conventional segment, which saw gross premium rise from BD69.2m ($183.7m) to BD77.1m ($204.5m). Gross premium for takaful firms, however, dropped slightly from BD43.9m ($116.4m) to BD43.8m ($116.1m).

Medical was the biggest line of business in terms of gross premium as of June 2021, with BD45.7m ($121.3m), up from BD41.9m ($111.2m) in June 2020. Motor came in second – despite an overall decline during the period, from BD36.6m ($97.1m) to BD34.5m ($91.5m). Lockdowns and repatriation of many residents decreased overall traffic and contributed to the fall in premium in these lines. Life insurance was the third-largest line, rising from BD24.7m ($65.4m) to BD30.4m ($80.6m). These rankings were the same for conventional and sharia-compliant insurance.

At the same time, the pandemic and heightened caution among the general public caused gross claims to fall in certain other areas. Motor, for example, saw gross claims fall from BD63.7m ($169m) in 2019 to BD41m ($108.8m) in 2020. The decline continued through 2021, with gross claims declining from BD24m ($63.7m) in June 2020 to BD19.7m ($52.3m) in June 2021. Medical claims increased from BD44.7m ($118.6m) in 2019 to BD46.7m ($123.9m) in 2020 but then eased, falling from BD24.6m ($65.3m) in June 2020 to BD23.1m ($61.3m) in June 2021. Life insurance claims continued to show significant growth throughout the pandemic, up from BD27.4m ($72.7m) in 2019 to BD28.7m ($76.1m) in early 2020, then rising further to BD11.1m ($29.4m) in June 2020 and BD19.2m ($50.9m) in June 2021.

Meanwhile, the conventional segment’s net profit expanded from BD36.8m ($97.6m) in 2019 to BD49.3m ($130.8m) in 2020, while the sharia-compliant segment’s shareholder fund profit saw a decline from BD3.8m ($10.1m) to a loss of BD40,000 ($106,000) over this period. The position then reversed, with conventional insurers seeing their net profit fall from BD28.6m ($759m) in June 2020 to BD22.2m ($58.9m) in June 2021. For takaful companies, shareholder fund profit increased slightly from BD2.3m ($6.1m) in June 2020 to BD2.6m ($6.9m) in June 2021.

Summing up the industry’s health, in December 2021 the CBB stated that the sector had shown remarkable resiliency throughout the pandemic, especially amid heightened public awareness of the importance of insurance. At the same time, the sector continued to move ahead with digitalisation, particularly in motor and medical insurance.

The period also saw new products enter the market, such as the first motor policy for electric vehicles, launched by Bahrain National Insurance in November 2021. Furthering the sustainability and renewable energy theme, Solidarity Bahrain began writing solar panel insurance policies the same year.

The Mandatory Private Cooperative Health Insurance Programme for Expatriates (PCHIP), part of Bahrain’s long-term strategy to provide mandatory health insurance for all citizens, residents and visitors, is another notable development. The programme was put to tender in December 2021, with implementation due in the second quarter of 2022 and a version for nationals scheduled for 2023.

Employers of expatriates will pay for the PCHIP package, but individuals will also have the right to sign up with private insurers that can provide the same level of coverage as the mandatory system. In addition, visitors will be obliged to purchase compulsory insurance to cover the duration of their stay in the country. Therefore, the programme is likely to trigger an expansion in activity for insurers offering these packages in the coming years.

Fintech Futures 

As a leading centre for financial services, Bahrain has long been a keen advocate for – and developer of – fintech solutions for its banking, insurance and capital markets entities. This was recognised in 2021 when the kingdom’s fintech segment came third in the Arab world, after the UAE and Saudi Arabia, in the Arab Monetary Fund’s Index of Modern Financial Technologies in the Arab Countries.

“For more than a decade, Bahrain has made notable efforts to develop the digital economy. Today, we are moving towards an advanced cashless and digital society, and all public and private stakeholders have an important part to play in the process to ensure Bahrain’s financial sustainability and economic advancement in the coming years,” Abdulwahed Al Janahi, CEO of Benefit – Bahrain’s electronic network for financial transactions – told OBG.

The CBB’s Fintech and Innovation Unit is the subsector’s supervisory and regulatory body, responsible for both conventional and Islamic fintech. The unit launched its first regulatory sandbox in 2017, which was updated and operates with an improved framework that was launched in December 2021. As of that month the unit had licensed 23 fintech outfits to participate in the sandbox.

The CBB is also behind FinHub 973, the region’s first cross-border digital innovation platform. The institution links fintech firms authorised by the region’s central banks to work seamlessly in a centralised digital sandbox. FinHub 973 also has a showcasing and promotional function, which allows qualified fintechs to demonstrate their products and collaborate on ventures across borders.

Going Digital

Bahrain has been particularly innovative in the open banking and digital currencies spheres. In 2020 the kingdom launched the Bahrain Open Banking Framework, the first initiative of its kind in the region. The CBB has also approved a move by Bahrain Telecommunications Company (Batelco) to become the first telecommunications firm in the region to offer an open banking service, called Batelco Financial Services. The platform is being established through a strategic partnership with Germany-based fintech company builder finleap, and will offer digital wallet creation, card issuance services, bank account aggregation, and payment services for both individuals and SMEs.

Meanwhile, in May 2021 the CBB moved to launch a settlement pilot in partnership with JP Morgan ONYX and Bank ABC, providing real-time, cross-border payment solutions via digital currency. Bank ABC is a leading agent in fintech development, majority-owning Arab Financial Services, which provides digital payment solutions. There has also been recent movement in digital currencies after the CBB first introduced the idea of a digital dinar in 2018: in December 2021 the CBB recommitted to the concept.

Subsector Growth

Identified as one of five priority areas in the CBB’s Financial Services Development Strategy 2022-26, the use of fintech is expected to grow in the coming years. As part of thsi, an expansion in digitalisation within finance is envisaged. Increased use of supervisory technology by regulatory bodies, new business models to combat money-laundering and terrorist financing, and enhanced access to fintech solutions among SMEs are among the targeted improvements. An upgrade to the electronic remittance infrastructure is planned, along with the rollout of more bank linkages to the Arabian Gulf System for Financial Automated Quick Payment Transfer.

With the commitment to fintech development and an established ecosystem, the kingdom has already produced a number of leading fintech outfits. These include Rain, a licensed cryptocurrency exchange with satellite offices in the US and Middle East. The platform allows for trading in US dollars and leading GCC currencies. Rain raised $110m in Series-B funding in January 2022, at which point it had conducted over $1.9bn worth of transactions and gained 185,000 active users since it was founded in 2017.

Other fintechs active in the market include Aion Digital, a brand of Bahrain’s business-to-businessto-consumer fintech firm Waqfe, which provides digital banking platforms; Sinnad, which works in the payments and card-processing space; Eazy Financial Services, which provides biometric payment network solutions; and Infinios, an ancillary services, payment services and card processor.

In the sharia-compliant segment, CoinMENA, founded in 2019, provides a digital asset trading platform that supports GCC currencies and the US dollar. In 2021 the company raised $9.5m in its first seed funding round, one of the highest amounts for such a round in the region that year.

Moving forwards, players in the segment hope that the authorities will continue to focus their efforts on regulating the cryptocurrency space, ensuring that the technologies enabling high-frequency trading are adequately tested, and improving know-yourcustomer processes through regulatory technology.

Outlook

With recent years seeing a succession of headwinds in the global economy, and continuing uncertainty about the course of the pandemic and Russia’s invasion of Ukraine in early 2022, Bahrain’s financial services sector appears capable of navigating future challenges. The banking sector is well capitalised and supported by good provisioning for future spikes in NPLs as pandemic-era measures unwind. The insurance sector has also maintained robust profitability, with new products in health and medical in particular likely to facilitate growth.

Meanwhile, the kingdom’s support for fintech and innovation in financial services leaves it well placed for the future development of innovative solutions, in turn boosting efficiencies, cutting costs and increasing productivity. Recent merger and acquisition activity in banking and insurance looks set to continue as these sectors consolidate further. It is also expected that the increasing attractiveness of Islamic finance options will result in the introduction of more sharia-compliant offerings from conventional institutions.

At the same time, the country’s economy is projected to benefit both from the updated FBP and recovering oil and gas prices, the latter of which could bridge the budget deficit. While this may mean banks’ bond portfolios – and overall asset growth – lag somewhat behind credit growth as the need for new issuances diminishes, the overall impact of increased economic growth and consumer spending will likely compensate for this loss. Foreign liabilities will remain balanced by the US dollar peg and ongoing CBB and GCC support measures, easing concerns over future rate hikes by the US Federal Reserve. Indeed, Bahrain is positioned to consolidate its position as a major centre for financial services in the region.