Sharia-compliant services and products continue to drive development in Kuwait

Over the course of 2017-18 Kuwait’s Islamic financial services (IFS) industry saw continued growth and ongoing development, shoring up the country’s long-standing reputation as a global centre for sharia-compliant banking, insurance and investment activities. At the end of 2017 Kuwait was home to 6% of all sharia-compliant assets, according to the “IFS Industry Stability Report 2018” published by the Kuala Lumpur-based Islamic Financial Services Board (IFSB) in June 2018. Global IFS assets topped $2trn for the first time in 2017, up 8.3% from the end of 2016, according to the IFSB.

At the end of 2017 Kuwait held an estimated $123bn in IFS assets. The majority of this total, as is the case at the global level, was held by Islamic banks, while the remainder was accounted for by takaful (sharia-compliant insurance) firms and sharia-compliant investment companies. In terms of Islamic banking, Kuwaiti institutions accounted for the fifth-largest asset base in the world, after Iran, Saudi Arabia, the UAE and Malaysia.

The majority of Kuwait’s IFS assets are concentrated in a single entity, namely Kuwait Finance House (KFH), which is one of the oldest and largest sharia-compliant lenders not only in the Gulf region, but worldwide. KFH reported total assets of KD17.4bn ($57.7bn) at the close of 2017, an increase of 5.2% from the previous year, and equal to almost half of all IFS assets held in the country at that time.

Gaining Ground

KFH has had to compete with a raft of new entrants since the early 2000s, resulting in the sharia-compliant segment steadily gaining a larger share of total banking assets over the past decade in particular. Indeed, the proportion of assets held at conventional banks has fallen from over 70% in 2008 to 60% of as of early 2018, according to the Central Bank of Kuwait (CBK). At the same time, the country’s thriving Islamic financial institutions (IFIs) have led the market in terms of technological innovation, and the introduction of new products, services and investment activities. As such, many local players expect to see continued expansion in the segment for the foreseeable future.

“The demand for sharia-compliant products has risen dramatically in the past 15-20 years,” Waleed Mohammed, vice-president of investment at Dimah Capital, a Kuwait-based Islamic investment company, told OBG. “Given the increased popularity of Islamic products worldwide, Kuwait could eventually become a predominantly Islamic financial market, though this is still a ways off.”

History

Kuwait’s government has been a pioneer in the development of IFS in the Gulf and, as such, the world. The state was a key driving force behind the organisation of a series of regional meetings focused on facilitating the introduction of early sharia-compliant products in the region, beginning in the early 1970s. These summits brought together financial regulators, sharia scholars, and various commercial interests to hash out details and regulatory frameworks around key issues related to Islamic banking, sukuk (sharia-compliant bonds) and takaful products. This planning and implementation work was organised in large part under the aegis of the Organisation of Islamic Cooperation, of which Kuwait was a founding member. Indeed, Kuwait hosted a number of key early meetings around the development of IFS products and services.

In 1977 the government launched KFH, which was the country’s first sharia-compliant financial institution, and remains a leader across a range of segments. Until the early 2000s KFH was the sole IFI allowed to operate domestically – others were banned under the 1968 banking law, which prohibited the establishment and operation of privately held sharia-compliant banks and other financial institutions. Consequently, through the 1980s and 1990s KFH effectively had a monopoly on the local market, as well as privileged access to public projects and financing as a state-owned institution.

This situation changed in the early 2000s, when Kuwait relaxed its regulations with regard to the establishment of new financial entities. This shift, which was in line with newly liberalised business and regulatory frameworks across the Gulf, heralded a major shift in Kuwait’s financial services industry. In 2003 the government passed Law No. 33, which allowed for the establishment of new Islamic banks and non-lending financial institutions.

Enter New Players

The following year the privately operated Boubyan Bank was established, becoming KFH’s first sharia-compliant competitor. In subsequent years Boubyan was followed by a handful of other new entrants or older conventional operators which converted to sharia-compliant status. In 2007 Kuwait International Bank, which had been operating as a conventional lender as Kuwait Real Estate Bank since the early 1970s, converted all of its operations to meet Islamic requirements. In April 2010 Ahli United Bank of Kuwait also moved from conventional to Islamic status. That same year Warba Bank, a newly established lender, obtained an operating licence, becoming the fifth Islamic bank in a market with a total of 11 domestic banks.

As of September 2018 there have been no further entrants to the banking sector, either on the conventional or Islamic side. And yet, a number of deals are currently under way which may eventually contribute to the growth of Kuwait’s Islamic market. In 2014 Commercial Bank of Kuwait, a conventional lender, announced that its shareholders had approved a plan to convert the institution to sharia-compliant status, though the plan has yet to be implemented.

In July 2018, meanwhile, KFH announced plans to begin merger talks with Bahrain-based Ahli United Bank, renewing discussions between the two entities that came to an end in 2017 due to a disagreement about the price of Ahli United Bank’s shares. If the deal goes ahead – negotiations had only just begun as of early September 2018 – it could potentially result in the establishment of a new sharia-compliant lender with assets valued at around $92bn, which would make it the largest Islamic bank in the world. Lastly, in April 2018, National Bank of Kuwait (NBK), a conventional lender and the country’s largest bank, announced ambitions to increase its controlling stake in Boubyan Bank, given an opportunity at the right price. At the time of the announcement, NBK held around 61% of Boubyan Bank’s shares.

Recent Performance

For much of the past decade Kuwait’s Islamic banks have posted higher growth rates than their conventional peers. In 2014, a high point for Islamic lenders across the Gulf, the sharia-compliant segment in Kuwait grew by 13%, compared to 4% in the conventional segment during the same period. According to the most recent available data from the CBK, the banking sector at large had a capital adequacy ratio (CAR) of 18.6% of risk-weighted assets in 2016, well above the regulator’s required minimum of 13%. Islamic banks had higher CARs than their conventional counterparts, which contributed to the sharia-compliant segment’s stability, but also to its lower efficiency ratios as compared to conventional lenders.

In another show of the industry’s strength, Islamic banks have expanded their branch networks considerably in recent years. In 2016 alone sharia-compliant institutions launched seven new branches, whereas there were no new openings by conventional lenders that year. Nonetheless, the conventional banking system had considerably more branches at the end of 2016 – some 235 against 173 operated by sharia-compliant lenders.

Kuwait’s 11 domestic banks posted net profits of KD745.8m ($2.5bn) in 2016, which represents growth of 5.8%, down slightly from the previous two years but up on the 2011-13 period. The Islamic segment accounted for much higher profit growth in 2016 than conventional lenders – 11% compared to 2.7%, according to CBK data. Furthermore, in 2016 the gap between industry-wide returns and the return ratio among Islamic banks continued to shrink. Whereas in 2010-12 sharia-compliant lenders posted considerably lower return on assets than their conventional counterparts, the difference has decreased considerably since 2013 and was nearly at parity as of late 2018.

According to IMF data, as of early 2017 the assets held by Kuwait’s Islamic banks were primarily debt-based instruments, which was in line with the nation’s banking sector as a whole. Bank loans, which are concentrated primarily in real estate, personal and interbank lines, account for some 60% of total Islamic bank assets.

Sukuk

Kuwait’s relatively recent formalisation of regulations governing the issuance of sukuk suggests further scope for growth in these products. In late 2015 the government introduced a new regulatory framework for the issuance of sharia-compliant debt instruments. The framework, which was developed and implemented in part to encourage new sukuk listings in Kuwait, established rules dealing with all aspects of the Islamic debt market, including those having to do with governance, special purpose vehicles and sharia compliance.

All sukuk issues in Kuwait are required to receive approval from both the CBK and the Capital Markets Authority (CMA), the latter of which regulates the stock exchange and other domestic trading activities, and must receive a credit rating for public issuance. The new regulatory framework, paired with the government’s rising financing needs due to slowing oil revenues, resulted in an influx of new sukuk and conventional bond issuance in Kuwait in 2016-17. In the year following the implementation of the new regulations, for instance, the CMA reported that it approved around $700m in sukuk and $4bn in conventional bond issuances.

Regional Issue

This disparity reflects the long-standing gap between bond and sukuk issuance not only in Kuwait, but across the GCC. In 2017 conventional issuances in the GCC as a whole totalled $81.4bn, according to data compiled by the Kuwait Financial Centre (Markaz), compared to $22.9bn in sukuk issuance. This latter figure is equal to 21.9% of the total, while conventional debt instruments accounted for the remaining 78.1%. Notably, however, sukuk issuance as a percentage of total debt issuance across the GCC rose by 81% in 2017; the region saw just $12.6bn in sukuk the previous year, according to Markaz figures.

Regional data indicates that sovereign issues contributed almost 63% to total debt issuance in 2017, which is commensurate with continued pressure on the oil price and, as such, government revenue across the GCC. As of the end of 2017 Kuwait was the only GCC sovereign that had yet to tap the sukuk market, despite the state announcing that it planned to do so in 2016; most analysts and market observers expect Kuwait to issue sukuk before the end of 2018.

The central bank, meanwhile, raised KD10.9bn ($36.2bn) in central bank local issuances (CBLIs) in 2017. CBLIs are issued by central banks in the form of fixed-income securities with short maturities in order to assist with regulating domestic liquidity levels. The CBK’s issuance in 2017 represented the highest amount in the GCC, accounting for 51.8% of CBLIs across the region.

In May 2018 KFH announced that it had established a $3bn sukuk programme, to be operated out of a special purpose vehicle incorporated in the Dubai International Financial Centre, and thus benefitting from free zone status. The instrument signals a major move into Islamic debt issuance on the part of KFH, which had previously issued sukuk via a Turkish subsidiary, Kuveyt Türk. KFH’s move is in line with global trends, which suggest that sukuk is becoming an increasingly important component of the IFS industry at large. According to data from the IFSB, in 2017 sukuk and Islamic funds saw growth of 25.6% and 19%, respectively, which made Islamic capital markets the fastest-growing segment in the global IFS industry during this period.

Furthermore, by the end of 2017 sukuk and Islamic funds accounted for a combined 22.8% of overall IFS assets, up from the 19.8% recorded the previous year. By comparison, the global Islamic banking industry posted growth of 4.3% in 2017, and the takaful market saw expansion of 4% that year.

Takaful

Sharia-compliant insurance is widely regarded as a high-potential growth area throughout the GCC, and Kuwait is no exception. Around 12 of the country’s more than 40 insurance companies currently operate as either fully fledged takaful providers, or maintain a so-called takaful window, offering Islamic insurance products alongside conventional lines. However, unlike in the banking segment, where sharia-compliant products have taken hold in recent years, the takaful business has yet to make major inroads into the domestic insurance market at large or, indeed, the IFS sector.

This has much to do with low uptake of insurance products in general. According to a recent industry report published by Alpen Capital, a Dubai-based financial advisory firm, in 2016 insurance penetration in Kuwait – which measures premiums as a percent of GDP – was just 1%, with the industry worth $1.1bn. Alpen forecasts indicate that the total value of the domestic insurance sector could rise to $1.7bn by 2021 – with penetration increasing to 1.1% by the same period – reflecting the small size and incremental expansion of the industry as a whole. Another key challenge has to do with the slow pace of regulatory development. The country’s current insurance law, which dates back to independence in 1961, is widely regarded as out of date and insufficient given current economic conditions. In April 2018 the Ministry of Commerce and Industry (MoCI), which is responsible for regulating the insurance sector, announced that it would form a committee to study and develop a new draft insurance law, with the objective of drawing up regulations aimed at both growing the insurance industry and protecting consumers (see Insurance chapter).

The MoCI’s efforts build on long-standing plans to develop a comprehensive regulatory framework for the local industry. Indeed, an early draft insurance law has been circulating among sector stakeholders since at least 2012, though it was never taken up formally by the government.

Creating a Framework

Any new insurance law is widely expected to address a number of key challenges facing takaful and conventional underwriters alike. It would likely raise capital requirements and tighten actuarial controls, which has the potential to encourage mergers and acquisitions, thereby consolidating the industry. This, in turn, is likely to result in a lesser degree of price competition among local underwriters, which would be expected to benefit takaful providers in particular.

Many sharia-compliant firms have been content to accept underwriting losses in order to accrue premium, which they then invest in an effort to turn a profit. A softening of competition, and thus less of a race to the bottom on prices, could therefore improve their bottom lines. This is particularly relevant for insurance lines like motor and property, which account for the largest share of gross written premium in Kuwait. Some firms are making a head-start at adjusting their portfolios with this in mind. First Takaful Insurance crediting its double-digit profit growth in 2017 to its success in cleaning up unprofitable lines such as motor.

As takaful continues to gain in prominence across the GCC and around the world, and provided a new insurance framework comes into effect in Kuwait in the near future, local sharia-compliant underwriters expect to see continued growth in the years to come.

Technology

In 2017 and 2018 technology started to gain prominence as a focus area for Kuwait’s IFIs, with potentially transformative results. In February 2018 a report by a sharia scholar in Indonesia, under the aegis of the Indonesian firm Blossom Finance, declared that blockchain technology was permissible under Islamic law. The report preceded an increase in the price of bitcoin – the cryptocurrency traded using blockchain technology – of more than $1000 in less than an hour, in what was widely regarded as a response to the news that the world’s 1.6bn Muslims may be allowed to make use of cryptocurrencies.

In April 2018, in what was widely regarded as a direct response to the earlier report, KFH announced that it would be the first bank in Kuwait to join RippleNet, a global corporate blockchain network aimed at enabling instant cross-border payments at low costs. Pending approval from the CBK, KFH’s participation in RippleNet could benefit local consumers sending and receiving money across Kuwait’s boarders before the end of the year.

Outlook

As the fifth-largest IFS market, Kuwait is well positioned to benefit from rising demand for sharia-compliant products. Taking into account plans to develop a comprehensive insurance regulatory framework, which will likely include propositions aimed at facilitating the expansion of takaful, sharia-compliant insurers are looking to gain increased market share (see Insurance chapter).

Another key area of potential growth is the sukuk market, which is widely expected to benefit from rising demand for sharia-compliant debt from both the government and corporate entities in the immediate future. Lastly, while the modest recovery in oil prices in 2017-18 has translated into a moderate reduction in pressure on public revenue in Kuwait, the government is nonetheless expected to draw on bank financing and debt instruments as it pursues the projects under the New Kuwait development plan, which lays out ambitious economic and social objectives for the country through to the year 2035.