How digitalisation will strengthen Kuwait's banking sector

An easing of disruptions associated with the Covid-19 pandemic, a sustained increase in oil and gas receipts, and the rollout of a new law providing a framework for establishing digital offerings have given Kuwait’s banking sector a renewed confidence that has been supported by the country’s wider economic recovery. Indeed, with real GDP returning to growth in 2021 and expected by the IMF to reach up to 8.7% in 2022, credit and profitability look set to see further expansions. The sector is notable for its high liquidity and strong capitalisation, both of which helped it navigate the uncertainties associated with the pandemic and other global headwinds. Government-led pandemic amelioration and recovery measures helped support depositors and banks, a trend reinforced by the stable rate of deposits from the retail sector and government-related entities observed during the second half of 2021.

In February 2022 the Central Bank of Kuwait (CBK) published new guidelines for establishing digital banks, with the deadline for the CBK to grant initial approval for such entities set for the end of 2022. This development promises a major new growth area as banks aim to modernise practices and attract new business. Indeed, as in other parts of the world, the pandemic and Kuwait’s response were major impetuses for the incorporation of digitalisation and financial technology (fintech) in business operations.

Although the addition of digital banking options is expected to improve penetration and service delivery in Kuwait, there are still concerns about the relatively large number of financial institutions in the country considering its population. With 11 local banks – five conventional entities, five Islamic entities and one specialised investment bank, along with 11 branches of foreign banks – the debate around the merits of consolidation is likely to continue. Higher CBK discount rates are helping boost the sector’s profitability, and its positive net external asset positions help make it one of the Gulf region’s most secure banking sectors.

Oversight

Kuwait’s central bank is the primary regulator for the country’s local and foreign banks, both Islamic and conventional entities. As of November 2022 the CBK was led by governor Basel Al Haroon, and its board of directors included representatives from Kuwait’s private sector, the Ministry of Finance, and the Ministry of Commerce and Industry.

The CBK’s Higher Committee of Sharia Supervision oversees the Islamic finance sector, acting as an arbiter in disputes that occur within the sharia boards of individual banks. Conventional banks are not allowed to operate through Islamic windows in Kuwait, meaning only 100% Islamic banks can conduct such activities. Some lenders have Islamic arms, such as the conventional National Bank of Kuwait (NBK), which has a majority stake in the sharia-compliant Boubyan Bank.

Regulatory Framework

The CBK has a supervisory and regulatory function for all finance, exchange and investment companies operating in Kuwait, with a reputation for enforcing standards and monitoring banks more strictly than required by international banking agreements. For example, the sector’s overall capital adequacy ratio (CAR) stood at 19.2% at the end of 2021, according to CBK figures, with a ratio of Tier-1 capital to the capital base of 88.7% – both above Basel III requirements. The CBK also ensures that banks continue to follow the latest version of the International Financial Reporting Standards 9.

In its efforts to remain competitive, the CBK employs an interest rate ceiling for conventional banks that sharia-compliant institutions also tend to follow in practice in their pricing. Although this protects customers and banks when credit information is hard to obtain, it in turn can make the pricing of risk more difficult, particularly when it comes to offering commercial loans to small and medium-sized enterprises (SMEs). The IMF has been advocating for a gradual relaxation of the CBK’s interest rate ceiling, along with other improvements to the country’s credit information databases.

The CBK is also following the strategic vision laid out at the 2019 international banking conference Shaping the Future, the goals of which include digitalising banking operations. The initiatives are in line with New Kuwait 2035, the country’s overall long-term development framework. As part of Shaping the Future, banks were directed to develop an integrated five-year strategy that brings together digitalisation, cybersecurity, and other stability and growth measures.

In December 2017 Boursa Kuwait published a sustainability disclosure guide for all companies listed on the stock exchange, although it has been the country’s banks that have often led the way when it comes to reporting on environmental, social and governance (ESG) issues. For example, NBK increased the size of its community investment by 20% from 2020 to 2021, and the bank has integrated its environmental and social priorities within its governance structure.

Local Players

The CBK is responsible for overseeing the country’s 11 local banks, with NBK, Kuwait Finance House (KFH) and Burgan Bank the top three by asset base. These entities – in addition to Gulf Bank, the Commercial Bank of Kuwait, Al Ahli Bank of Kuwait and the Industrial Bank of Kuwait – were included on a list of the world’s 1000 largest banks published by The Banker in July 2022. According to the Arab Union of Banks, as of August 2022 the total core capital of these seven institutions reached around $29.8bn, with total assets under management of $272.4bn. The Kuwaiti government provides strong support for local banks, a fact reflected in their high ratings from international credit agencies. For example, Fitch gave NBK a government support rating of “A+” in February 2022, while the 10 other local banks all received an “A” grade.

KFH, a sharia-compliant financial institution, completed a merger with Bahrain’s Ahli United Bank in October 2022 for a reported $11.6bn. The institution is the Gulf region’s seventh-largest bank and offers services in 12 countries, with some $118bn in assets under management. It is also a major player in Kuwait (see Islamic Financial Services chapter).

NBK is another major player and its interim report for the third quarter of 2022 disclosed total assets of KD34.7bn ($114.2bn) compared to KD32.5bn ($107bn) at the end of the third quarter of 2021. The bank has overseas interests – namely NBK International and NBK France, and branches in Europe, Asia and US. NBK also has a majority stake in the Islamic financial entity Boubyan Bank, which has an international subsidiary, Bank of London and the Middle East. In addition to NBK, the conventional banking segment includes Gulf Bank, the Commercial Bank of Kuwait and Burgan Bank.

KFH posted interim total assets of KD22.7bn ($74.7bn) in the third quarter of 2022, an increase from KD22bn ($72.4bn) in the third quarter of 2021, while Boubyan Bank’s interim report for the third quarter of 2022 showed total assets of KD7.76bn ($25.5bn) compared to KD7.3bn ($24bn). According to the most recent CBK figures, local banks’ total assets in the fourth quarter of 2021 were KD77.1bn ($253.7bn), representing the activity of local banks and their branches within Kuwait. NBK, KFH and Boubyan Bank collectively held some 64% of the local sector’s assets at the end of the year.

Foreign & Islamic Entities

While the majority of the foreign banks in Kuwait are branches from other GCC countries – such as First Abu Dhabi Bank, Qatar National Bank, Abu Dhabi Commercial Bank, Mashreq Bank, Doha Bank, BBK and Bank Muscat – others are from farther afield, such as the Industrial and Commercial Bank of China, Citibank, BNP Paribas and HSBC.

Despite the variety of conventional entities in the country, Kuwait’s banking sector has a strong Islamic banking presence. Indeed, by the end of the first half of 2022, Islamic financial institutions accounted for 45.5% of the banking sector’s total assets.

Structure

Retail banking dominates the sector in Kuwait, with personal facilities accounting for KD18.1bn ($59.6bn) of balances in local banks out of a total of KD51.3bn ($168.8bn) in August 2022. In terms of the distribution of bank balances by business sector, real estate is the country’s largest segment, accounting for KD9.5bn ($31.3bn). The other major sectors included trade, with KD3.4bn ($11.2bn); industry, with KD2.9bn ($9.5bn); crude oil and gas, with KD2.8bn ($9.2bn); and construction, with KD2.1bn ($6.9bn).

The dominance of real estate and construction in bank balances has given periodic cause for concern over the potential concentration risk, particularly during the pandemic, when sales and investment in property stalled. However, due to its better economic performance and the lifting of many pandemic-related restrictions, the real estate sector – in particular residential sales – has seen a recovery.

Kuwaitisation

Like other sectors of the economy, banking is subject to Kuwaitisation, or the appointment of Kuwaiti nationals in a bid to bolster local employment opportunities. Each industry has a target percentage of Kuwaiti employees they must hire, and Kuwaitis must fill specific jobs – particularly leadership roles. These rules apply not only to local banks, but to foreign ones operating in the country as well. Starting in April 2021 the CBK required all banks to provide their plans for meeting a Kuwaitisation rate of 70% in their middleand senior-management positions by the end of 2023.

Pandemic Response

Although the pandemic had a negative effect on the Kuwaiti banking sector, the country’s lenders showed resilience and were able to quickly return to growth. In March 2020 the CBK acted rapidly to support the economy, cutting the discount rate by 125 basis points to a historic low of 1.5%, lowering the minimum CAR from 13% to 10.5% and reducing the risk weight for SMEs from 75% to 25%.

As the pandemic continued into 2021, the CBK relaxed financial concentration limits, extended filing times, granted SMEs a six-month deferral for loan repayments and allowed for a gradual accounting of losses out to 2024. The other steps taken included lowering the liquidity ratio from 18% to 15% and the liquidity coverage ratio from 100% to 80%. Additional measures were introduced to ease the burden of economic lockdowns, closed borders and declines in consumer activity, with direct fiscal support estimated to have accounted for around 1.5% of GDP in FY 2020/21. Wage subsidies and health care spending accounted for much of Kuwait’s pandemic relief package.

In October 2020 a new bankruptcy law took effect, the aim of which being to streamline and modernise Kuwait’s insolvency regulations. Along with de-stigmatising business failure and de-criminalising failures to make debt payments, the law encourages distressed companies to restructure their debts early.

Performance

There was an initial decline in oil and gas prices at the start of the pandemic as demand shrank due to limited mobility, with government revenue falling from an estimated KD21.9bn ($72.1bn) in FY 2019/20 to KD15.5bn ($51bn) in FY 2020/21, according to the IMF. As a consequence of this, the fiscal deficit grew to an estimated 16.6% in FY 2020/21, a reversal of Kuwait’s historical surplus. A new proposed debt law that would enable the government to access its Future Generations Fund to reduce the deficit stalled in Parliament, leading the government to turn to liquid assets held elsewhere, in particular the General Reserve Fund. The upturn in oil and gas prices in the second half of 2021 was a welcome development for government coffers, with real GDP growth reaching 1.3% in 2021. In October 2022 the IMF upgraded its GDP growth outlook for Kuwait to 8.7% for the year, followed by an expected slowdown to 2.6% in 2023.

The cut in deposit rates resulted in credit growth for many banks – mainly in household borrowing – in both 2020 and 2021, with the figure up 3.6% and 6.2%, respectively. However, the pandemic-related economic downturn led to lower overall profitability, with the average return on assets falling from 1.2% in 2019 to 0.6% in the fourth quarter of 2020, before edging up to 0.9% by the third quarter of 2021. Indeed, 2021 saw a substantial recovery in net profit, with Kuwait’s banks outperforming all other GCC lenders in this metric. A June 2022 KPMG report showed growth of 91.4% in net profit among Kuwait’s GCC-listed banks in 2021, while total assets were up 6.3% over the same period.

Kuwait’s banks retained a CAR well above the minimum set by the CBK during the height of the pandemic. In the fourth quarter of 2019 the ratio stood at 18.5% before dropping to 17.2% in the first quarter of 2020. It rose again to 19% by the fourth quarter of the year and stood at 19.2% as of the end of 2021.

This period saw the ratio of net non-performing loans (NPLs) to net total loans remain low, thanks in part to pandemic relief measures implemented by regulators and an initially low starting point. The ratio stood at 1% in the fourth quarter of 2019, rising to a high of 1.9% in the second quarter of 2020 before then dropping to 1.4% in the fourth quarter of 2020 and falling further to 0.9% in the fourth quarter of 2021. The NPL coverage ratio fluctuated around 200% in 2020 and 2021, ending at 270.6% in the fourth quarter of 2019 before dropping to 164.8% in the second quarter of 2020. The figure then improved to 222.1% in the fourth quarter of 2020 before rising to 309.7% in the fourth quarter of 2021.

After cutting interest rates in March 2020, the central bank began raising the key discount rate again, to 1.75% in March 2022, 2% in May 2022, 2.25% in June 2022, 2.5% in July 2022, 2.75% in August 2022, 3% in September 2022 and 3.5% in December 2022. Banking sector income is expected to rise along with profitability, with further rate hikes likely. The Kuwaiti dinar is not pegged to the US dollar – it is tied to a basket of currencies – but further monetary tightening by the US Federal Reserve and other central banks could exert additional upward pressure on rates. NBK reported interim net interest income of KD156m ($513.4m) for the third quarter of 2022, up from KD126.8m ($417.3m) in the third quarter of 2021, while net profit rose from KD97.7m ($321.5m) to KD141.6m ($466m) over the same period. Indeed, the bank’s net income for the first half of 2022 was up nearly 50% year-on-year (y-o-y), with bank officials citing lower provisioning charges for credit and impairment losses as reasons for the improvement.

Meanwhile, Gulf Bank returned to the MSCI Kuwait Index from the MSCI Emerging Markets Small Cap Index in 2022 due to robust growth, including a 26% y-o-y increase in profit for the first quarter of 2022. Rising profitability and income have dovetailed with higher government revenue, which is expected to lead to greater government investment in major projects.

New Technologies

A key element in the increasing profitability of Kuwaiti banks has been the adoption of new, cost-cutting technologies. This trend began before the pandemic but accelerated during the period of lockdowns, remote work and travel restrictions. A digital-first policy has widened accessibility while decreasing the need for a physical presence.

In 2018 the CBK announced regulations for the electronic payment of funds and a regulatory sandbox for fintech. In its role as the national fintech regulator, which includes a dedicated fintech unit that was set up in 2018, the CBK also oversees electronic payment providers and agents. These efforts have paid off, with banks across the market adopting technological solutions. KFH and NBK have partnered with US-based blockchain digital payment network Ripple, while Gulf Bank has implemented biometric facial recognition technology on its mobile banking app.

In February 2020 the CBK introduced its cybersecurity framework for the country’s banking sector. The Kuwait Automated Settlement System for Inter-participant Payments has improved the sector’s payment security and monitoring, as well as has allowed for the instant settlement of bank balances. Other developments include Boubyan Bank’s smartwatch payment system and NBK Capital SmartWealth, a personalised online investment services platform. The NBK Group Digital Office has also acted as an accelerator for the development of fintech, one such example being Weyay, Kuwait’s first fully digital bank that NBK rolled out in November 2021. In September 2022 Boubyan Bank launched the Boubyan Accelerator Programme in collaboration with the Dubai International Financial Centre’s Fintech Hive to support the development of 10 Gulf region start-ups selected from 250 applicants.

In February 2022 the CBK moved to regularise and formalise digital banking, launching new digital bank guidelines and establishing an application process for granting licences. The deadline was set for June 30, 2022, with approvals to be granted by the end of the same year. In August 2022 the Kuwaiti Competition Protection Authority – which is also reviewing the applications – said it had received applications from three alliances of banks and digital entities. Of these, two are likely to receive their operating licences as soon as the end of 2022. The fact that the applications all come from alliances – Boubyan Bank, for example, has applied in collaboration with Zain Telecom Group and several undeclared investors, while Warba Bank has reportedly applied with telecommunications company Ooredoo, the Kuwait Investment Company and Al Manar Finance and Leasing – shows that banks prefer to work with established technology firms and agile fintech outfits instead of setting up their own units.

Outlook

With Kuwait’s banks outperforming their regional peers in 2021, the outlook for 2022 and 2023 is positive thanks to the sector’s robust foundations and the support systems established by its regulators. The Kuwaiti government expects to receive a boost from windfall oil and gas receipts as global hydrocarbons prices continue to rise, a trend that is expected to bolster the country’s wider economy and support sustained government investment.

Important structural reforms and the increasing focus on digitalisation have created a stronger, more cost-competitive banking sector that strengthens the position of Kuwaiti players in the Gulf, regardless of the external forces that could have a negative impact on the country’s economy. The sector has shown resilience to various headwinds, and it has demonstrated an ability to adapt in a period of high volatility in international trade and business. The recent performance has resulted in greater levels of confidence from both residents and investors, further supporting the economic recovery.