Kuwait's banking industry looks to the future

After more than half a decade of heavy provisioning and regulatory reforms, Kuwait’s banking sector is now in the early stages of resurgence in credit issuance and various other activities. The industry’s overall stability and performance has improved markedly since the 2007-08 global economic downturn, due in large part to a series of new rules put in place by the Central Bank of Kuwait (CBK) and other regulatory organisations in recent years. Today Kuwait’s 11 domestic and 11 foreign banks constitute one of the oldest and one of the most developed financial industries in the Gulf region.

Since the downturn the local banking sector has reported a steadily expanding asset base, and in recent years lending has also picked up. In response to these positive indicators, in 2014 the government relaxed a number of laws related to investment activities in the domestic sector, which has been widely interpreted as a sign of potential future growth (see analysis).

Challenges

According to a report published in December 2014 by Fitch Ratings, structural weaknesses constitute the industry’s key challenges. For example, Kuwait’s continued reliance on oil income – which according to Fitch accounts for 40% of GDP and 80% of government revenues – represents a major long-term issue that has only been exacerbated by the rapid decline in oil prices since mid-2014, affecting the entire economy. “Oil revenues fund the public sector, and government contracts and low energy prices support much of the private sector,” reads the report.

Indeed, the low oil price has the potential to slow forward momentum on the government’s five-year Kuwait Development Plan 2015-20, which was passed by parliament in February 2015 (see Economy chapter). The new plan replaces an older five-year development plan that was repeatedly stalled due to political and bureaucratic disagreements about financing.

Other challenges currently facing the sector include a lack of placement options for the large amounts of liquidity currently held by most banks, and the unavailability of timely statistics on the market as a whole. The CBK, the Ministry of Finance (MoF), the Capital Markets Authority (CMA) and other related institutions are working to address these issues.

History

Kuwait is home to one of the oldest banking industries in the GCC region. In 1941 Sheikh Ahmed Al Jaber Al Sabah – the Emir of Kuwait from 1921 until 1950 and the father of the current Emir, Sheikh Sabah Al Ahmed Al Jaber Al Sabah – issued a 30-year concession to a group of British investors to set up the nation’s first bank. When the concession period ended in the early 1970s, the government purchased a controlling share in the bank, which would eventually become the Bank of Kuwait and the Middle East (BKME). In August 2002 Ahli United Bank acquired a 48% stake in BKME, increasing this to 75% in 2005 and effectively acquiring BKME outright. Kuwait’s largest bank, the National Bank of Kuwait (NBK), was established by a group of local businessmen in 1952.

In the early 1960s Kuwait’s financial sector began to formalise as a result of regulations that were put in place by the new government. Prior to this, local financial institutions had carried out business with individuals and corporations alike in multiple currencies, including the Indian rupee and the Gulf rupee, both of which were issued by the Indian government.

In 1960 Kuwait’s government established the Kuwait Currency Board (KCB), which had a mandate to oversee the development of a national currency. The Kuwaiti dinar was launched less than a year later. The KCB managed the new currency and oversaw the banking sector for most of the 1960s. In 1968 the government passed Law No. 32, which resulted in the establishment of a host of new banking rules and regulations. The law also formally established the CBK, which replaced the KCB as Kuwait’s central financial regulator in 1969. Though it has been updated several times over the past 45 years, Law No. 32 continues to serve as the backbone of Kuwait’s financial system today.

Nationalisation 

In line with several other Arab countries, in 1971 the CBK nationalised the banking system to ensure the economy’s long-term stability. In 1977 speculation on the stock exchange followed by a market correction resulted in the government bailing out many local investors. In response, the state put in place strict rules and regulations related to trading and other capital markets activities.

Souk Al Manakh

 In an effort to circumvent this new, stricter formal market, a number of local traders joined together to create a new, more informal stock exchange. The market, which was known as Souk Al Manakh, attracted a large number of young investors, many of whom became wealthy as a result of the newly booming oil market. Trades on the Souk Al Manakh were carried out primarily via post-dated cheques. In August 1982 one of these debt transactions bounced and subsequently brought down the entire market. By the time the MoF intervened and shut down the bourse, total debts were estimated at around $26bn in 1983 dollars, and only one domestic financial institution – NBK – remained solvent. The MoF and the CBK promptly drew up and instituted a long-term recovery plan for Kuwait’s financial system. Part of this plan involved the establishment of the Kuwait Stock Exchange (KSE) in 1983 (see Capital Markets chapter).

The government’s recovery programme was still under way in 1990 when the Gulf War threw Kuwait’s financial system into disarray. As a result of the Iraqi invasion, Kuwait’s banking system was shut down from December 1990 to late March 1991. Institutions lost records and employees – many of whom were foreigners – fled, while large amounts of capital were stolen. When the war ended the CBK drew up a reconstruction plan, which involved invalidating stolen currency, issuing a new Kuwaiti dinar, reconstituting and recapitalising banks and other financial institutions, and ensuring citizens were able to access their money.

Rebuilding the financial sector for the third time in three decades was a slow process. Nonetheless, by the mid-1990s most of Kuwait’s banks were once again self-sufficient and on a growth track. From the late 1990s onward the country’s financial system expanded exponentially on the back of booming oil prices and rapid growth in international and regional markets.

During this period local investment companies (ICs) borrowed large amounts of cheap credit from Kuwaiti banks to invest in real estate and the stock market. With the property and equity markets booming through the early 2000s, this practice seemed like a safe and easy way to turn a profit. As a result of this effort, many ICs were left holding large amounts of debt following the 2007-08 international economic downturn.

Although Kuwait’s banking sector as a whole was relatively well insulated against the crisis, some individual banks reported a jump in non-performing loans in 2008. For example, Gulf Bank, which is today Kuwait’s fourth-largest lender, was hit particularly hard after the crisis as a direct result of the institution’s foreign derivatives trading business (see analysis).

Quick Response

The CBK and other government entities were quick to react in the wake of the downturn. In a successful effort to avoid a bank run, the government announced that it would guarantee all deposits of any size in all Kuwaiti banks in the immediate aftermath of the crisis. In March 2009 the CBK introduced the Financial Stability Law (FSL), which was developed to support those domestic financial institutions – primarily ICs – that had been particularly hard hit by the downturn. In 2009, 2010 and 2011 a handful of local investment firms entered debt restructuring under the FSL, including Gulf Investment House, in a KD49.5m ($170.5m) deal; the Noor Financial Investment Company, with a KD62.5m ($215.3m) deal; and The Investment Dar, in a KD813m ($2.8bn) deal.

In 2010 the government introduced the Capital Markets Law (CML), a new legislative framework for the capital markets sector. The CML also resulted in the establishment of a new market regulator, the Capital Markets Authority (CMA), which has a mandate to ensure that the KSE operates in line with best practices and to simultaneously deepen and widen the capital market by developing and launching new products and attracting new listings and investors. Kuwait’s domestic banks, all of which are listed on the local bourse, fall under the supervision of the CMA in this regard (see Capital Markets chapter).

As a result of these recovery measures, Kuwait’s banking sector has seen a steadily improving performance since 2011-12. Most banks today are sitting on large amounts of cash reserves as a result of heavy provisioning against bad loans after the downturn. With this in mind, the sector as a whole is currently well positioned to lend to both individuals and businesses. While credit issuance in particular has grown in recent years, the government is also working to encourage additional lending (see analysis).

Turnaround 

Recent data from the CBK reflects the industry’s strong performance over the past few years in particular. As of the end of 2014 Kuwait’s domestic banking sector held assets of KD55.46bn ($191.1bn), up considerably from KD51.48bn ($177.4bn) at the end of the previous year, KD47.15bn ($162.4bn) at the end of 2012 and KD44.08bn ($151.9bn) at the end of 2011.

It is perhaps a sign of the banking sector’s overall stability that asset growth slowed but did not come to a halt during the downturn. Total sector assets grew from KD26.99bn ($93bn) at the end of 2006 to KD35.55bn ($122.5bn) at the end of 2007, KD39.24bn ($135.2bn) at the end of 2008 and KD40.35bn ($139bn) at the end of 2009. Deposits have also grown substantially in recent years. At the end of 2014 total customer deposits – including government deposits – held by local banks had reached KD37.62bn ($129.6bn), up slightly from KD36.44bn ($125.5bn) at the end of 2013 and KD33.5bn ($115.4bn) at the end of 2012, according to CBK data.

Bank profits have grown considerably since the downturn, largely in inverse proportion to provisioning. In 2008, according to KIPCO Asset Management Company (KAMCO), the sector posted profits of around KD300m ($1.03bn), compared to provisions of nearly KD900m ($3.1bn). By 2013 overall profits had almost doubled to more than KD500m ($1.72bn), while provisioning over the course of the year had declined to around KD700m ($2.41bn).

These figures are perhaps best understood in conjunction with loan data, which shows steadily improving quality among banks’ loan portfolios over the past eight years. According to KAMCO, at the end of 2009 Kuwait’s banks were sitting on KD2.99bn ($10.3bn) in non-performing loans (NPLs), which was equal to 10.3% of the sector’s overall credit portfolio.

Through the institution of heavy provisioning efforts and various other initiatives that were meant to shield the country’s banks from bad debt, these figures had fallen to KD2.49bn ($8.58bn) and 8.5% by the close of 2010; KD2.02bn ($6.96bn) and 6.6% by year-end 2011; KD1.87bn ($6.44bn) and 5.6% as of the end of 2012; and KD1.7bn ($5.86bn) and 4.7% by the close of 2013. In December 2014 the IMF reported that the gross NPL rate as a ratio of total loans was at 3.5%.

Shoring Up

These improvements in the sector are largely a result of the CBK’s effort to encourage banks to improve their corporate oversight, internal governance, business practices and overall transparency in recent years. In addition to the FSL and the CMA, both of which are widely acknowledged as having had a positive impact on the industry as a whole, the central bank has since 2012 instituted a steady stream of new rules and regulations aimed at fortifying the sector against any future shocks. As part of these efforts the CBK introduced a thoroughly revised corporate governance law in June 2012. Implemented in mid-2013, the new law required banks to invest in their risk management departments and improve financial reporting.

Kuwait’s implementation plan for Basel III capital regulations is another important plank in the government’s recent efforts to ensure long-term stability in the banking sector. In early February 2014 the CBK announced that it would mandate phased Basel III implementation over the following five years, with full implementation to take place by January 1, 2019.

This long implementation period – which is in line with targets introduced by the Basel Committee on Banking Supervision – is ostensibly meant to give institutions time to build up their capital reserves. In Kuwait, however, most banks already boast capital adequacy ratios (CARs) well above the expected future minimum of 13%, and similarly high rates of liquidity. Indeed, by the end of September 2014 the banking sector’s overall CAR was at 18.3%, according to the IMF, down slightly from 18.9% at the end of 2013, but up significantly from before 2010. At the end of 2008, for example, Kuwait’s CAR was at 15.6%, though by the end of 2009 it had already grown to 16.7% (as a result of provisioning), according to KAMCO. Additional Basel III recommendations – including the introduction of liquidity and leverage ratios, a capital conservation buffer, stricter conditions for tier 2 capital and the complete elimination of tier 3 capital, the latter of which is considered to be relatively high risk by the Basel Committee – are either already in place in Kuwait, or are expected to be fully instituted by 2019.

Facta

Signed into law in March 2010 and effective January 2013, the Foreign Account Tax Compliance Act (FACTA) is a piece of US legislation that is designed to identify and prevent tax evasion by US citizens using foreign bank accounts. The law requires foreign banking institutions to provide the US tax agency, the Inland Revenue Agency (IRA), with the details of any accounts controlled by US citizens, US Green Card holders or some US-owned businesses. Foreign financial institutions that fail to provide this information are subject to a 30% withholding levy on all transactions that pass through US banking institutions.

At the personal level, all affected individuals must ensure that they declare global assets and earnings via an annual IRS tax return, even if they are not resident in the US or have no US holdings or earnings.

In April 2015, Kuwait signed a tax compliance agreement with the US, thereby establishing the expectation that all Kuwaiti banks will provide the applicable account information for 2014 by September 2015. In Kuwait’s case, local banks provide the necessary data to the MoF, which is responsible for the subsequent transmission to the IRS. Training and systems revisions are now under way to facilitate these data transfers.

Market Organization

Kuwait’s banking sector is highly concentrated, with the country’s top five largest banks holding 82.3% of total assets as of the end of the third quarter of 2014, and the top two institutions – NBK and KFH – accounting for 57.8% of total assets in the same period, according to data from KAMCO. NBK alone, which is the single largest bank in Kuwait and, according to a recent ranking in Gulf Business magazine, the sixth-largest bank in the GCC, accounted for 32.3% of total banking assets in Kuwait as of the end of September 2014, based on KAMCO data. KFH was in second place with 25.4% of total banking assets, followed by Burgan Bank with 11.1%, Gulf Bank with 7.7% and the Commercial Bank of Kuwait (CMBK) with 5.8%.

The banking sector makes up nearly half of market capitalisation on the KSE. As of the end of 2014 banks were the largest sector on the bourse, with 49% of total listed firms by market capitalisation, followed by telecoms listings with 11%, financial services with 10% and industrials with 9%, according to KAMCO.

Similarly, NBK and KFH are the first- and second-largest listed companies on the KSE, with the former accounting for 14.7% and the latter accounting for 10.5% of total bourse capitalisation. Six of the top 10 largest companies listed on the KSE at the end of 2014 were banks. In addition to NBK and KFH, other institutions on this list included Ahli United Bank (AUB), Burgan Bank, Al Ahli Bank of Kuwait (ABK) and CMBK.

Sharia-Compliant

Kuwait is home to a growing Islamic banking industry, with the market share of local Islamic banks increasing from 23% of banking system assets at the end of 2005 to 39% by the end of June 2014. As of the end of 2014 five of the nation’s 11 banks carried out business in line with sharia principles, according to the CBK, while in April 2014 CMBK announced that it had also received approval from its shareholders to make the switch from conventional to Islamic banking. The bank will join KFH, Boubyan Bank, Kuwait International Bank, AUB and Warba Bank in the sharia-compliant arena, which is widely considered to be a growth market. In the first nine months of 2013 – the most recent period for which data was available at time of publication – Islamic banking assets in Kuwait grew by 8.7%, compared to 7.1% expansion among the banking sector as a whole. By the end of September 2013 total sharia-compliant assets in the country had reached KD22.5bn ($77.52bn), which was equal to around 45.2% of total banking assets. This figure was up from around 43.5% of total banking assets in the same period the previous year.

Most local players expect to see continued growth for the foreseeable future. “As for Islamic banks and financial institutions, whether in Kuwait or the whole region, we are greatly optimistic,” Adel Al Majed, the CEO of Boubyan Bank, told local media in April 2014. “All indicators show an increasing demand for Islamic banking and financial products and services, which have become very popular even for non-Muslims, as the matter has to do not only with sharia but also with the service provided to customers.”

NBK

NBK is both the oldest and largest bank in Kuwait by a considerable degree. The institution leads the market in terms of total assets, deposits, lending and stock market capitalisation. In 2014 NBK reported net profits of KD261.8m ($902m) for the year, up from KD238.1m ($820.3m) the previous year. This jump in profits was accompanied by a 17% increase in total assets, to KD21.8bn ($75.11bn). A major contributing factor to the large jump in profits in 2014 was NBK’s 2012 acquisition of 58.4% of the Islamic lender Boubyan Bank, which cut into profits in 2012 and 2013 but has now begun to pay off. “A fundamental change in Boubyan Bank has been witnessed in growth and profitability trends,” Nasser Al Sayer, the chairman of NBK, told local media in early March 2015. “NBK will continue to support Boubyan Bank by providing the bank with expertise and guidance. NBK is fully committed to the independence of the two banks according to the provisions of sharia law.”

As of the end of 2013 NBK held 32% of total bank deposits and nearly 31% of the total sector loan portfolio, according to data from KAMCO. Given NBK’s strong recent performance, these figures are expected to have gone up in 2014 and early 2015. Much of the bank’s recent growth can be chalked up to its various foreign business interests. In addition to Kuwait, NBK is currently active in more than 15 countries, including Saudi Arabia, Bahrain, the UAE, Turkey, Egypt, Jordan, the US, the UK, France, Switzerland and China, among others. In 2014 the institution sold its 30% stake in the International Bank of Qatar, partly in order to free up capital to expand elsewhere in Qatar and in other GCC markets, which remain NBK’s primary focus.

KFH

Kuwait’s second-largest bank, KFH, is also the second-largest Islamic financial institution in the world, boasting assets of KD17.2bn ($59.26bn) at the end of 2014, up 12.4% from KD15.3bn ($52.71bn) at the end of 2013. The bank reported profits of KD126.5m ($435.8m) in 2014, up 9.1% over the previous year. As a sharia-compliant bank, KFH distributes most of its annual profits among its shareholders.

Founded in 1977, KFH was the first sharia-compliant financial institution to set up shop in Kuwait. Just over 50% of the bank is listed on the KSE, while the remainder is held by a number of key government entities, including the Public Authority for Investment, the General Organisation for Social Insurance, the General Secretariat of Awqaf and the General Authority for Minors Affairs, among others.

KFH, like NBK, is active in numerous markets, including the UAE, Bahrain, Saudi Arabia, Malaysia and Turkey, among others. In 2013 the bank completed a fiveyear transformation programme, which saw KFH consolidate its business into three umbrella entities: KFH Capital, KFH Investment and KFH Real Estate.

Other initiatives implemented under the transformation programme were aimed at upgrading the corporate governance and risk management departments, and diversifying the firm’s revenue streams.

Other Banks

Rounding out Kuwait’s top-five banking institutions are Burgan Bank, Gulf Bank and CMBK. Burgan Bank, which was established in 1977 by a group of local investors, is today controlled by KIPCO, which owns more than 40% of the institution. Other key shareholders include the Public Institution for Social Security, which owns 8%, and United Gulf Bank, which is based in Bahrain and controls 17% of Burgan. Some 33% of the bank is listed on the KSE. In 2014 Burgan reported net profits of KD61.8m ($213m) on the back of rising operating profits of KD153.5m ($529m), the latter of which was up 9% on the previous year.

Like many other banks in Kuwait, Burgan has engaged in heavy provisioning in recent years and has paid down NPLs. By the end of 2014 the institution’s nonperforming assets were at just 1.5% of gross assets, and the bank’s NPL coverage ratio stood at 278%.

“In 2014 we initiated our capital optimisation plan that yielded more than KD300m ($1.03bn) in proceeds to adjust for Basel III requirements and to further support our growth plans,” Majed Essa Al Ajeel, Burgan Bank’s chairman, told local media in early 2015.

Gulf Bank, meanwhile, was launched in 1960. Today just over 50% of the institution is publicly listed on the KSE, while the remainder is held by the Kuwait Investment Authority and a handful of other institutional and private investors. In 2014 Gulf Bank posted net profits of KD35.5m ($122.3m), up 10% over the previous year. Increasing the bank’s credit facilities has been a key area of focus in recent years. In 2014 the bank reported a 9% jump in market share in loans, due primarily to a 23% increase in retail lending.

“I am pleased to report that we have continued the progress of previous years, even accelerated it,” said Cesar Gonzalez-Bueno, the CEO of Gulf Bank, in a press release in January 2015. “The bank’s capital adequacy ratio per the new Basel III regulations is 15.5% against the regulatory requirement of 12%.”

Founded in June 1960, CMBK is the second-oldest bank in the country, and the fifth-largest by assets as of the end of 2014, at KD4.2bn ($14.47bn), up 7.2% from the previous year. The bank reported a 7.7% rise in operating income for the year, due primarily to a jump in fees and commissions income.

CMBK has written off around KD505.5m ($1.74bn) of bad debt over the past five years. As of the end of 2014 the bank’s NPL coverage ratio was at 752%, nearly double the end-2013 rate of 367%.

Other domestic banks include Boubyan Bank, Warba Bank, Kuwait International Bank and ABK, the latter of which is the largest and, with KD3.5bn ($12.1bn) worth of total assets in 2014, is approaching the topfive. ABK’s profits for 2014 reached KD37.6m ($129.5m), up 6.2% from the KD35.4m ($122m) posted the previous year. The bank has historically pursued a more conservative strategy, allowing it to post a capital adequacy ratio of 23.68% at the end of 2014, compared to the minimum of 13% set by the CBK. However, according to the company’s most recent annual report, the bank will now be adopting a more assertive approach to ensure that it can continue to adapt to new market opportunities as they arise, potentially leading to a period of accelerated expansion.

Outlook

Despite a variety of challenges, Kuwait’s banking sector is widely expected to post solid growth for the foreseeable future. By almost all metrics Kuwait’s overall fiscal position remains strong. The government’s sovereign net foreign assets were valued at 269% of GDP at the end of the 2014 – the highest of any rated sovereign, according to Fitch – and government debt was at just 5.3% of GDP during the same period. Furthermore, unlike some of its peers in the GCC, Kuwait’s fiscal break-even oil price is below $50 per barrel, which has served it in good stead in a period of price volatility. Finally, the strong recovery of the banking sector over the past eight years has contributed to its improving reputation among the domestic population and potential foreign investors alike, which bodes well for future expansion. Taking these factors into account, most local players seem well positioned to enjoy continued growth going forward.