Strength in numbers: After years of provisioning, the sector is poised for expansion

Despite a variety of ongoing challenges, Kuwait’s banking sector has performed well in recent years. The country’s 10 local banks and 11 foreign players make up one of the oldest banking sectors in the region and the third-largest in the GCC, with total assets of KD48.8bn ($174.3bn) at the end of March 2013. In 2012 the industry saw asset growth of around 11%, profit growth of around 3% and, perhaps most importantly, a 5% jump in lending, the highest expansion of credit issuance since 2009.

STATE INVOLVEMENT: Like many other sectors in Kuwait, the banking industry is primarily government driven, with public deposits accounting for a substantial percentage of total bank holdings. Since the 2007-08 international financial downturn, the government – and particularly the Central Bank of Kuwait (CBK) – has led the recovery effort. A handful of new laws and regulations have had a positive impact on corporate governance and risk management at many institutions, for example, which bodes well for future expansion. Kuwait’s banking sector is well positioned to contribute to, and benefit from, a number of upcoming economic initiatives, particularly the government’s National Development Plan (NDP), which is currently in progress. “In general, banks have done better in 2012 and early 2013 than previously,” Hamad Ali Al Hasawi, the secretary general of the Kuwait Banking Association, an industry organisation, told OBG in early 2013. “At this point recovery is clearly under way.”

NEW REGULATIONS: Despite the solid recent performance, the industry faces a wide variety of challenges. While Kuwait was relatively well insulated against the direct effects of the financial downturn, the country has been negatively affected by the ongoing credit crunch in the EU and the US. Additionally, a number of local non-bank financial institutions suffered as a result of holding substantial real estate investments when the crisis hit. Consequently, the economy has yet to bounce back to the highs of the early and mid-2000s. Activity at the Kuwait Stock Exchange (KSE) has remained somewhat sluggish since the downturn, and a handful of local investment firms are in the midst of a series of debt restructuring efforts. Finally, the government’s new regulatory regime has also put substantial pressure on many financial institutions. “Many banks feel that it could take some time to fully adjust to the banking sector’s new corporate governance regulations,” said Sami H Al Alanbaee, the manager of the CBK’s economic research department. “This adjustment will be costly, but it is considered to be necessary to the future development of the sector.”

While the CBK’s new regulations could potentially have a negative short-term impact on operating profits, most local players agree that in the long run the sector will benefit from the new regulatory environment, which has the potential to result in a jump in incoming economic activity. The banking industry is well situated to take advantage of these opportunities. As a result of years of heavy provisioning since the downturn, most banks are currently sitting on a substantial amount of liquidity, and, in most cases, rapidly declining amounts of bad debt. With this in mind, in recent years local institutions have been casting around for new investment prospects. While these issues represent a challenge to Kuwait’s banks moving forward, in general the sector is expected to expand considerably in the coming years.

EARLY HISTORY: Kuwait’s banking sector can be traced to 1941, when a handful of British investors launched the country’s first bank under a 30-year concession granted by the then-emir, Sheikh Ahmad Al Jaber Al Sabah. When the concession ran out in 1971 the government bought a controlling share of the bank and it became the Bank of Kuwait and the Middle East (BKME). Meanwhile, in 1952 a small group of local merchants launched the National Bank of Kuwait (NBK), which today is one of the largest and oldest financial institutions in the GCC region. The NBK is also one of the first shareholding firms in the Gulf: when it was established the founders issued just over 13,000 shares at around 1000 Indian rupees each. Prior to the development of the Kuwaiti dinar in 1961, a variety of regional currencies circulated in the country, including the Indian rupee and the short-lived Gulf rupee. The dinar was established and issued by the Kuwaiti Currency Board, which was set up in 1960 with a mandate to establish an independent currency for the new country.

SECTOR FRAMEWORK: In 1968 the government passed Law No. 32, which laid out a comprehensive framework for monetary policy and banking, and still serves as the backbone of the financial system today. The new law replaced the Kuwaiti Currency Board with the CBK in April 1969. The new central bank had a broad mandate, which included managing the dinar, directing the credit policy (i.e. interest rates) with an eye to encouraging economic development, supervising the banking system, and overseeing the government’s financial affairs. These four points remain the CBK’s primary duties today.

Just before and in the years that followed independence in 1961, a number of new domestic banks set up shop in Kuwait, including both the Commercial Bank of Kuwait (CMBK) and Gulf Bank in 1960, Al Ahli Bank in 1967 and the aforementioned BKME in 1971. During this period, the government also launched a number of specialised banks, including the Credit and Savings Bank in 1965 and the Industrial Bank of Kuwait in 1974. In 1971 Kuwait nationalised its banking system, which cleared a path for even more rapid growth in the domestic segment. Additionally, in the early 1970s the government became a leading proponent of the development of the Islamic financial services (IFS) sector, which formally kicked off in Kuwait in 1977 when the state launched Kuwait Finance House (KFH) under special decree. Today KFH is the second-largest IFS institution in the world, according to Ernst & Young.

GROWTH CYCLES: Strong economic growth through the 1970s led to speculation on the KSE, which, in turn, resulted in a minor market correction in 1977. In response to the bust, the government introduced stricter regulations and bailed out the affected investors. The bailout contributed to the subsequent establishment and rapid expansion of the Souk Al Manakh, an unofficial, unregulated exchange dealing mostly in speculative financial instruments and post-dated cheques. In August 1982 this market crashed as well, and due to its sheer size – estimates put the total outstanding value of post-dated cheques on the souk at the time of its crash at around $94bn – the losses reverberated around Kuwait’s financial sector and the GCC region at large (see Capital Markets chapter). When the dust settled the only domestic financial institution still solvent was NBK. In the wake of the 1982 downturn, the government implemented a programme to save the other banks.

This initiative was still under way in the early 1990s, when the 1990-91 Gulf War effectively halted economic activity in Kuwait. After the conflict ended, the government purchased a substantial percentage of the banking sector’s domestic credit portfolio in exchange for bonds from local institutions, thereby freeing the local population of debt and wiping out non-performing loans in the banking sector in one fell swoop. This had the intended effect of allowing the country to focus on rebuilding and recovery.

In the early 1990s the CBK introduced a raft of legislation aimed at boosting transparency, corporate governance and risk management in Kuwait’s financial sectors. This resulted in rapidly expanding activity. Indeed, local financial institutions grew steadily through the 1990s and into the early and mid-2000s. From KD10.97bn ($39.2bn) in total banking sector assets at the end of 1994, for example, the sector grew to KD12.91bn ($46.1bn) by the end of 1999, KD17.1bn ($61.1bn) by the end of 2002 and KD39.2bn ($140bn) by the end of 2008, according to the CBK. This rapid period of growth came to an end during the 2007-08 global economic crisis, largely as a result of the fact that many banks were fairly heavily exposed to real estate and securities, both of which took a hit in the wake of the downturn.

OVERSIGHT & MONETARY POLICY: The CBK has instituted a number of major amendments to the 1968 Central Bank Law. In 2003 the regulator introduced an amendment that codified the regulatory framework in regard to sharia-compliant financial tools, which up until that point was not mentioned explicitly in the law (see Islamic Financial Services chapter). In 2004 the institution passed Law No. 28, which overhauled the sector’s regulatory framework in line with best international practice. The 2004 legislation also liberalised the banking industry and allowed foreign banks to set up shop in Kuwait for the first time since the sector was nationalised in 1971. Under the law, foreign institutions are allowed to open only one branch in Kuwait, and they are banned from carrying out retail banking of any kind.

CENTRAL ROLE: The CBK has played a key role since the downturn as well. In November 2008, for instance, the central bank announced that it would guarantee all bank deposits of any size in Kuwait, including foreign deposits. In March 2009 the bank introduced the Financial Stability Law, which set up a formal process for debt restructuring among local companies. Additionally, in the years since the crisis, the CBK has injected liquidity into the banking system in a variety of ways; it has brought down the discount rate substantially, from 6.3% at the end of 2006 to 2% as of early 2013, and instituted a number of new laws in an effort to assist struggling institutions and strengthen the system as a whole.

Finally, perhaps the most important response to the downturn was the February 2010 introduction of the Capital Markets Law, which established the Capital Markets Authority, a new regulator for investment-related firms and stock market. Prior to the establishment of the new regulatory regime, Kuwait’s investment sector was overseen primarily by the CBK (see Capital Markets chapter).

Most recently, in June 2012 the CBK announced a raft of new corporate governance rules, aimed specifically at Kuwaiti banks. Replacing the 2004 law, the new legislation requires that deposit-taking financial institutions shore up their risk management regimes, improve internal oversight and reporting, and work to protect shareholder interests, among other goals. The banking sector has responded mostly positively to the new rules.

“The CBK’s stance now is conservative, which is good in such bad times in the global economy,” said Eduardo Eguren, the CEO of Burgan Bank, the third-largest local bank by assets. “I am optimistic that the central bank will work with the banks to put together a strategy that will be best for the country.” At the same time, however, the new regulations have attracted criticism from other players. Michel Accad, the CEO of Gulf Bank, told OBG. “Certain regulations that are supposed to protect the people end up making the banks’ lending criteria much more stringent.”

BY THE NUMBERS: While the downturn had a negative impact on growth rates among Kuwait-based banks, the sector continued to expand through the crisis, albeit at a slower rate than before. As previously mentioned, as of the end of March 2013 the domestic banking sector boasted total assets of KD48.8bn ($174.3bn), up from KD47.3bn ($168.9bn) at the end of 2012, KD44.1bn ($157.5bn) at the end of 2011 and KD41.4bn ($147.9bn) at the end of 2010. In general since the downturn most local banks have dedicated a substantial percentage of their capital to provisioning, with the result being a decline in non-performing loans (NPLs). According to the IMF’s 2012 Article IV Report, the ratio of gross NPLs to total loans in Kuwait has dropped from a high of 10.3% in 2009 to around 5.5% at the end of October 2012. At the same time, most institutions continue to boast high provisions-to-NPL ratios. CMBK, with an end-2012 ratio (excluding collateral) of 169%, was the country’s strongest bank in this regard, followed by NBK at 152%. KFH, meanwhile, which was hit especially hard during the downturn, had a provisions-to-NPL ratio of 69%, which was the lowest in the country as of the end of 2012. KFH, which is in the midst of restructuring, has written off a substantial amount of bad debt in recent years, which has contributed to this figure.

According to NBK data, credit issuance by Kuwait’s domestic banks increased by around 5% over the course of 2012 to reach KD26.9bn ($96.07bn). While relatively modest by regional standards, this is a considerable gain on Kuwait’s 2011 credit growth rate of 1.6% and the 2010 rate of just 0.4%, according to CBK figures. The 2012 increase was closely related to the high liquidity levels at most banks and was considered to be a signal of a potential turnaround in lending trends. Personal loans accounted for around 87% of new credit issued in Kuwait in 2012. Indeed, while personal loans have generally accounted for a minority of the banking sector’s overall loan portfolio – around 37% as of the end of 2012 – the Domestic banking assets, 2006-12 personal segment has driven credit growth in recent years. This can be attributed primarily to rising salaries in the public sector, which have had a commensurate impact on purchasing power throughout the population. “We are currently at a tipping point and can see a scenario where the domestic condition will be relatively more favourable for Kuwaiti banks,” Paul-Henri Pruvost, an analyst at the international credit ratings agency Standard & Poor’s, told local press in April 2013. “What has really helped Kuwaiti banks in terms of growth is the retail element.”

Additionally, the revival of the NDP over the course of 2013 and 2014 is expected to result in a considerable boost in corporate lending in Kuwait for the foreseeable future. According to a recent report released by EFG Hermes, an Egyptian financial services company, the country is expected to see additional credit growth of 6-7% over the course of 2013. As of the end of April 2013 total loan issuance was recorded at KD27.5bn ($98.2bn).

ON THE EXCHANGE: The banking sector dominates the KSE, accounting for around 46% of the exchange’s total market capitalisation as of the end of 2012. In 2012 the segment saw a decline in market performance of around 0.3%, with KSE net banking profits worth KD618m ($2.2bn) at the end of the year. This drop reflects the sector’s heavy provisioning and increase in credit facilities, not to mention the widespread lack of investor confidence on the exchange recently (see Capital Markets chapter).

MAJOR PLAYERS: The market is heavily concentrated at the top, with NBK and KFH – the two largest financial institutions by a substantial degree – together accounted for almost 66% of total banking assets at the end of 2012. Islamic banks, a number of which have set up shop in the country in recent years, accounted for about 42% of total banking assets as of the end of September 2012, up from around 39% at the end of 2011, according to data from KFH, which is the largest sharia-compliant lender by a wide margin. In addition to the domestic banks, since 2004 a number of foreign banks have established branches in Kuwait. As of the end of 2012 there were 11 foreign banks carrying out corporate business in Kuwait, including the Saudi Arabia-based Al Rajhi Bank, which is the largest Islamic financial institution in the world; the National Bank of Abu Dhabi; Qatar National Bank; and HSBC Middle East, a subsidiary of the UK-based HSBC, among others.

NBK: Kuwait’s banking landscape is dominated by NBK, which is the largest local lending institution by assets, deposits and credit issuance. In 2012 NBK brought in some KD305.1m ($1.09bn) in net profits, up from KD302.4m ($1.08bn) in 2011, and bringing the bank’s total asset base to KD16.4bn ($58.6bn) at the end of 2012. This figure was equal to nearly 35% of total banking sector assets at the time. As one of the oldest banks in the Middle East, NBK has established itself as a major international player over the years. In addition to 64 branches in Kuwait, the institution oversees 109 branches outside the country. Indeed, the bank is active in most major banking markets throughout the Middle East and around the world, and holds shares in subsidiary companies in the UK, Turkey, Switzerland, Qatar, Lebanon, Iraq, Egypt, Bahrain and the Cayman Islands. In 2012 NBK’s international banking profits jumped nearly 23% year-on-year. Nearly 95% of the bank is listed on the KSE, with the government’s Public Institution for Social Security owning the remaining 5%.

Among Kuwait-based financial institutions, NBK was widely considered to be the top performer during the 2007-08 downturn. The institution’s strong capital position meant that it was well placed to deal with NPLs, for example. Indeed, as of December 2012 the bank’s provisions-to-NPL coverage ratio stood at 152%, while the NPL to total loans ratio was just under 3%, which was the lowest in the domestic market. In recent years NBK has worked to diversify its income streams considerably. In 2012 the bank increased its stake in Boubyan Bank, a local Islamic institution, to more than 58%, after acquiring some 47% of the bank over the past few years.

Sharia-compliant banking is considered to be a centrepiece of NBK’s plans moving forward. The institution is also expected to play a major role in the upcoming NDP. “The recent directions from the highest authority and the proposed measures to boost economic activity and spur growth are expected to lift the overall sentiment and create new opportunities in the local economy,” Ibrahim Dabdoub, NBK’s CEO, said in a press release in early 2013.

KFH: KFH, with KD14.7bn ($52.5bn) in assets at the end of 2012, is both Kuwait’s second-largest lender by total holdings and the second-largest Islamic bank in the world. The bank accounts for more than 31% of Kuwait’s total banking assets and more than 71% of total sharia-compliant banking assets. KFH was launched in March 1977, which makes it one of the world’s oldest existing Islamic financial institutions. Today, around 49% of the bank is owned by various government institutions – including the Kuwait Investment Authority, the country’s sovereign wealth fund, which holds around 24% of KFH – while the remaining 51% is listed on the KSE. The bank is active in many major, and predominantly Islamic, markets around the world, including Malaysia, Saudi Arabia, Turkey and Bahrain. Due primarily to its substantial property holdings, KFH was hit relatively hard by the economic downturn. After the crisis the bank implemented a transformation programme, with the goal of improving corporate governance and risk management, boosting asset quality and ramping up operational revenues. The programme appears to have had the intended effect so far. Indeed, in 2012 the bank put KD255.3m ($911.8m) towards provisioning, thereby reducing the NPL ratio from 9.3% in 2011 to 5.3% at the end of 2012.

BURGAN BANK: Burgan Bank, meanwhile, posted net profits of KD55.6m ($198.6m) in 2012, bringing the bank’s assets to KD5.9bn ($21.07bn), or around 12.5% of total sector assets. Burgan, which was established in 1975, is a subsidiary of the Kuwait Projects Company, an international investment firm. Since the downturn the institution has expanded aggressively in a variety of foreign markets, acquiring a number of international institutions, including Eurobank Tekfen in December 2012, an Istanbul-based bank (see analysis). “For the banking sector to progress banks must be adaptable, resilient, and focus on organic growth,” said Eguren, Burgan’s CEO. “You cannot be successful in acquisitions if you are not effective at driving growth in the core market.”

OTHER PLAYERS: Gulf Bank and CMBK boasted total assets, respectively, of KD4.8bn ($17.1bn) and KD3.7bn ($13.2bn) at the end of 2012. Both banks have provisioned heavily against NPLs, and as of the end of 2012 were sitting on a substantial amount of liquidity. “Unlike many other markets, in Kuwait it is not the lack of liquidity that is the issue,” said Carlos Ribeiro, Gulf Bank’s CFO. “Here we have quite a lot of liquidity, but we lack opportunities to deploy it.” Other domestic banks include, on the conventional side, the Commercial Bank of Kuwait and Al Ahli Bank of Kuwait; and on the Islamic side, the aforementioned Boubyan Bank, the International Bank of Kuwait, Al Ahli United Bank and Warba Bank.

OUTLOOK: While the solid financial performance of Kuwait-based banks in 2012 was widely considered to be the beginning of a period of growth, some challenges still remain. “In 2012 the banking sector did much better than it did in 2011,” the CBK’s Al Alanbaee told OBG. “The sector is well capitalised and has high liquidity rates. Nonetheless, caution is called for.” Indeed, due to slow growth in the wider economy, opportunities for expansion within the local market are few and far between.

Due to price competition and the relatively conservative regulatory environment, most banks have seen downward pressure on margins in recent years, though this could very well change as NDP-related projects begin to move into the financing phase. At the same time, local banks have retained some exposure to bad assets, primarily in the form of struggling local investment companies or debt-laden real estate. Resolving these issues remains a central concern at most local financial institutions.

That said, despite the challenging economic environment, Kuwait’s top banks all posted profits in 2012, and many local institutions are looking forward to continued expansion over the short to medium term. Indeed, Kuwait-based lenders stand to be major potential beneficiaries of a number of upcoming initiatives. In addition to the NDP, which is expected to be perhaps the single-most important contributor to economic growth in Kuwait for the foreseeable future, some banks have begun to look into expanding their business outside the country.

Additionally, the planned privatisation of the KSE will likely have a positive impact on investment activity in the country, which, in turn, bodes well for local financial institutions (see Capital Markets chapter). With these opportunities in mind, Kuwait’s banks are looking forward to a bright and promising future.

Ratio of non-performing loans to total loans, 2006-12