A strong focus on improving asset quality and ramping up reserves has paid dividends

Kuwait’s banking sector has consistently posted solid growth in recent years, with this coming on the back of strong economic activity both at home and throughout the Gulf as a whole. The industry, which comprises 11 local banks and 11 foreign banks, is widely considered to be the backbone of the country’s non-oil economy, and is one of the oldest banking sectors in the region. As of the end of March 2014, local banks had total assets of KD54.1bn ($190.2bn), according to data from the Central Bank of Kuwait (CBK).

Background

Lending opportunities have expanded considerably in recent years, after half a decade of stagnant credit growth in the wake of the 2007-08 international economic downturn. Kuwait’s banking sector has been steadily improving over the course of 2013 and early 2014, both in terms of financial performance and overall stability and transparency. With this in mind, optimism is prevalent among sector analysts. While this outlook is broadly shared across the banking sector, the industry continues to face a number of challenges. Indeed, although balance sheets throughout the industry have improved markedly in recent years, many banks continue to have major holdings in real estate and equities, both of which lost value in the wake of the downturn.

After a number of years of heavy provisioning against these debts, many banks now hold considerable amounts of liquidity, which they have been deploying in the form of credit to viable businesses and projects. “Demand for loans has picked up substantially over the past year, but we have the capacity to lend more,” Elham Yousry Mahfouz, the deputy CEO of the Commercial Bank of Kuwait, a major local financial institution, told OBG. “Given rising demand in 2012 and 2013 we are forecasting 5% corporate loan growth in 2014.”

Long History

Kuwait’s banking sector has been active since the early 1940s, which makes it one of the oldest formal financial industries in the GCC. The country’s first bank was established in 1941, when Sheikh Ahmad Al Jaber Al Sabah – Kuwait’s emir from 1921 to 1950 – granted a group of British investors a 30-year concession to set up and operate the institution. The government bought a controlling share in the bank in 1971, when the concession agreement expired, becoming the dominant shareholder in the institution that would eventually evolve into the Bank of Kuwait and the Middle East (BKME) and subsequently into the Ahli United Bank (AUB). During the previous three decades the nation’s financial industry had grown rapidly. The National Bank of Kuwait (NBK) – which is the single largest financial institution in the country today, and one of the largest in the region – was established by a handful of local merchants in 1952.

Maturity

Prior to independence in 1960, the small financial firms offering banking services in Kuwait dealt with a variety of regional currencies. Popular trading currencies during this period included the Indian rupee and the Gulf rupee, the latter of which was in circulation in the region for seven years, between 1959 and 1966. The Kuwaiti Currency Board (KCB), which was established in 1960, launched the dinar in 1961, and went on to serve as the young nation’s central financial regulator for the next decade. In April 1969 the KCB was replaced by the CBK, which was established under Law No. 32 of 1960. In addition to founding the central bank, the law set out a comprehensive collection of regulations and standards for banking and monetary policy in Kuwait, many of which continue to underpin the current banking system in the country.

The CBK, for example, was established with a four-pronged mandate to manage the dinar; direct Kuwait’s credit policy in order to encourage investment and economic development; regulate the banking system; and manage the state’s finances. These tenets underpin the central bank’s activities today.

In 1971 – the same year the state purchased a controlling share in BKME – the government nationalised the banking system, which was carried out with the goal of encouraging development in the sector. The state also established a handful of new banks during and just prior to this period, including, in 1965, the Credit and Savings Bank, and, in 1974, the Industrial Bank of Kuwait. Further, in 1977 the government issued a special decree to establish Kuwait Finance House (KFH), which remains one of the region’s oldest and largest Islamic financial institutions (see Islamic Financial Services chapter).

Volatile Period

From the 1970s through to the 1990s Kuwait’s banking system faced a variety of hurdles. In 1977, for example, the government bailed out a number of investors (and instituted a raft of new regulations) after a period of speculation at the formal equities exchange (the predecessor to the Kuwait Stock Exchange, KSE) resulted in a market correction. The bailout contributed to the formation and expansion of the Souk Al Manakh, an unregulated, informal securities exchange that was set up on the outskirts of Kuwait City in the late 1970s. This market operated almost entirely on the basis of debt transactions in the form of cheques, which fuelled high-volume, speculative trading activity through the early 1980s.

In August 1982 a bad cheque bounced, resulting in the crash of the Souk Al Manakh, which, in turn, led to a series of defaults that rippled throughout Kuwait’s financial sector. After the dust had settled, only NBK was left standing – the rest of the nation’s financial institutions were insolvent. The state responded by shutting down the informal market, bailing out the financial system and implementing a comprehensive plan to rebuild the industry. The KSE was formed a year in later, in August 1983. Finally, the 1990-91 Gulf War effectively destroyed Kuwait’s financial system once again, leading the state to once again bail out the country’s banks and put in place another plan to rebuild.

Recent Years

From the mid-1990s through 2007 Kuwait’s capital markets sector (not to mention the economy at large) grew rapidly on the back of low barriers to entry and cheap credit. During this period the banking system supported the expansion of a large number of investment companies (ICs), which borrowed heavily to invest in the property and equity markets, both of which were flourishing. When these segments dropped off in 2007-08, the ICs were left footing the bill. Many of these firms have since gone into debt restructuring, either on their own or under the state-run Financial Stability Law (FSL), which was introduced in March 2009. While most Kuwaiti banks were relatively well insulated against the direct effects of the crisis, most local institutions suffered as a result of their exposure to real estate and securities via the ICs.

Consequently, since the downturn, the banking sector as a whole has carried out a substantial amount of provisioning against non-performing loans (NPLs). This effort has been relatively successful thus far. Indeed, according to data from the IMF, the ratio of NPLs to the country’s overall loan portfolio was 4.4% as of the end of June 2013, the most recent data that was available at the time of writing. This is down from a high of 10.3% in 2009 and 7.06% at the end of 2011. Similarly, in June 2013 Kuwait’s banks had a provisioning ratio of some 107%, according to the IMF.

By Numbers

In general, the banking sector has posted steady growth since the downturn, and particularly since mid-2012. Total assets at local banks were at KD54.1bn ($190.2bn) at the end of the first quarter of 2014, up from KD51.5bn ($181.1bn) at the end of 2013, KD45.1bn ($158.6bn) at the end of 2012 and KD42.5bn ($149.4bn) at the end of 2011. Heavy provisioning over the past half decade has facilitated increased coverage and stability throughout the banking system.

According to the IMF, as of June 2013 “the banking system is resilient to potential shocks” and “high capitalisation, continued profitability, declining NPLs and high provisioning of the banking system support financial stability”. Indeed, the average capital adequacy ratio in the banking system as a whole was at 18.3% during this period – well above the future target ratio of 13% under Basel III standards, which are at present being implemented by the CBK in Kuwait. Some financial institutions currently boast capital adequacy ratios in excess of 20% (see analysis).

Despite the sector’s strong fiscal position, a handful of risks remain. The industry stands relatively exposed to real estate and equities, for example. As of the end of June 2013, roughly 18.5% of the sector’s total loans were concentrated directly in property, while equities accounted for a further 23% of banks’ total investment portfolio, according to IMF data. Similarly, loans to ICs made up around 4.8% of total loans during this period, though across the board, banks have been careful to maintain enough liquidity to cover risky credit.

Monetary Policy

The government has played a significant role in strengthening the nation’s banking system both before and after the downturn in 2007-08. In the years leading up to the crisis a number of new pieces of legislation were put forward, including a law that formalised standards for Islamic financial activity (2003), and a law that updated the regulatory framework in line with international standards and opened up the sector for foreign banks to compete for the first time since the 1971 nationalisation drive (2004). “Financial diversification is extremely important in a country such as Kuwait, where the government has complete control over the business sector,” Loai Mukamis, CEO of Kuwait International Bank (KIB), told OBG.

In the wake of the downturn, meanwhile, the CBK moved quickly to guarantee all deposits of any size in Kuwaiti banks and to establish the FSL, under which local companies that had been affected by the downturn were able to restructure their debt with government assistance. Additionally, since the downturn the central bank has reduced the discount interest rate from a high of 6.3% at the end of 2006, for example, down to 2% as of the end of March 2014.

In 2010 the government introduced the Capital Markets Law, which laid out a new regulatory framework for the country’s capital markets sector and created a new regulator, the Capital Markets Authority (CMA). This has had a significant impact on the financial sector as a whole. Banks, which make up the largest percentage of market capitalisation on the KSE, have been directly impacted by the new law (see Capital Markets chapter). “The biggest change under the CMA so far is that listed companies have been required to boost transparency considerably,” said Ziad Shehab, vice-president of the investment research department at the KIPCO Asset Management Company (KAMCO), a major local financial conglomerate. “The effect on the banking sector thus far has definitely been positive, but there is a learning curve,” he added.

Market Regulations

In June 2012 the CBK announced new legislation related to corporate governance in the banking sector. Broadly, the new rules required banking institutions to strengthen their internal oversight departments and shore up risk management across the board, with the objective of protecting investors and clients alike. Meeting the requirements laid out by the CMA and the 2012 corporate governance law has been a challenging and costly exercise for many financial institutions. “We need to meet all the regulatory entities which are active with enhancing our market and strengthening our competitiveness, and ultimately growing our business,” Thunayan Al Ghanim, general manager of the Treasury and Investment Department at KIB, told OBG.

Most recently, in February 2014 the government announced a plan to require local banks to institute Basel III standards by 2018, which is in line with the implementation targets put in place by the Basel Committee on Banking Supervision in April 2013.

“The major changes under Basel III relate to liquidity and capitalisation,” Mahfouz told OBG. “Because of the large amount of provisioning that has taken place here since the downturn, most Kuwaiti banks already meet – and in many cases surpass – these goals.” Indeed, according to the CBK’s instructions for implementing the Basel III standards, by the end of 2016 all domestic banks are expected to have raised their minimum capital adequacy ratio to at least 13%.

However, as of June 2013, the average capital adequacy ratio across the local banking sector was 18.3%, according to IMF data (see analysis). Liquidity rates were also similarly high.

Major Sector Players

The banking sector represents the single largest component of listed companies on the KSE, accounting for 47% of market capitalisation on the bourse at the end of 2013, according to data from KAMCO. NBK was the largest company on the exchange in the same period, with the firm’s market capitalisation of KD4.07bn ($14.3bn) equalling 13.1% of the exchange’s total value.

KFH, meanwhile, boasted a market capitalisation of KD3.07bn ($10.8bn) at the end of the 2013, which put it in second place in terms of overall value on the KSE. In the same period six other banks – namely AUB, Gulf Bank, Boubyan Bank, Commercial Bank of Kuwait and Burgan Bank – were among the 10 largest firms listed on the KSE. In 2013 listed banks saw their market trading improve by 8.7%, up from a decline of approximately 0.3% in 2012. The sector’s recent performance is considered to reflect the renewal of investor confidence in financial services in particular and, more broadly, the Kuwaiti economy as a whole. Activity in the domestic banking sector is dominated by local banks, and is heavily concentrated at the top. The top two institutions by value – namely NBK and KFH – accounted for 48% of total banking market capitalisation on the KSE at the end of 2013, according to KAMCO.

Islamic Banking

Kuwait is home to one of the oldest modern sharia-compliant financial sectors in the world. Indeed, five of the country’s 11 local banks operate according to Islamic principles, including KFH, which is the second-largest sharia-compliant financial institution in the world after Al Rajhi Bank, which is based in Saudi Arabia but operates an investment-focused branch in Kuwait. According to KFH, as of the end of 2013 Kuwait was home to about 6% of global Islamic banking assets, making it the world’s fifth-largest sharia-compliant banking sector. The sharia-compliant sector is widely considered to be a growth market, particularly in the years since the 2007-08 downturn (see Islamic Financial Services chapter). Indeed, according to KFH, sharia-compliant banking assets made up approximately 42% of total sector assets as of the end of 2012, the most recent year for which reliable data was available at time of publication. This figure was up from around 39% at the end of 2011.

NBK

In addition to its status as the oldest bank in the Gulf region, NBK has been a market leader for several decades. In recent years the institution has led the domestic sector in most major banking categories, including overall assets, lending and deposit taking, among other areas. As of the end of 2013 NBK boasted KD18.6bn ($65.4bn) in total assets, up 12.8% from the previous year. Net profits at the bank totalled KD238.1m ($837.2m) for the year, down from KD305m ($1.07bn) in 2012. This decline is the result of the fact that in 2012 NBK had an exceptional year due to the acquisition of Boubyan Bank, a local Islamic institution, which resulted in a major uptick in earnings. Excluding the revenue from this deal, the firm reported net profit growth of 6.5% in 2013.

NBK has carried out business outside of Kuwait for years. As of the end of 2013 the bank was active in a total of 16 different countries, including Iraq, Jordan, Lebanon, Saudi Arabia, Bahrain, Qatar, the UAE, Egypt, Turkey, Switzerland, France, the UK, the US, China and Singapore. Much of this global activity was carried out through local subsidiaries. Just over 94% of the bank is listed on the KSE, while the remainder is controlled by the Public Institution for Social Security, a state-managed social welfare fund. NBK has consistently been one of the top performers both in Kuwait and the Gulf as a whole. The firm was the only bank left standing after the Souk Al Manakh crashed in mid-1982, for example, and in the wake of the 2007-08 downturn it was able to use its large capital reserves to provide cover against NPLs. At the end of 2013 the bank boasted an NPL-to-gross-loan ratio of 1.96%, down from 2.75% at the end of 2012. Over the same period NBK’s NPL coverage ratio rose from 157% to 200%.

Income diversification, meanwhile, has been a key area of focus at NBK in recent years. The acquisition of Boubyan Bank in 2012 gave NBK more exposure to the rapidly growing Islamic market, for instance. “Our expansion into Islamic banking through the acquisition of 58.4% of Boubyan Bank continues to pay off as Boubyan’s contribution to the group’s profitability and balance sheet increases over time,” Ibrahim Dabdoub, NBK’s group CEO, told the media in late January 2014. Similarly, the bank’s international activities have been a key source of revenues, with foreign-sourced profits growing at 9.5% year-on-year in 2013, which is a faster rate than domestic profits during the same period.

KFH

Kuwait’s second-largest bank, KFH, is also the second-largest IFS institution in the world in terms of assets. At the end of 2013 the firm had KD16.1bn ($56.6bn) in assets, up some 10% from the previous year. This growth can be largely attributed to the fact that the bank brought in revenues of KD996m ($3.5bn) and gross profits of KD292m ($1.03bn) over the course of 2013, both of which were up on the previous year.

Under the Islamic model, KFH is required to distribute the majority of its annual profits among its investors. Some 51% of the bank is listed on the KSE, while the remainder is controlled by a small handful of government-run entities, including the Kuwait Investment Authority (KIA), which owns just over 24% of KFH, the Public Authority for Minors Affairs (10%), the Kuwait Awqaf Public Foundation (8%) and the Public Institutions for Social Security (6%).

KFH is active around the world, both directly and in the form of a variety of subsidiaries. While most of the bank’s activities take place in the Middle East – including in Saudi Arabia, Bahrain and the UAE – the company also has interests in Malaysia, the Cayman Islands and Turkey, among other locations. In the wake of the 2007-08 downturn, KFH implemented a transformation programme, with the objective of diversifying revenue streams and improving overall corporate governance, risk management and asset quality, among other areas.

In 2013 the company’s transformation programme resulted in the consolidation of KFH’s major lines of business into three overarching units, namely KFH Capital, KFH Investment and KFH Real Estate. In the same year, the institution saw its NPL-to-total-loan ratio fall to 4.4% from 5.7% the previous year. Similarly, at the end of 2013 KFH’s capital adequacy ratio stood at 17.44%, well above the Basel III minimum target rate of 13%.

Other Kuwaiti Banks

Burgan Bank, the nation’s third-largest lender, boasted assets of KD7.15bn ($25.1bn) at the end of 2013, up nearly 20% from KD5.97bn ($21bn) at the end of 2012. This jump was driven by operating income, which grew by 33% over the course of the year to reach KD254m ($893.1m) at the end of 2013. Similar to NBK and KFH, Burgan has worked to both improve the quality of its assets and diversify revenues. The bank has subsidiaries in Turkey, Algeria, Tunisia, Jordan, Iraq and Malta. “Our regional operations remain profitable, contributing 54% to the group’s revenues [in 2013],” said Majed Essa Al Ajeel, the bank’s chairman, in a press release in early 2014.

Burgan is controlled by KIPCO, which owns 41% of the bank, while 33% of the company is held by public shareholders and the remainder is owned by Bahrain-based United Gulf Bank (17%) and the Public Institution for Social Security ( just under 8%).

Rounding out the five largest banks in Kuwait are Gulf Bank and the Commercial Bank of Kuwait. Gulf Bank had assets of KD5.06bn ($17.8bn) in 2013, up 4.3% on the previous year from KD4.85bn ($17.1bn). The bank has focused on expanding its retail segment, and it now operates a total of 58 branches. Net profits were up 4.2% in 2013 to reach KD32.2m ($113.2m) from KD30.9m ($108.6m) the previous year. Meanwhile, the bank saw a 40% reduction in NPLs, with the NPL ratio dropping from 10.9% in 2012 to 6.5% by December 2013. Some 51% of Gulf Bank is listed on the KSE, while other major shareholders include the KIA and a handful of local private investment firms.

For its part, the Commercial Bank of Kuwait registered total assets of KD3.93bn ($13.8bn) for 2013, up 7.1% from KD3.67m ($12.9bn) the previous year. During the same period, net profits increased by 95% to reach KD23.7m ($83.3), although this was from a low base of KD1.1m ($4.1m) in 2012. The bank is primarily listed on the KSE (nearly 77%), with the remainder held by the local Al Sharq Holding Company. In early April 2014 the bank announced that the majority of its shareholders had approved a plan to convert the bank to a shariacompliant lender. “The decision does not take immediate effect,” the Commercial Bank of Kuwait’s chairman, Ali Mousa Al Mousa, told local media outlets. “It is just a first step in a legal process involving several studies and approvals.” If the plan does go through, the Commercial Bank of Kuwait will become Kuwait’s sixth sharia-compliant bank, out of a total of 11 domestic banks (see Islamic Financial Services chapter).

Other smaller domestic banks currently operating in Kuwait include Boubyan Bank, which is owned by NBK; AUB; Warba Bank; KIB; and Al Ahli Bank of Kuwait (ABK), the latter of which is fast approaching the top-five in terms of assets and has shown solid profitability in recent years. Established in 1967, and operating a 30-branch retail network and two overseas branches in Dubai and Abu Dhabi, ABK’s total assets reached KD3.8bn ($13.36bn) as of June 30, 2014, while net profits for the six-month period increased 10.6% to KD19.1m ($67.16m). With a capital adequacy ratio of 23.2% – well above the sector average of 18.3% and nearly double the Basel III requirement of 13% – ABK is in a strong position to expand its business in the future.

Looking Forward

Taking into account the growth in activity and revenues in 2012 and 2013, most local players are looking forward to a period of sustained growth. At the same time, a number of hurdles remain to ongoing expansion. Indeed, while credit issuance has picked up substantially in recent years, particularly on the retail side, slow progress on the government’s National Development Plan (NDP) has meant that demand for bank credit remains somewhat depressed overall (see analysis). Additionally, while the banking sector has expanded notably, structural and regulatory challenges remain. Indeed, since 2009 the CBK and other regulatory entities have put in place a series of new laws aimed at shoring up operations and governance in the sector. While this new framework is expected to benefit the sector in the long run, many firms have had difficulties implementing the rules effectively.

Outlook

With this in mind, most local banking groups are looking forward to continued expansion for the foreseeable future. Indeed, the potential opportunities for growth in Kuwait’s banking sector in the coming years are manifold. “Kuwait has the geographical advantage of becoming the gateway to neighbouring countries, and with a clear monetary policy and financial plan, this can be possible in the future,” KIB’s Mukamis, told OBG.

The new banking and financial sector legislation that has been put in place since 2009 is expected to eventually result in better risk management and corporate governance at most local institutions, which bodes well for future growth prospects. With these opportunities and strengths in mind, and taking into account the high liquidity levels at many of the leading local institutions, the coming years should see Kuwait’s banks increasingly active across a variety of sectors. “Banks are now starting to provide both corporate and retail customers with new products and services, which is directly correlated to the increasing competition within the sector,” César González-Bueno, CEO of Gulf Bank, told OBG.