Shaking off the turbulence that rocked its economy in 2011, Bahrain is back to business and its Islamic banks look set to profit from it
Its outlook having been declared 'stable' by rating agency Standard & Poor's, it seems the political unrest that nibbled at the Kingdom's economy during 2011 hasn't shaken its financial foundations. Bahrain remains the Middle East's most comprehensive Islamic finance market, and with its troubles seemingly behind it 2013 looks set to be an active year for Islamic banks operating in the Kingdom.
"This year [2012] has been a turnaround - several of the Islamic banks managed to improve their performance, although a few still have to book more provisions to clean up their balance sheets," Khalid Hamad, Executive Director of Banking Supervision at the Central Bank of Bahrain (CBB) and Chairman of the International Islamic Financial Market (IIFM) told Islamic Business & Finance.
Hamad also highlighted one of the industry's most anticipated developments, with Bahrain's Islamic banks looking at opportunities to merge. "This is because the CBB was pushing for it, and from the other side the banks are realising the need for them to merge, because they are now facing difficulties with assets and balance sheets," he said, adding that the global economy has aggravated these problems. "Because of the slow economy and low growth, especially with the problems in Europe and the budget issue in the US, things are slow in terms of recovery. I think Islamic banks seriously realise the need for mergers in order for them to move forward with more robust business plans."
Bahrain began 2013 with the welcome news that three of its Islamic banks, Elaf Bank, Capital Management House and Capivest, would be merging. The combined banks create a financial institution with a total equity of approximately $340 million and total assets in excess of $400 million, spanning the Middle East and North Africa, Europe and Asia.
The same month, Al Salam Bank confirmed it was also in merger talks with a regional bank. Al Salam had been teasing the industry with talk of a tie-up between itself and Bahrain Islamic Bank, however the much-anticipated merger collapsed last year on a disagreement over valuation. Khaleeji Commercial Bank is also said to be studying merger options with other Bahraini banks.
It is a welcome development in an industry frequently criticised for failing to build banks of scale, however Hamad believes this is set to change and more tie-ups are imminent in Bahrain. "Banks are feeling now that it is necessary for them to move forward and merge. So far we've seen good mergers, and we are anticipating more in 2013 and 2014. There are currently discussions and assessments being done on this."
Despite the global economy highlighting the need for mergers, Hamad insists that Bahraini banks are protected from the troubles in the Euro Zone. "We are not concerned about exposure to the EU, because most our banks' dealings are with the UK and developed economies such as Germany. We have done a lot of assessments and we are not concerned about exposure to the EU. The banks [in Bahrain] took early steps when the problems in the EU arose."
And Hamad believes that the dust has settled closer to home. "In the beginning of 2011, immediately after the unrest, a small amount of deposits left the country because there was uncertainty," he explained. "But in a couple of months all these deposits were returned. There was some reduction in the demand for credit, especially in the commercial sector.
"But this year we've seen recovery, if you compare last September to this September we have seen a large growth in commercial lending. Of course consumer finance was not affected and continued to grow. Deposits also were growing at nine to 10 per cent; if the deposits are growing and commercial lending is recovering, although not to pre-crisis levels, it's a good sign. It gives us comfort that things are moving into a recovery stage."
Hamad is also hopeful that megaprojects being planned by the GCC will also give Bahraini banks a boost. "These projects will call upon the contractors and service providers to get some funding from the banks to be able to participate in infrastructure projects. These infrastructure projects, which have started already and will continue for a few years, are really sizeable," he said.
However, it seems that Islamic banks, still in their first flush of youth, have some catching up to do with their conventional peers. "If you go back to the financial crisis, Islamic banks did better in terms of performance," explained Hamad. "But of course when the financial crisis turned into global crisis Islamic banks got hit because of the economy. This year [2012], because conventional banks have already developed portfolios while Islamic banks are still building theirs there is, of course, a difference [in performance].
"The developed portfolio generates stable yields while the developing portfolios' yields are not as stable, and are still low compared to conventional banks. So of course someone would expect that the performance of conventional banks, in terms of size and quality to be better because it has been built over many years. Because Islamic banks are still young there is a big difference but I think Islamic banks are making the competition even fiercer for conventional banks because demand for Islamic financial services is very high."
Demand for Islamic finance is also global, offering a great opportunity for Bahrain to attract foreign investment. "The demand is an encouragement, not only in Bahrain but in Muslim countries in North Africa and the Middle East, Indonesia and Malaysia and even in non Muslim countries; so foreign investors will need find the right place to set up their entities, and I don't think they will find a better place than Bahrain," said Hamad.
"I'm not saying this because I am Bahraini," he quickly added, "We have the infrastructure, the best regulations you can find for Islamic finance. One of the objectives of the Central Bank is to continue to enhance regulations. Today we have comprehensive regulations for Islamic finance, not just for banks but for Takaful companies, financing companies and even capital markets. We have been also focussing more on enhancing the resources. We have developed so many programmes through the Waqf Fund to help people become more skilled in Islamic finance."
Beyond Bahrain, Hamad hopes to use the Kingdom's resources to enhance Islamic finance across the globe. "We are putting a lot of pressure on regulatory bodies such as AAOIFI to get more support and to deliver," he explained. "For example, the IIFM is mandated to develop market documentation standards for capital and money markets. We have been doing a lot in this area. One of our objectives is to help the market develop through filling the gaps."
One of these gaps is the Islamic equivalent of the interbank market, the absence of which is hindering Islamic banks globally. "Conventional banks can work together and place money with each other easily, but Islamic banks don't have that sort of thing. They need someone to develop a framework for them. The Central Bank has taken the initiative to develop this. There are also many institutions and countries that are helping develop similar frameworks in other places," Hamad said.
The IIFM is now in the final stages of developing this much-awaited framework, pending some legal issues which it is currently addressing. "We hope it will serve banks not just in Bahrain but worldwide through filling the gap in terms of the money market," he said.
Given its vital role, is Khalid Hamad happy with the IIFM's progress? "I am the Chairman so I'll try not to be biased!" he laughed. "The IIFM role is very important. IIFM plays the same role as ISDA (International Swaps and Derivatives Association) in the west. We have cooperation with these organisations. IIFM has worked hard to develop market documentation standards."
The IIFM has even braved the issue of hedging - previously a no-go area for Islamic institutions. "Now we have two documents being endorsed by the market as the master agreement for Islamic hedging. We also developed a specific product which is the profit rate swap, the equivalent to the interest rate swap. Now banks have a market standard product. We are now also working on a cross currency swap, an FX swap, an FX forward and are talking about an equivalent repo (repurchase agreement) structure. It's not repo itself but you can use it in the same way, obviously with a different structure because repo is not Shari'ah-compliant."
However, the IIFM still has a long way to go in terms of implementing its work. "I think what's needed now is for the market to absorb all these developments. We've been calling on the market to accept these standards and adopt them. Adoption, of course, takes time, but we are encouraged by the interest."
Hamad added that the organisation needs more support from the industry in terms of adopting its standards and becoming members. But is this too much to ask from an industry where many believe Islamic hedging is an oxymoron?
"The problem we see is banks have been busy with their performance, and they have not recognised the benefits that they will gain through adopting these standards. If I am telling the banks this is a hedging instrument, what message am I delivering to him?" Hamad responded.
"I am saying you do not need to go to a lawyer to negotiate - I've done that for you. I am reducing the time, I am reducing costs. Second, I'm telling you that this standard has been approved by so many prominent scholars, bankers and lawyers that when you negotiate with a counterparty you only need to negotiate fees. That's it. The document is a market standard - both parties should accept it.
"The most important thing is this is a product which will mitigate your risk. It will reduce operational risk including legal risk and compliance risk. If I am a CEO with this document I have no choice but to adopt it - because it's in the interest of the market and for any market, any sector to develop, it needs market practice. We are setting the market standard for free to the market. We have so many international banks working with us as members and also as facilitators to move forward. ISDA is also working with us, especially with the hedging instruments, and it is selling this to its members. So we are hopeful that these sorts of market documents will definitely be implemented very soon."
So what's next for the IIFM? According to Hamad, it has many new projects in the pipeline, including a new Wakala instrument. "We call it unrestricted Wakala, which will help dealings between banks. We have been working very hard with Malaysia.
"There is also the collateralised Murabaha which is similar to a repo structure but different, however it serves the same purpose. There are several hedging instruments that we are working on. We are hoping to reach a conclusion in terms of the Sukuk Ijarah documentation. We feel this is a project that will be accepted in the market, because most Sukuk in the market now have an Ijarah structure. One documentation for Sukuk Ijarah will really help the market," Hamad said.
Sukuk Ijarah has long been a market favourite because it's easy to lease the assets, but it's not easy to transfer ownership. "That's why Sukuk Ijarah is always easy, because you have the asset, you lease it, and then you get rental," explained Hamad. "Several Sukuk in the past have been asset-based. The trend should be on asset-backed Sukuk. We are trying through the IIFM to shift it to asset-backed Sukuk."
It seems the IIFM has its work cut out for it, but the sentiment in Bahrain has definitely shifted from when I was there in 2010 and 2011. With its confidence returning, the IIFM has an optimistic base from which to continue its mission.
S&P revises Bahrain's outlook to stable
On 28 January, Standard & Poor's Ratings Services revised its outlook on Bahrain to stable from negative, and affirmed its long- and short-term foreign and local currency sovereign credit ratings at 'BBB/A-2'. The transfer and convertibility (T&C) assessment remains 'BBB'.
"The outlook revision reflects our view of Bahrain's stable growth, the likelihood of no further deterioration in the political environment, the inflow of GCC development funds, and our medium-term assumption of higher oil prices of about $111/barrel," said S&P. "Our ratings on Bahrain are supported by the country's strong external and fiscal positions, both of which are underpinned by hydrocarbon resources.
"Though Bahrain's 2011 political crisis weakened growth potential and damaged the country's reputation as a business services hub, we believe a post-crisis status quo has been established.
"The stable outlook reflects our opinion that political risks and the potential for sharp oil price declines are unlikely to be severe enough to lead to a downgrade in the near term. Large-scale public investment and greater hydrocarbon production should support growth prospects."
In 2006, the Central Bank of Bahrain established the Waqf Fund to finance research, education and training in Islamic finance; and is active in working with the industry and stakeholders in developing industry standards and the standardisation of market practices.
About the IIFM
IIFM is the international Islamic financial market's organisation focused on the Islamic Capital and Money Market (ICMM) segment of the Islamic financial services industry. Its primary focus lies in the standardisation of Islamic financial products, documentation and related processes at a global level.
IIFM was founded with the collective efforts of the Islamic Development Bank, Autoriti Monetari Brunei Darussalam, Bank Indonesia, Central Bank of Bahrain, Central Bank of Sudan and the Labuan Financial Services Authority (Malaysia) as a neutral and non-profit organisation.
Islamic finance in Bahrain
Bahrain plays host to the largest concentration of Islamic financial institutions in the Middle East, with seven Takaful companies, two Re-Takaful companies, 26 Islamic banks with combined assets of $25.3 billion operating and 55 Islamic funds domiciled in the Kingdom.
In addition, the Bahrain Institute of Banking and Finance (BIBF) offer courses on Islamic finance and Takaful. Bahrain also boasts an Islamic securities market which includes short-term Government Sukuk as well as leasing securities.
The market share of Islamic banks has surged from 1.8 per cent of total banking assets in 2000 to 13.3 per cent in August 2012.
The Central Bank of Bahrain has installed a comprehensive prudential and reporting framework, tailor-made for the specific concepts and needs of Islamic banking and insurance. The rulebook for Islamic banks covers areas such as licensing requirements, capital adequacy, risk management, business conduct, financial crime and disclosure/reporting requirements.
Similarly, the insurance rulebook addresses the specific features of Takaful and Re-Takaful firms. Both rulebooks were the first comprehensive regulatory frameworks that dealt with the Islamic finance industry.
Bahrain also plays host to a number of organisations geared towards the development of Islamic finance, including the standard-setting body AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions), Liquidity Management Centre, the International Islamic Financial Market (IIFM), the Islamic International Rating Agency (IIRA) and the Shariya Review Bureau.
© Islamic Business and Finance 2013
