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4| pfi | Middle East Report 2010 GCC banks Many


obligations have been renegotiat- ed quietly.


where in the region to failing, with the Central Bank of Bahrain (CBB) placing two banks in administration and the Kuwaiti authorities helping to bail out another that got into difficulty. However, while both jurisdictions have had their problems, most of the factors at play are specific to one country and not the other. The one similarity that both the Kuwaiti and Bahraini systems have is that banks, like elsewhere in the GCC, have been hit by the real estate downturn. While the bursting of the asset bubble has impacted on many banks’ balance sheets, institutions in both states have been affected more than most as many invested heavily in the sector. According to the Moody’s analysis of the Bahrain bank- ing sector, 33% of all loans made by retail banks in the King- dom are linked to construction and real estate. Meanwhile, figures from the International Monetary Fund (IMF) put real estate and construction loans at 32% of total credit extended to the private sector by Kuwaiti shops. Only the UAE, which saw many institutions invest heavily in Dubai’s real estate boom, is near the same levels. One factor that helps to explain the significant sums linked to the property sector is that both Kuwait and Bahrain have a high ratio of Islamic banks. Given the con- straints placed upon the areas in which Sharia-compli- ant institutions can operate, real estate – with its tangible underlying asset – provided banks with a growth sector during the middle of the decade in which to invest their capital. As well as providing cash, many Islamic banks also had their own development arms; thereby increasing their exposure to the sector. So when the real estate bub- ble burst, this hurt them more than their conventional brethren.


What Islamic banks do have in their favour is that some of this exposure can be treated as collateral; thereby avoid- ing the need to make large write-downs. However, the risk that the sector’s problems pose to both conventional and Sharia-compliant banks is significant.


According to Moody’s, the authorities in Bahrain have been pro-actively monitoring the situation for the past sev- eral months, with the CBB “actively recommending asset sales and capital injections from shareholders in cases where their financial condition [from real estate exposure] is under particular pressure”. The agency also noted that many banks in the Kingdom wouldn’t see a recovery in their performance before a reciprocal upturn in the real estate market; a point that is also applicable to Kuwait. Apart from real estate, the factors that are impacting most on the performance of the Kuwaiti and Bahraini banking sectors are unique to each state. And, even within the individual jurisdictions, there are variations. For example, in Kuwait, personal loans used to invest in the stock market are a significant problem and make up a large chunk of the total non-performing loans (NPLs) at many banks. According to the IMF, in its report: “Kuwait: Financial System Stability Assessment – Update”,


these loans represented 11% of the total credit extended by the banking sector at the end of September 2008. While this figure wasn’t too much of a problem when the Kuwaiti Stock Exchange (KSE) was going up, once the market followed global stock markets in plummeting at the end of 2008 – the KSE closed the year down 35.4% from its mark on January 1 – this credit became a millstone around investors’ necks. By the end of 2009, the ratio of NPLs across the Kuwaiti banking sector stood at 9.7%; much of this relating to lending for shares. On top of personal loans, Kuwaiti banks were also exposed to the bourse through money provided to invest- ment companies. These firms, which blossomed during the middle part of the decade on the back of easy cred- it, now represent, arguably, the biggest threat to the finan- cial stability of the Kuwaiti system. There have already been a number of high-profile restructurings linked to the sector, such as Global Invest- ment House, involving billions of dollars of debt. However, anecdotal evidence points towards a sector-wide problem, with few firms escaping the need to correct a mismatch between short-term funding backing long-term assets. Many obligations have been renegotiated quietly as sen- ior management – many of whom are considered promi- nent businessmen and belong to important families – are eager to avoid the shame of a failing business and banks are equally keen to prevent the need for massive write- downs. While provisioning has been a drag on bank prof- its since 2008, analysts indicate that little of this is related to investment companies. With 11.5% of total loans made by Kuwaiti banks going to investment com- panies as of the end of 2009, the potential ramifications for banks are all too clear.


As for Bahrain, the main problems in its banking sys- tem have emanated from its large offshore financial sector. Like Kuwait’s investment companies, many insti- tutions were caught out by the freeze in international money markets after the collapse of Lehman Brothers. These banks, which were reliant on wholesale funding, had also grown in the boom times on the back of cheap short-term finance. However, once these markets were closed to them, they were unable to refinance these facilities and problems ensued. This lack of available funding combined with another problem to cause further headaches; primarily for those that were set up as investment banks. The global slow- down and the collapse of the real estate boom led to rev- enues from structuring deals drying up very quickly. This meant that for many investment banks, their business plans became redundant and, with few other sources of income, their cashflows were severely impacted. This had a knock-on effect in their ability to meet the maturities of their short-term obligations.


The most obvious example of this problem has been Gulf Finance House (GFH), which in August completed its


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