While institutes in the world’s leading financial centres are coming to terms with the damage done by the global financial crisis, the Middle East is stuck in the quagmire of debt defaults and restructurings.
In late March, Dubai World announced its first proposal to creditors for the restructuring of its $23bn debt pile and speculation continues as to whether further debt restructurings will be necessary in the emirate. While in Qatar, the bursting of the real estate bubble has forced many firms to reschedule loan repayments. Kuwait’s financial sector, meanwhile, has been hit by over-leveraging to invest in the financial sector and real estate assets, and debt problems continue to blight the economy.
The CBB stops retail banks from over-extending by ensuring the loan to deposit ratio does not exceed 75-80 per cent
Source: Central Bank of Bahrain
Robust banking system
Even larger restructurings could be forced in the fallout of the dispute between two of Saudi Arabia’s biggest conglomerates, Saad Group and Ahmad Hamad al-Gosaibi & Brothers. Analysts say both companies have defaulted on more than $20bn of debt, and what looks like a long and bitter legal battle between the two and some of their lenders has broken out in courtrooms worldwide.
[Banks] must decide what to do in … this crisis. We decided the quicker you take the medicine, the better
Ted Pretty, Gulf Finance House
Bahrain, by contrast, has emerged from the financial crisis largely unscathed, despite being one of the largest financial centres for the Middle East. And luckily for the kingdom, the problems at two local banks, The International Banking Corporation and Awal Bank, subsidiaries of Saad and Al-Gosaibi, were seen as being rooted in Saudi Arabia, rather than in Bahrain.
In fact, Bahrain insists that the local banking system is robust, despite the financial crisis. “Part of our regime in Bahrain is very tight regulations when it comes to retail banks,” says Rasheed al-Maraj, governor of the Central Bank of Bahrain (CBB). He says by ensuring the loan to deposit ratio of the banks does not exceed 75-80 per cent, the CBB stops retail banks from becoming over-extended, and reliant on funding sources outside deposits.
“We are very comfortable with the level of provisions and the quality of financial institutions in the retail banking sector,” adds Al-Maraj.
But while the small retail banking sector is viewed as stable, Bahrain’s larger investment banking sector, particularly those which are sharia-compliant, has been less fortunate. “For the wholesale banking and investment banking sector, as the regional economic outlook has changed they have faced challenges to recalibrate their business model,” Al-Maraj says.
One of the first to go through this process is Gulf Finance House. The bank, launched in 2002, is one of the region’s most high-profile institutions and is responsible for major local developments such as the Bahrain Financial Harbour, now home to a large portion of Bahrain’s financial services companies.
After making a loss of $728m in 2009 and embarking on an asset sell-off and rescheduling of debts, Gulf Finance House is leading the charge of banks addressing the new realities Al-Maraj alludes to. Analysts in Bahrain say the emergence of problems at Gulf Finance House, although long speculated about locally, served as a wake-up call to the regulator.
The firm’s chief executive officer, Ted Pretty, says that although the process has been brutal, it is necessary. “Every bank has to decide what to do in response to this financial crisis,” says Pretty. “In our case, we have decided that the quicker you take the medicine, the better.”
The emergence of the problems at Gulf Finance House has raised questions about the stability of other banks in the country. “It is difficult to believe that some of the smaller banks in the country’s are not facing the same issues as Gulf Finance House,” says a local analyst.
Another source based in Manama close to several banks in the country says, “There is definitely a sense of waiting to see who is next at the moment.”
Pretty is also keen to point out that while attention is currently focused on Gulf Finance House, others will follow. “We have been among the first in the GCC to do that and are getting beaten up for it. But, over the next few quarters, I forecast that the focus will shift from us to some of our peers, and other banks will come under scrutiny, with people asking why they haven’t taken aggressive steps in relation to their balance sheets and their cost base.”
During the past few years when the regional economy was booming and investors believed the real estate bubble would never burst, Bahrain was a popular choice for new Islamic investment banks. Many new Sharia compliant banks investing in structured products, with small capital levels, were set up there, helping Bahrain develop its reputation as a centre for Islamic finance.
Much of the profit reported by these investment banks relied on accounting for the increase in asset prices through the profit and loss statement, even though the increase had not actually been realised through a sale.
The CBB is a lot tougher now. But had it started doing this four years ago it would be a very different story
Chief executive officer of a Bahrain-based bank
The CBB has since moved to stamp this out, saying banks should only report and pay dividends on realised profit. It also moved to start trying to limit the exposure of banks to real estate, insisting now that it could see trouble on the horizon. Some bankers in Bahrain say these moves come too late though.
“The CBB is becoming a lot tougher on the banking sector now,” says the chief executive of one Bahrain-based bank. “But if [it] had started doing this about four years ago it would be a very different story.”
Arcapita, another local investment house, has also seen a deterioration in its financial position. At the start of 2009 it was rated BBB by the US rating agency Standard & Poor’s, by June this was lowered to BB-, or junk status, before it was withdrawn. Other local banks do not have the transparency a rating demands to have the insight into their financial position.
Investment house Ithmaar Bank has also announced plans to merge with its retail banking subsidiary Shamil Bank to expand its access to deposits as a funding source. It will also bring greater scrutiny from the CBB.
To avoid another debt crisis emerging, the CBB has been working with the banks to help them develop new business models that do
not rely on short-term money pumped into longer term assets. Pretty reveals the Gulf Finance House has worked closely with the CBB on devising its new strategy. Other local analysts say that several banks are in talks with the regulator about how they should move forward.
The question now facing the Bahrain banking sector is whether the deleveraging and shift away from a reliance on real estate projects will take place publically, or if banks will be able to complete their negotiations in private, before facing any liabilities they are unable to pay.
The outlook for growth in the Bahrain economy at about 3 per cent, is slightly better than some of its peers, but with the work-through of the economic crisis on real estate prices still not complete, banks are not yet out of the woods. Bankers in Bahrain say liquidity is still expensive, and will probably remain so for the next few months, meaning refinancing debt will be a tough sell without pushing up interest rates considerably from where they were a few years ago.
Positive signs are emerging though. Gulf Finance House has so far been successful in its asset sales and extending the tenor of some of its debts. This is helping to create some optimism that these issues can be resolved amicably.
Following the headlines caused by the Gulf Finance House restructuring, the CBB is also much more engaged in working with banks to prevent problems emerging.
By viewing the retail and investment banks separately, Bahrain is confident that a systemic issue that could bring down some of the country’s largest banks is unlikely to arise.
However, with the financial sector contributing more than 20 per cent of gross domestic product (GDP) and a key part of the government’s aim to bring high-paid jobs to Bahrain, it cannot afford to have anything less than the best reputation in the region for regulating the financial sector.
On a pratical level, Bahrain also lacks the huge government reserves of cash to pour into the banking sector if problems do emerge, making it even more important for Manama to ensure the stability of the financial system.
Already Bahrain has recognised that the debt problems elsewhere in the region present it with an opportunity to make up some of the ground it has lost to neighbours such as Dubai, who are trying to wrestle away the title of financial hub for the region.
If trouble emerges at more Bahraini banks throughout the next 12 months, that reputation could be seriously damaged.