One year after the economic crash that shook some of Kuwait’s leading financial institutions to their foundations, the country’s bankers and investment houses are still adjusting to the aftermath.

For a country that has been proud of its role as a Gulf pioneer in financial market development – it was the first Gulf state to open a national bank, National Bank of Kuwait (NBK), in 1952 – the past 12 months have been a painful experience for Kuwait.

In October 2008, shares in Kuwait’s second-biggest bank by assets, Gulf Bank, were suspended from trading to halt their decline in value. The same month, two of its biggest investment houses, The Investment Dar and Global Investment House (GIH), were overwhelmed by repayment demands and forced into debt restructuring.

In October this year, a majority of GIH’s shareholders agreed to the restructuring plan to resolve its $3bn December 2008 debt default. The Investment Dar’s restructuring is ongoing, and plans were due to be announced on 12 November, after MEED went to press.

As a result of these problems, tough questions are still being asked in Kuwait’s financial community about the effectiveness of its regulatory structures. The financial events of autumn 2008 may imprint themselves on the Kuwaiti business psyche as deeply as the collapse and closure of the Souk al-Manakh, Kuwait’s unofficial stock market, in 1982.

Damaged reputation

Internationally, the country’s image has taken a serious knock as a result of the financial crisis. In August, ratings agency Moody’s Investors Service downgraded the credit ratings of three Kuwaiti banks: Gulf Bank, National Bank of Kuwait (NBK) and Burgan Bank.

However, a less negative picture emerges from MEED’s interviews with senior Kuwaiti bankers. There is wide agreement that the near collapse of Gulf Bank resulted from internal misjudgements over lending and risk control, and so in no way reflects the wider health of the financial system or the rigour of Central Bank of Kuwait’s supervision or prudential standards. In October 2008, the central bank intervened to save Gulf Bank, after the revelation that it had made KD375m in losses on its derivatives business in the year to date.

In January, the rescue was consolidated when the Kuwait Investment Authority took a 16 per cent stake in the bank, laying the foundations for the bank to raise KD376.16m in new capital through a rights issue the same month.

But the treatment of Gulf Bank was not replicated by the government. The authorities’ wider support for the financial industry took the form of an offer of guarantees, closely tied to tough new conditions, such as a requirement to merge with rival institutions.

“What the government has done is to protect the banking sector,” says Mohammad al-Omar, chief executive officer of Kuwait Finance House, the world’s second-largest Islamic bank by assets. “Because low confidence affected the whole society, the government has guaranteed all deposits, so this has kept all the money in the banking system. There is also the banking sector stimulus package – any shortfall in provisions will be compensated by the government. The same goes for any losses on non-performing loans or on real estate lending portfolios and investment assets. These are all protected.”

But any financial institution that has to call on such comprehensive support will be forced to overhaul its internal risk-management controls. “If any bank chooses to go for  the full stimulus package, it will find itself subjected to the new rules on corporate governance,” says Al-Omar.

“This crisis is forcing Kuwait to live up to the international standards it has set itself in the banking sector”

Abdulmajeed Alshatti, chairman, CBK

He says the global credit crunch has forced banks worldwide into a massive “deleveraging” exercise, effectively pruning back their loan portfolios, a problem that Kuwaiti banks have largely eluded due to strong regulation. “We are not allowed to lend more than 80 per cent of our retail and government deposit base,” says Al-Omar.

By comparison, Abu Dhabi Commercial Bank’s loans-to-deposit ratio stood at 139 per cent in June 2009.

Abdulmajeed Alshatti, chairman and managing director of Kuwait’s second-largest conventional banking institution, Commercial Bank of Kuwait (CBK), praises the government for putting emergency measures in place to support the banking sector.

“The government announced the economic stabilisation law, which provided a safety net to the banks just in case there was a major systemic risk,” says Alshatti. “The law was issued as an emergency measure, but parliament has the right to retrospectively ratify it, which it has yet to do.”

Alshatti draws a contrast between the Kuwaiti authorities’ use of guarantees and the more interventionist approach taken by other countries in the region. “In other Gulf states, government bought investments held by the banks,” says Alshatti. “Kuwait is fundamentally different from the rest of the Gulf.”

Even so, like other countries, Kuwait had become complacent about the risks, Alshatti concedes. “Instead of looking at risk with two open eyes, we tended to close one eye,” he says. “Now, this crisis is forcing Kuwait to live up to the international standards it has set itself in the banking sector. That is why I think that after this crisis we will be much better banks than we are now.”

International expansion

Analysts, however, argue that the crisis has exposed some flaws in Kuwait’s overall regulatory model. While the regulation of banks is strict, the banks found themselves exposed to risks taken on by their clients. “Banks had lent a lot to investment companies, to real estate firms and to retail customers who had invested in shares,” says Naveed Ahmed, financial analyst at GIH.

However, others say the damage to the Kuwaiti banks has been limited because of the country’s tough regulatory rules, notably the requirement that loan exposure cannot exceed 80 per cent of deposits. “The Kuwaiti banks have been hurt by problems in the investment companies,” says Ahmed. “But National Bank of Kuwait, for example, has not suffered much because it had limited its exposure to the financial sector to just 5 per cent of its portfolio.”

The more severe effect of the financial crisis on Kuwait’s investment companies is partly explained by the limited size of the domestic economy. Their ambitions outgrew Kuwait, with the likes of The Investment Dar and GIH investing in real estate and equities internationally. When the  crash came, the value of their assets fell. GIH, for example, reported its first ever net loss in 2008, of KD257.6m, down from profits of KD91.4m in 2007.

As their assets fell in value, the investment houses came under growing pressure from their lending banks to restore their level of collateral coverage, but some were unable to do so. This has resulted in calls from Kuwaiti MPs for the government to strengthen the financial regulation system.

Kuwaithad already been planning an overhaul of its non-bank financial regulation before the crisis, although the implementation of plans for a new capital markets authority had been typically sluggish. Last year’s 30 per cent slump in the market capitalisation of the Kuwait Stock Exchange, and the crisis in the investment sector, have highlighted the urgent need for the new regulator.

The finance and economics committee of Kuwait’s National Assembly (parliament) has now approved the overall framework legislation for creating the new regulator. Although the measure still has to be voted on by the whole house, senior government sources report that most of the technical preparatory work for the new non-bank financial regulatory system has been completed by consultants.

One of the motives for creating a new authority is the perception that the Kuwait Stock Exchange has not been sufficiently rigorous in supervising non-bank financial institutions. “Before the crisis, some brokers were clearing deals without efficiently completing the settlement process,” says Walid Mohamed, a senior financial analyst at GIH. “There were some [brokers] whose licences had been withdrawn for committing illegal actions, but who continued to do business under the name of colleagues who were still approved.”

Even before the regulator is established, the financial stability law will toughen up the disclosure requirements imposed on investment firms. The legislation bans investment companies from refinancing existing loans, except for 25 per cent of the loans they have taken from foreign banks.

As a result of the government’s handling of the financial crisis, Kuwait’s financial community is applying considerable pressure on the cabinet to take decisive action on both the financial stability law and the capital markets regulator. “The government did not come up to expectations,” says one senior analyst, contrasting Kuwait’s caution with the speed of the rescue interventions mounted by the authorities in Qatar and the UAE.

It is these unfavourable comparisons with its fellow GCC states that may force Kuwait into action to improve financial regulation following the turbulence of the past 12 months.