THE recent history of Kuwaiti banking has been a turbulent one. The Souk al-Manakh stock market crash in 1982 burdened banks with debts of more than $20,000 million. Their problems were compounded by the multiple effects of the seven-month Iraqi occupation in 1990-91.

But the years since liberation have been ones of consolidation and modernisation. After years of prevarication, the key issue of bad debts is now close to resolution. The government took over the banks' bad debts in 1993 and gave them low-yield bonds in return. These bonds are now being redeemed as debtors pay up, freeing up funds for the banks to grow their business. Although there are now concerns about the effect of low oil prices, analysts believe the sector is in a strong position to weather the storm.

As its rivals readily admit, National Bank of Kuwait (NBK), the biggest bank in the country, is in a league of its own. It accounts for about 35 per cent of all the assets held by Kuwaiti banks and is the only institution with a significant overseas presence.

NBK's main focus is retail. 'NBK took the strategic decision a few years ago to focus itself on retail banking,' says chief executive officer Ibrahim Dabdoub. 'To do that we have concentrated on technology.' The bank has invested heavily in automated teller machines (ATMs), telephone banking systems and debit cards. They are also developing home banking services on the internet. 'Now 70-80 per cent of our banking transactions happen outside the branch,' says general manager Roderic McKenzie. 'This is a very high figure anywhere in the world.'

NBK's current priority is to enhance its overseas operations. 'Retail banking is a niche we have mastered. We are going to carry this into the Arab world with the ultimate goal of becoming the major regional retail bank,' says Dabdoub. The wholly-owned subsidiary NBK Lebanon has grown to nine branches, and Egypt and North Africa are being considered with a view to setting up operations. 'Where ever there is a middle class we will go after it,' Dabdoub adds. 'We also target high net worth individuals.'

NBK has a strong strategic alliance with National Commercial Bank in neighbouring Saudi Arabia. The arrangement covers a variety of activities including fund management and corporate finance. In November 1996 the two worked together as global co-ordinators on the $291 million public offering for Bahrain-based Arab Insurance Group and last March they teamed up to market an Islamic global equity fund. Enhancing this strategic relationship is a key priority for NBK. 'Hopefully it will go beyond alliance into a partnership,' says Dabdoub.

When it comes to Islamic commercial banking activities in Kuwait, the market is dominated by Kuwait Finance House (KFH), one of the country's biggest and most profitable lenders. It is extremely active in funding real estate projects and virtually every car showroom in the country has a KFH desk offering financing schemes.

KFH is keen to benefit from the government's privatisation plans. 'We are looking to expand through privatisation, especially in the telecoms sector,' says Mohammed al-Omar, deputy assistant manager of the Investment Sector. Having underwritten $200 million in Islamic financing for the Equate project in 1996, the bank wants to increase its involvement in the petrochemical industry. 'We see more business coming from PIC [Petrochemicals Industries Company],' adds Al-Omar.

The bank is also taking a leading role in private real estate development. It is keen to fund housing projects for the government, should it decide to carry out new schemes on a build-operate-transfer (BOT) basis. It is also leading the consortium selected by the Kuwait Municipality to develop phase four of the waterfront project. The scheme involves the development of a 2.5-kilometre stretch of coastline with retail, commercial and recreational facilities on a BOT basis.

However, a degree of uncertainty about KFH's future status persists. Technically, it is not a bank at all. As an Islamic institution it is regulated by the Commerce Ministry rather than by the Central Bank of Kuwait (CBK). However, a proposed Islamic banking law could end its special status and bring it under CBK control. The law would also allow the creation of other Islamic commercial banks, ending the monopoly KFH has enjoyed since its establishment in 1977.

The passage of the law has proved long and arduous, largely because KFH objects to the rules demanded by the CBK. 'It is a problem if this [Islamic banking law] restricts the activities of KFH,' says Omar. 'There are a lot of meetings with CBK to try and convince them of our needs.'

The problem is that many of KFH's commercial and real estate activities fall foul of the rules proposed in the law. If it is passed, Islamic banks will be banned from practising trade and industry on their own accounts. Nor will they be able to own or deal in moveable assets. The law also sets targets for liquidity, provisions and investments. Furthermore, Islamic banks will be forced to guarantee that they will restore in full the deposits of customers, regardless of the profits of the bank.

CBK Governor Sheikh Salem Abdul Aziz al-Sabah says the likely impact of the law on KFH's activities has been overstated. 'There has been a misunderstanding by KFH...the proposed draft law does not restrict their activities,' he says. 'They can create companies to do these activities and can set up mutual funds.'

However, others beg to differ. Jassem al-Saadoun, general manager of Al-Shall Economic Consultants, says if the law is enforced as it stands it will have a dramatic impact on KFH's business: 'If CBK gets what it wants, KFH will not be able to function.'

Unresolved differences

Sheikh Salem is confident that agreement can be reached with KFH on a draft law in two-three months. However, Al-Saadoun is not so sure. He says the gulf between the two remains wide and that the large contingent of Islamist MPs in parliament will block any law that might have a negative impact on KFH. 'KFH has the backing of the National Assembly,' he argues. 'The law is likely to stay in cabinet for a long time until CBK and KFH manage to close their differences.'

Until the issue is resolved, there is no scope for the establishment of other Islamic commercial banks despite strong enthusiasm from the business community. CBK has received a large number of applications for licenses to operate an Islamic bank and Burgan Bank is understood to be considering converting into an Islamic institution.

Apart from KFH, the only other Islamic financial institution operating in Kuwait is The International Investor (TII). TII has carved a niche for itself as a provider of Islamic financial services to banks. 'Our mission is to provide others with the tools and knowledge to access the Islamic market,' says chairman Adnan al-Bahar. TII has forged partnerships with the Bank of Bahrain & Kuwait (BBK) and the local Gulf Bank. 'We are also in negotiation with other banks in the Gulf,' says Al-Bahar.

TII has found a strong appetite for Islamic products and this year plans to open branches in Dubai and Qatar and establish a joint venture company in Bahrain with BBK. It recently launched a range of Islamic share indexes in a joint venture with the UK's FTSE International. The indexes track Islamically acceptable companies in the stock markets of North America, Europe, the Pacific Basin and South Africa.

The current economic downturn in Kuwait is not expected to have a major effect on the bottom line of most banks, at least in the short term. This is largely due to the ability of the government to tap into its reserves to shield the economy from the worst effects of the slump in oil prices. 'If the low oil price continues for two-three years, then the banks will start to be affected,' says Redha Behbehani, deputy chief executive officer at Al Ahli Bank of Kuwait.

In theory, the tight restrictions on margin lending imposed by the central bank should have prevented overexposure to the stock market, which lost 40 per cent of its value last year. Margin lending was banned in May 1997 when trading levels reached record levels. CBK allowed its limited resumption this February after it satisfied itself that the market had bottomed out.

However, in a report published late last year, the US ratings agency Moody's Investors Service expressed concern about the high level of private sector credit extended since 1996, which they feared might have ended up on the stock exchange. 'We do not think that real growth in the Kuwait economy during that time justified increases of 25-30 per cent in private sector lending, and we therefore believe that a substantial portion of this credit has been fuelling speculation on the exchange,' Moody's said. Although most banks have a policy of not lending for share purchases, bankers privately admit that they do not always know where the borrowed funds eventually end up. In addition, they do not always know when people are borrowing against real estate and stocks. 'Loans are given on the basis of the balance sheet which does not always say whether they have real estate or stocks,' says one.

Despite its fears about a potential rise in non-performing loans, Moody's says Kuwaiti banks have sufficient pre-provision earnings and capital to cope with any deterioration in asset quality that could have been caused by the downturn in the equity market.

Whispers of mergers between the smaller banks are commonplace in Kuwait, although none have actually materialised in recent years. Commercial Bank of Kuwait and Burgan Bank were understood to be holding talks last year, but a deal has not materialised. Analysts say a major deterrent to mergers is the ownership structure of smaller banks in which power rests with key board members who routinely interfere in day-to-day management and are prepared to block mergers for personal reasons, despite the commercial benefits that might accrue from a union.