Key fact

The financial sector made up more than 20 per cent of Bahrain’s gross domestic product in 2009

Source: MEED

The tanks that sit at the end of the approach roads to the Bahrain Financial Harbour, a key part of Manama’s financial district, are a stark reminder that a just a few weeks ago the city was under siege.

In mid-March, as anti-government demonstrations took on a new violent edge, much of the financial sector grounded to a halt. The towers of the Financial Harbour were shrouded in tear gas as police and protests battled for control of the area. It was a sight none of the expatriate workers in the towers expected to see when they came to Bahrain.

Bahrain financial sector
Number of financial institutions 409
Total workforce 14,137
Bahraini workers 9,467
Non-banks 5,077
Banking sector assets ($bn) 215.1
Islamic banking assets ($bn) 25.4
Number of Islamic banks 27
Source: Central Bank of Bahrain

During those few days in mid-March, bankers found themselves unable to get into their offices because of roadblocks and gangs of armed citizens, who had succeeded in temporarily taking over the city.

One banker at a local institution recounts how he was chased back into his office building by a gang of youths.

Damaged reputation

For a country, which prides itself on being the financial centre for the region, these stories can be especially damaging. Just few days’ work was actually lost, but many people were forced to work from home or move into alternative sites.

“There has been very little in terms of real capital flight … just 3-4 percentage points”

Patrick Gallagher, HSBC

Although the anti-government protests were largely peaceful, by the time they took over Manama’s business district, many expatriates say there was a lot of intimidation intended to keep them from their workplaces. Coupled with that, armed gangs of both Sunni and Shia set up makeshift check points around the island, making travel difficult and adding to the sense of unease.

Banking sector performance
Index points 31-Dec 28-Apr Percentage change
Commercial banks 2005.59 2022.38 0.84
Investment banks 978.79 936.9 -4.28
Insurance 1922.94 1951.1 1.46
Source: Bahrain Stock Exchange

Bahrain may have got through the last few months without any systemic banking issues arising, or major banks leaving the country. But the impact of the protests and the subsequent crackdown, aided by troops from neighbouring GCC states, including the UAE and Saudi Arabia, could take much longer to be felt.

Much is at stake. The financial sector made up more than 20 per cent of Bahrain’s gross domestic product in 2009, and developing skills in financial services is a key part of Bahrain’s Vision 2030 development plan.

So far, banks in the country are keen to point out the stability of the financial sector. Even capital flight appears to have been limited.

Market capitalisation (BDbn)
  31-Dec 28-Apr Percentage change
Commercial banks 2.623 2.646 0.88
Investment banks 2.241 2.151 -4.02
Insurance 0.171 0.173 1.17
Source: Bahrain Stock Exchange

“There has been very little in terms of real capital flight,” says Patrick Gallagher, chief executive officer of the UK’s HSBC in Bahrain. “Figures in the region of just 3-4 percentage points have been seen in terms of overall fall in deposits according to the CBB. That is relatively small in the overall context, and in itself is quite a positive sign.”

Positive signs

The Central Bank of Bahrain (CBB) is also adamant that there was no pressure on the country’s peg to the US dollar. “There has been no flight to the US dollar and there are no pressures on our policy of maintaining the peg,” says CBB governor Rasheed al-Maraj.

“Our markets continued to operate normally over the past two months and no institution approached us with a specific request for liquidity support.”

Some of the largest international banks in Bahrain, including the UK’s HSBC and Standard Chartered, and France’s BNP Paribas, have said they have not relocated people out of Bahrain. Some companies in the financial services and legal space have redeployed people around the region, but that is expected to be temporary, or part of wider plans to move resources in centres of growing importance such as Abu Dhabi or Qatar. Some international banks are understood to have panicked, and moved their people out of Bahrain, although this is also expected to be temporary.

Bahrain’s Economic Development Board says that four banks are leaving Bahrain and that two of them had already decided to leave before the protests began. Of the other two, one is quitting the region altogether. The EDB also says that job losses as a result of these moves will be minimal.

However, the damage could be more noticeable in the long term. Banks are likely to explore how they deploy people in the region in the light of the problems in Bahrain and that could result in staffing levels falling, even if they keep an office in the country.

“We have to acknowledge that Bahrain has been portrayed pretty negatively in the media,” says Jonathan Morris, chief executive for Standard Chartered in Bahrain. “You cannot underestimate the challenge that Bahrain now faces, because the region looks very different now to the past. Businesses have other centres to look at such as Dubai, Abu Dhabi and Qatar. However, we have to  consider the context of Bahrain as a leading financial centre over decades not weeks and the fundamentals which previously made Bahrain an attractive investment destination and regional financial centre still remain”

Security concerns

It is this security issue that may be hard for Bahrain to overcome. One diplomat in the country says many expatriates are waiting to see what happens over the next few months before deciding whether they want to stay in Bahrain. “People are still thinking about the security situation, school terms and job security,” says the diplomat. “So we may see a gradual decline in the numbers of expatriates here as they make decisions over the coming months about whether they want to stay.”

Disdain at the way the crackdown was handled may also prompt some to leave the island.

While security is weighing on some people’s minds, many of the factors that made Bahrain an attractive financial hub are still in place such as its regulatory environment, proximity to Saudi Arabia and open economy.

“Bahrain has a long-established track record as a financial centre … over a period of more than 40 years”

Rasheed al-Maraj, Central Bank governor

Al-Maraj says Bahrain’s reputation as a financial services hub will not be dented by a short period of unrest. “Bahrain has a long-established track-record as a financial centre that we built up over a period of more than 40 years. Throughout that time we have faced many difficult times due to wars, the collapse of the oil price and regional political tensions, but each time we have emerged from them stronger,” he says. “I see no reason why recent events should be any different.”

However, things could be very different this time around. When Bahrain emerged as a finance hub for the region in the 1970s, stealing the crown from Lebanon, which was suffering from its own period of instability, there was no competition in the region. Now, there are several alternatives to choose from.

Bahrain may also suffer because for most financial institutions it will serve mainly as a hub to serve the region, rather than a business destination itself.

“Bahrain remains attractive and I don’t think banks will leave because of the crisis, but the economic reality is if the business is not here then the banks will move on,” says a banking head in Bahrain.

For the local banks, with little presence outside Bahrain, a slow economy will be bad news. Coupled with that, the sovereign downgrade by two notches resulted in all local banks being downgraded. That will have an immediate impact on their cost of capital, potentially making them less profitable. So far the first quarter results of the Bahrain banks has been mixed and it is difficult to tell if there has been any impact from the protests. National Bank of Bahrain reported a 3.1 per cent increase in profit in the first quarter, while Bank of Bahrain and Kuwait reported a fall in profit from BD12.5m ($33m) in the first quarter of 2010 to BD11.7m in the first quarter of 2011.

“Business-wise, from mid-February to now things have slowed down a lot,” says HSBC’s Gallagher. “But we view this as only a delay and not a halt. We are now beginning to see the return of confidence. We remain very committed to the country.”

Quick recovery

The difficulty banks will face is that the business calendar in the Middle East is skewed towards the first half, and most deals have to be booked before things slow down over the summer and Ramadan period. In Bahrain, the first half looks like it will be lost to the unrest. A recovery later in the year will have to be dramatic if banks are to make a decent profit.

The CBB said that by the end of 2010 there were 14,342 people employed in the financial services sector. Of those, 9,467 were Bahraini, or about 66 per cent. With employment being one of the major issues behind anti-government protests, along with housing and equality, the financial sector will have to play a vital part in providing skilled jobs for locals.

That will be tough unless the economy quickly recovers from the stagnation in the first half. By late April, the Bahrain Stock Exchange was down 2.2 per cent, indicating economic activity and trading has been depressed since the year began. However, it has not fallen as much as other stable markets like Kuwait, which is down 7.4 per cent year-to-date.

Sentiment will take a while to recover, and in the meantime most banks will be sticking with Bahrain. The government will have to engineer an economic recovery to match the swift return of security.

If it fails to do that, then Manama will find that its neighbours are likely to be equally helpful in offering firms leaving Bahrain a new home, as they were in offering Bahrain troops to help put down the protest movement.