Restoring Bahrain’s crown in financial services sector

29 October 2009

As the global economic slowdown continues to affect rivals such as Dubai, the kingdom has a chance to regain its title as the region’s financial services hub

The financial services sector is a key part of Bahrain’s economy, and is expected to continue to play a vital role for the country as part of the Vision 2030 masterplan. It contributes more than 20 per cent of gross domestic product (GDP) and is one of the government’s favourite targets for growth as it has the potential to create high-paid, private sector jobs for locals.

But achieving this growth will require Bahrain to challenge the increasing dominance of Dubai as a financial services hub. The success of the Dubai International Financial Centre in attracting global banks has shifted the balance of power away from Bahrain, which had held the crown as the region’s principal financial hub since stealing it from Lebanon after the outbreak of civil war in the country in 1975.

Bahrain’s main asset in the finance sector is the strength of the financial services regulator, the Central Bank of Bahrain (CBB).

“When we spoke to investors about establishing an investment bank, Bahrain was the obvious choice as it had local talent and the legal and regulatory framework to enable us to attract investors internationally,” says Atif Abdulmalik, chief executive officer (CEO) and founder of Arcapita bank, which was set up in the kingdom in 1997.

Strategic rethink

But the global banking crisis of the past year has taken its toll. Gulf International Bank and Arab Banking Corporation, both headquartered in Manama, reported combined losses of about $2bn for 2008, largely because of investments hit by the sub-prime crisis. Both banks benefited from the support of their government shareholders, but have had to rethink their business models.

More recently, problems at Saudi conglomerates Saad Group and Ahmed Hamad al-Gosaibi & Brothers Company have resulted in defaults at two Bahrain-based banks owned by these companies. The banks, International Banking Corporation (TIBC) and Awal Bank, have been placed into administration by the CBB, which hopes to be able to return as much to the firms’ creditors as possible.

“Bahrain is not immune from the financial crisis or from bank failures,” says  Khalid Hamad, director of banking supervision at the CBB. “With TIBC and Awal Bank, they failed themselves and will have no systemic impact on the financial sector in Bahrain.”

He adds that most of the loans to these banks and their parent companies came from inter-national banks and the rest of the region, with little held by domestic creditors. This has helped to ensure that the local banking system has remained stable.

But the problems have undoubtedly knocked Bahrain’s reputation. “Of course things like this damage the reputation of any regulator,” says Sameer Abdi, head of Islamic financial services at international accounting and consultancy group Ernst & Young.

Until the financial crisis, the CBB had been doing well in developing its reputation as a tough regulator, unafraid to enact unpopular measures such as capping banks’ exposure to the real estate sector and preventing speculators from betting on a revaluation of the Bahraini dinar as they were on other Gulf currencies.

The limited impact of the crisis on the local economy highlights how prescient those decisions were. Bahrain avoided the liquidity crunch that hit Saudi Arabia in late 2008 and is still affecting the UAE, and there have been only limited write-downs of the value of investments in real estate.

“A lot of the CBB’s measures to protect the banks, like capping real estate exposure, were very unpopular at the time, but now people need to thank the CBB,” says Mahmood Hashim al-Kooheji, deputy CEO of Bahrain’s sovereign wealth fund, Mumtalakat.

With the rest of the region still looking shaky, Bahrain now has an opportunity to regain some lost ground. “The setbacks in Dubai have been helpful for Bahrain,” says one bank executive in Manama. “They have shown the depth and maturity of the financial sector and regulation in Bahrain.”

Hamad says the CBB is in talks with inter-national firms located in Dubai in an attempt to persuade them to relocate to Bahrain.

Another step the CBB has taken because of the financial crisis is to dramatically increase the level of supervision and inspections. “We are subjecting all the banks to risk-management assessment,” says Hamad. “We are encouraging risk-management com-panies to come to Bahrain to expand the knowledge pool.

“After [US investment bank] Lehman Brothers collapsed [in September 2008], we have also intensified our inspections to make sure we know what every bank is doing to protect itself from future shocks.”

Job losses

Given how prominent a role Bahrain’s financial services sector plays in the overall economy, it was inevitable that some redundancies would occur as a result of the shocks to the financial sector. But the CBB says it has been working with institutions to monitor who they plan to make redundant and what their role within the bank is, to ensure that banks are not laying off staff who are strategically important to the risk-management and reporting procedures within the institution.

It has also been proactive in dealing with firms to ensure they are prepared for what is potentially a long and deep slowdown. This has included working with some institutions to help them reassess their business models to ensure they are not overly reliant on funding from the capital markets, as well as putting some of its own resources into banks.

As part of a broader aim of the Vision 2030 plan to support education, local financial bodies are also involved in initiatives to support the development of the local workforce.

“We used to be known for mainly providing entry-level qualifications but now, to fit in with the Vision 2030 strategy to develop a higher-skilled workforce, we are offering more advanced and technical training,” says Garry Muriwai, director of the Bahrain Institute of Banking & Finance (BIBF), a training organisation for the financial services sector.

More than 9,000 of nearly 14,000 professionals working in the financial services sector are Bahraini. The BIBF says its courses, which are free for nationals and subsidised for expatriates, are so popular it frequently overspends.

A further element to the Vision 2030 strategy is to boost Bahrain as a centre for sharia-compliant finance. Ernst & Young bases its Islamic finance practice in Bahrain because, according to Abdi, whether businesses are from Qatar, Saudi Arabia or the UAE, if they are involved in Islamic finance transactions, they like to do them through Bahrain.

Overall, the CBB says, the domestically focused retail banks have managed to survive the banking crisis without any major problems. But there are still some areas where further work is needed.

“Setbacks in Dubai have been helpful for Bahrain. They have shown the maturity of the financial sector”

Manama-based bank executive

There are concerns that some banks are restricting the amount of credit they provide to the private sector because of continued fears about how bad the recession will become. This is despite efforts by the CBB to pressure banks into passing on low interest rates to consumers to stimulate economic activity.

The CBB also plans to overhaul the country’s banking regulations to force banks to hold more liquid assets. This should help to prevent any future shortage of liquidity, which has weakened the region’s banking sector.

Whether Bahrain’s financial industry can continue to punch above its weight in the region is uncertain, even with the more severe difficulties in other centres such as Dubai. As richer neighbours develop their financial services sectors, it will be difficult to make a case for basing operations in Bahrain in terms of deal flow, as there is little domestic activity.

French bank BNP Paribas says it has based its regional operations in Bahrain because of the lack of quotas on employing local workers and the lower cost environment, which means it can relocate entire teams from other markets and place them within an hour’s flight of all the major GCC markets. Others, however, prefer to be in the larger centres.

There is also currently little project finance activity in Bahrain. “Every project finance transaction in the region used to come through Bahrain,” says Dominic Harvey, banking and finance partner at UK law firm Norton Rose in Bahrain, referring to when Gulf International Bank and Arab Banking Corporation were regional project finance giants.

Whether this continues to be the case as those two banks struggle with their sub-prime losses is unclear, although, given their mandate to support the development of the region and the continued support of their GCC government shareholders, it seems likely that they will return to prominence at some point.

Fortunately for Bahrain, the problems at TIBC and Awal should also prove short-lived. They are generally accepted by industry observers as being the result of problems in Saudi Arabia, rather than domestic issues.

But perhaps the most important element Bahrain has managed to retain through the downturn is its reputation. Muriwai claims the CBB’s efforts mean it will remain the most advanced financial hub in the region from a legal and regulatory perspective.

During the boom years it was commonly said that the various regional financial centres were not in competition with each other. Bahrain has now abandoned that rhetoric.

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