Kuwait’s banking industry has risen to new challenges and increased prominence in the past two years as the Gulf’s northernmost emirate was simultaneously tested by its ballooning revenues and by the deflation of the regional stock market bubble. With a handful of commercial and even fewer Islamic banks, the banking sector’s importance is considerably weightier than the number of players might suggest.
A clear indicator for the sector’s growing role in the national economic fabric is the position of banking in the Kuwait Stock Exchange (KSE), where the nine listed Kuwaiti banks account for close to one third of total market capitalization although they make up barely 5% of listed companies.
Banks were at the forefront of the upward trend on KSE this year, which outdid other Gulf equity markets in terms of stable improvements and overall performance. Compared with the 12% gain of the KSE’s general index from the start of the year to mid May, the banking sub-index grew twice as strong, showing an improvement of 24%.
As Safaa Zbib, head of research at Kuwait-based financial firm Bayan Investment told Executive, commercial banks ended the first quarter of 2007 with strong earnings that helped them outperform the other seven sectors on the KSE.
The eight banks that published quarterly financial reports by the end of April, indeed showed their consistent qualities in the first quarter results that (excluding BKME for which no result was available) totaled KD218.3 million – equal to $757.8 million, 28.8% better than in the first quarter of 2006.
Sector leader National Bank of Kuwait (NBK) had the lowest percentage growth with 13.4% but topped the results list in absolute numbers with KD64 million, ahead by almost KD13 million on runner-up Kuwait Finance House, the country’s top Islamic bank.
The banking sector’s share in the KSE market capitalization climbed six percentage points to 31% at the close of the first quarter of 2007, Zbib said. In mid-May, the cumulative market cap of the eight stood at nearly $54 billion, with NBK and KFH accounting for more than $32 billion between them.
Also noteworthy, KFH had considerably narrowed the valuation distance to sector leader NBK to less than $400 million from more than $3.5 billion at the end of 2006. KFH caught up with NBK’s market value through a combined bonus shares and rights issue for 40% of its capital this spring. NBK on its part executed a 5% bonus issue but also extended again a share buyback program for 10% of its stock, which went into a third six-month round in May.
Successful strategies
NBK told Executive in a written statement that it credited the fast growing economy’s hunger for loans, investment, and core banking services on both the retail and corporate levels as lead factors in its success. The bank’s successful strategy enabled it “to deepen our market penetration both in terms of customer acquisition and providing our customers with a wider scope of service offerings.”
Zbib said the banking sector’s strong development in the past few years was partly due to the opening up of the Islamic banking sector in 2004. Until then, Kuwait Finance House held a government-enforced monopoly on Kuwait’s sharia-compliant banking market. After the central bank lifted prohibitions against the creation of new Islamic banks, Boubyan Bank entered the field, raising $260.7 million in its IPO and one specialized bank, Kuwait Real Estate Bank, switched to sharia-compliance. However, numbers prove that allowing the entry of new Islamic banks did not harm the profits at KFH, to the contrary.
Oil, being the life juice of the Kuwaiti economy, also figured in the growth spurt of the banking sector. The banks’ performance both for the quarter and the past few years come on the back of loans to finance large oil and gas projects, said Mihir Marfatia, a financial analyst with Kuwait’s Global Investment House.
The banks’ total assets grew 29% to $97.6 billion in 2006 from $75.7 billion in 2005, not including Kuwait Real Estate Bank, for which 2006 figures are not available.
Commercial banks have also indirectly impacted the market through providing a means for economic growth and diversification, said Jan Randolph, an analyst with US-based Global Insights, which studies Gulf Cooperation Council (GCC) markets. Randolph told Executive that banks in Kuwait act as vehicles for development in the economy, supporting the development of other sectors.
With their consistent earnings growth, Kuwaiti banking stocks became attractive investments, according to Zbib. “The banking sector in general is a steady sector – and not risky,” she said.
Although banks are an important source for the upward share price momentum that the KSE experienced this year, they did not influence the market through big-time share buying. “You won’t see banks impact the Kuwaiti stock market directly,” said the head of research at Oman’s BankMuscat, who did not want to be named.
According to BankMuscat’s research, Kuwait’s banks have fueled the buying of shares on the KSE only through their lending activities, which were dominated by retail lending in 2004, 2005 and 2006.
Keeping close watch
A key factor in the sector’s stability has been the watchful eye of Kuwait’s Central Bank, which monitors commercial banks to ensure they follow international standards, practice transparent corporate disclosures and maintain high capital adequacy levels, said Karim Kamal, who heads the research department at NBK.
“It’s not that there are very strict rules on how to do business, but there’s very strict control and follow-up that doesn’t allow banks to do risky things,” he said. “Because of this, investors see the low-risk aspect of investing in the banking sector. So whenever they feel there are winds of change or a downturn in the stock exchange, they park their money in the relatively safe banking sector.”
In one example of its sector control, the Central Bank stepped in during 2004 by mandating banks to lower their lending ratios from 92% of deposits and follow what was called the 80:20 rule. It stipulated banks could only lend 80% of their deposits, but re-classified deposits to make the rule less restrictive.
While it was not exactly followed, the rule brought lending ratios closer to the 80% mark. The central bank has since increased the ceiling to 88% of deposits, Marfatia said.
The year 2004 was a busy one on the regulatory front as the central bank also opened Kuwait’s banking sector to foreign operators while maintaining restrictions that offered domestic banks protection of their retail business. “While the Central Bank has been granting licenses to international and regional banks in Kuwait, it has been limiting those licenses to one branch, making it impossible for those banks to compete on the retail level,” Kamal said.
The only exception to the rule is the Bank of Kuwait and the Middle East (BKME). It was privatized in 2003 by the Kuwait Investment Authority, which allowed Bahrain’s Ali Ahli United Bank to buy a controlling stake, 67.33%, in BKME (originally a foreign bank that the Kuwaiti state had bought from the British in 1971) and allowed it to keep operating its multiple branches.
But by and large, foreign banks wanting to work in the Kuwaiti market – the first operating license went to BNP Paribas in 2004 – have to focus on the corporate market and on private banking for high net-worth individuals.
After having expanded their local activities in the past few years, Kuwaiti banks are now facing the challenges of taking the leap abroad and become players outside of their borders.
“Our challenge is not on the local scene,” Randa Azar, NBK’s chief economist, told Executive. “It is more related to the regulatory barriers to our ability to execute our regional expansion strategy.”
Some analysts, like Randolph of Global Insights, cautioned that banks in Kuwait and other GCC countries ought to take care to cover themselves against over-concentration of lending to particular sectors, such as real estate, where a fall in asset qualities and investment losses could have devastating consequences for overexposed lenders.
The latest measure of the Kuwaiti authorities, the surprise announcement on May 19 that the dinar will shift from a dollar peg to be tied in the future to a currency basket, may not make regional expansion easier for Kuwaiti banks, as the move enforces doubts on the implementation of a GCC monetary union in 2010. For the moment, though, analysts agree it is too early to say what impact the re-pegging of the dinar will have on the business of Kuwait’s commercial banks.
