Exploiting strengths

Published in The Gulf, 1 February 2016

Bahrain is searching for ways to re-invent its banking hub credentials.

The latest data from the Central Bank of Bahrain (CBB), released in January, showed a further decline in the value of assets held by the country’s banks. The consolidated balance sheet of the banking system was $190.5 billion at the end of the third quarter of last year according to the CBB, compared to $191.8 billion at the same point in 2014. It might only be a small drop, but it highlights the fact that the authorities in Manama have yet to find a way to revive a sector that has been struggling for the best part of a decade.

Since 2008, the overall size of the Bahraini banking system has fallen by around 25 per cent, according to ratings agency Standard & Poor’s (S&P). That fall has not been across the board, but concentrated in one particular part of the market.

Local retail banks have actually been steadily expanding since 2008, with assets growing from $63.5 billion in 2008 to $81 billion by the end of September 2015, while Islamic banking institutions have been stable, with their balance sheet barely changing from $24.7 billion in 2008 to $25.5 billion last year. Instead, the main problem has been with the position of wholesale banks, which have been gradually reducing the value of their balance sheets in Bahrain. Given the worsening regional economic environment and the country’s uncertain political climate, there are few reasons to suppose that trend will change soon.

The decision by Fitch Ratings to revise its outlook on Bahrain from stable to negative in early December won’t have helped things either. The change to the sovereign outlook prompted Fitch to make similar changes to its outlook on two of the country’s big banks, National Bank of Bahrain (NBB) and Bank of Bahrain & Kuwait.

S&P’s outlook on Bahrain is also classified as ‘negative’. Both it and Fitch have said that they could lower their BBB- ratings this year if the Bahrain economy or the government’s financial position worsens more than expected. Such a move would push the country’s debt into junk bond territory.

Nor will Bahrain’s position be helped by predictions that its economy may contract in 2016. The low oil price means that government budgets are under pressure across the region, but weaker economies like Bahrain are in the most vulnerable position.

“Some smaller, more vulnerable economies, such as Bahrain and Oman, could even be tipped into outright recessions [in 2016],” warns Jason Tuvey, Middle East economist at London-based research firm Capital Economics.

But while there are reasons for pessimism, Bahrain does have a few strengths that it can exploit.

Chief among those advantages is a decent pool of local talent. According to the CBB, locals represent around 77 per cent of the work force in the banking sector and 68 per cent in the wider financial services industry. That is far ahead of many other regional centres.

“Local human resources is our main resource, our main wealth,” says Abdulrahman al Baker, executive director of financial institutions supervision at the CBB.

Manama is also a relatively cheap place to do business, compared to other Gulf commercial centres. Renting office space in the capital currently costs around BD7-9 per square metre per month for the best quality developments, according to real estate consultancy CBRE. The figure has been stable since late 2012 and remains below where it was in 2009. At a time of low oil prices and stretched budgets, there is much to be said for being a low-cost business centre.

“The Bahraini value proposition is suited for all types of financial services, because of the experience and the diversity [of the sector in Bahrain], but I think it is particularly suited for areas where what matters above all is skill and reasonable cost of operation,” says Jarmo Kotilaine, chief economist of the Economic Development Board (EDB). “I think that is in particular the case with mid-office and ancillary services.”

One other advantage that Bahrain has over the likes of Qatar, Dubai or Abu Dhabi is its proximity to the Saudi market, which is by far the largest economy in the region. However, Saudi Arabia has been building up its own financial hub, the King Abdullah Financial District in Riyadh. Last year it also took measures to make it easier for international investors to put money into its stock market, the Tadawul.

Such factors could undermine the position of Bahrain as a base from which to target the Saudi market. As one international executive based in Dubai puts it, half-jokingly, “Bahrain might well be close to the Saudi market but Riyadh is even closer.”

All this is reflected in research that ranks the relative strength of financial hubs in the region and beyond. In the most recent Global Financial Centres Index, published by research group Y-Zen in September, Dubai was the best-placed hub in the Gulf and 16th best globally. You had to scroll all the way down to 50th place before Bahrain appeared, some four places lower than the previous year’s index.

In some market niches, Bahrain is better placed, however. The brightest spot remains Islamic finance, where the country has managed to sustain its regional leadership position. That in part stems from the fact that Bahrain is the home base of standard-setting bodies such as the Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the International Islamic Financial Market (IIFM), but there are also 25 Islamic banks in the country, including six retail banks and 19 wholesale banks.

Globally, the Islamic finance industry has been growing healthily in recent years, which is to Bahrain’s advantage. However, even here it is not all good news as some parts of the market appear to be struggling, not least the sukuk market where activity has been coming under pressure. The number and value of Islamic bonds issued has been falling steadily in recent years and that trend is likely to continue.

In a report issued in January, S&P said that a combination of the rise in interest rates by the US Federal Reserve in mid-December, along with the continuing low oil price and the complexities involved in issuing sukuk, means that activity in this area of the market is likely to remain subdued this year. The ratings agency predicts that the total value of sukuk issuance is likely to be in the range of $50 to $55 billion for 2016, compared to $63.5 billion in 2015 and $116.4 billion in 2014.

Going forward, Islamic banks, like their conventional counterparts, are also bound to be affected by the weaker levels of economic growth in the region as a result of falling oil revenues and reduced government spending. In its review of the Bahraini economy in December, S&P noted that competition between retail banks is likely to put some strain on their profitability, something which ought to encourage further consolidation among them. It also pointed out that Bahraini banks are still heavily exposed to the real estate and construction sector, which is still in a correction phase.

All this means that Bahrain’s credentials as a financial hub are looking rather stretched.

For the foreseeable future, when international financiers think of the Gulf they are likely to continue to think of the opportunities in places like Dubai, Riyadh, Abu Dhabi or Doha before they turn their attention to Bahrain.