Belatedly, Gulf states are realizing that a financial revolution is required – involving governments, regulatory authorities and banks – if the region is to be competitive in a market-driven global economy. There are signs of a readiness to create a regional capital market and to examine the size and role of Arab banks in a world increasingly dominated by massively capitalized financial institutions.
The traditional approach of protected trading markets and closed financial markets is becoming unsustainable because of the revolution in international business. The most recent General Agreement on Tariffs and Trade (Gatt) settlement dealt a blow to those bodies, including the European Union and the Gulf Cooperation Council (GCC), that wanted to establish protected markets. Local bankers say that if the Gulf states wish to diversify their economies away from oil by selling downstream products and industrial goods, they will eventually have to offer reciprocal access to products imported from Europe, the US and Asia.
The GCC states (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE) are no longer capital exporters. The first phase of the region’s financial evolution in the late 1970s involved the recycling of petrodollars by international banks; in the next decade this process was increasingly taken over by Arab financial institutions. The challenge now is to attract money into the region.
As Bahrain’s finance and national economy minister, Ibrahim Abdul-Karim, notes: “New regional financing needs arise from GCC industrial diversification policies designed to reduce reliance on the energy sector, from GCC budget deficits, from GCC and other Middle East privatization, from Middle East economies undergoing major reconstruction and from rapid growth prospects in the neighbouring subcontinent.”
There is no shortage of Arab capital abroad. Arab bankers estimate that Gulf nationals, at least 180,000 of whom are reckoned to be millionaires, hold more than $350 billion in assets overseas. There is also more liquidity in the local market as states, particularly Saudi Arabia, have recently released more funds for government contract payments. But the lack of a developed capital market and tradeable instruments means that private money is either moved rapidly overseas or invested in property. As a result, companies looking to expand have to borrow from international financial institutions rather than through a local market.
Investment by example
Nor will foreign investment fill the gap. According to Abdullah Saudi, now chief executive of ASA Consultants and in the 1980s the creator of Arab Banking Corporation, foreign investors “look at how domestic private – as opposed to public – capital is behaving and, for sure, if they see that local private investors are reluctant to place funds in local markets, then they are hardly going to do so either. Until we can persuade Gulf nationals to invest more locally, we shall have difficulties in attracting foreign capital as well”.
There is growing acceptance that the Gulf must create its own market in which shares and other financial instruments, such as bonds, can be traded, and that there must be a more flexible approach to foreign participation. That will require a break with present practice whereby regulatory authorities, particularly in Saudi Arabia, have been reluctant to allow local companies to be controlled by outside investors or become vulnerable to stock markets outside the country.
“The trouble with the Saudis is that they are control freaks,” says one Arab banker. Another says that “the Saudis must start to accept that security does not come from 100% ownership”.
Abdullah Saudi, a long-time critic of the Arab world’s slowness in coming to terms with global change, says that despite having established modern industrial states by investing oil money, the Gulf states’ economies have not been able to cope with rapid change in international markets.
Says Saudi: “The state still has a prominent role in the provision of basic services (power, telephones, transport, housing); privatization has barely had an impact; VAT [value-added tax] and income tax do not figure as the major contributors to state revenue; economic activity in the private sector continues in large part to be generated by subsidized inputs; and the labour force is still heavily distorted in favour of cheap foreign labour (which spends little locally) while increasingly young nationals find it difficult to find jobs.”
That assessment is possibly too bleak, say regional and expatriate bankers in Bahrain. There are signs of a willingness to confront the new challenges, particularly in Bahrain, whose future prosperity depends on greater Gulf cooperation.
Even in Saudi Arabia, there is a readiness to open up the market – the region’s most closed. Bankers consider it significant that the government has decided to approve a closed-end fund to be established for investment in the still unofficial Saudi stock market. Further liberalization could be proposed by a committee consisting of the Saudi Arabian Monetary Agency (Sama), the commerce ministry and the finance ministry that is looking at the operation of the financial market.
In addition, says a Saudi Arabian banker: “Attitudes in Riyadh are changing. But they have to make up their minds whether to ask a company like Saudi Arabian Basic Industries (Sabic) to go for bonds. This would benefit them as it is a cheaper and more flexible instrument and would help create a regional market. The world is hungry for this type of paper.”
One western offshore banker says: “The Saudi government is concerned about the lack of general liquidity in the corporate market, the lack of stock market instruments and the lack of development of their stock exchange. Everyone is telling them they have to deregulate and allow foreign ownership if they really want the boost to industrial growth that will bring jobs.”
The ambition of Fawzi Behzad, director of the Bahrain Stock Exchange, is to have Saudi shares – potentially worth $60 billion – quoted on a Gulf-wide exchange. He has agreements to link the exchange with those of Egypt, Jordan, Kuwait and Oman, creating a Gulf market of 70 companies with a $25 billion capitalization. But Saudi involvement would be the jewel in the crown. “We want to bring all the markets together and create one large regional one. That will encourage local investment and persuade foreign investors to come in,” he says.
As Saudi points out: “Successful stock markets are not just dependent on a good basic infrastructure, such as a prestige location or good computers. Much more important is volume and liquidity. Even if we combine the market capitalization of the five active GCC stock markets [Bahrain, Kuwait, Oman, Saudi Arabia, the UAE], we still arrive at a figure of no more than $72 billion or 32% of Malaysia’s and 38% of Taiwan’s capitalization.”
Bahrain has most to gain from a local capital market as it looks for new ways to retain its position as the region’s financial centre. From his office overlooking the new causeway linking Manama with Muharraq island, Abdullah Saif, governor of the Bahrain Monetary Agency (BMA – the central bank), says: “The goal is across-the-board listing. Regionally we hope all markets will be open. Saudi Arabia needs the comfort that comes with regulation. Their authorities will be happy to see across-the-board listing. It is coming and will happen when the rules reach a certain maturity.”
Saif says that among the key elements are “the expansion of domestic investment vehicles, for example through the development of medium- and long-term tradeable government debt instruments, the establishment of a viable secondary market in such instruments and the extension of Bahrain’s bond and equity markets to wider domestic and foreign participation, including through the listing of mutual/investment funds”.
Developing markets
The Bahrain government could lead the way this year following approval to increase government borrowing by Bd300 million ($796 million). “We could raise this money through a tradeable instrument, not necessarily in local currency, on the Bahrain market. Treasury bills could be issued on a tender basis,” says a local banker.
Saif, who has presided over the most respected central bank in the region for nearly two decades, believes the key to developing a capital market is “the right regulatory framework to ensure fair play for all. We are working to formulate those regulations. We are also determined to encourage the listing and issuing of instruments, not just from the government but by the large companies and banks. In addition we have enhanced training facilities and courses available through the Bahrain Training Institute”.
Among the instruments traded on the Bahain exchange are shares, bonds, warrants and mutual funds. Behzad says: “The exchange today is open for the listing of foreign companies and foreign private or government bonds. We also allow non-GCC nationals to buy shares so long as they are resident in Bahrain and that regulation will be relaxed in the near future. We are the only exchange in the region with corporate bonds and which lists currency warrants. We now want to introduce Bahrain deposits and receipts.”
The next stage will be more difficult. Behzad believes privatization will force governments to be more flexible about foreign ownership and attract investors, but the idea is at an embryonic stage. The Bahrain Stock Exchange has tried to persuade local family-held firms of the benefits of flotation. Last December a conference was held with the region’s largest private firms. “We tried to show them the future is best for traded firms. It will help them grow on a regional basis and that there are advantages of separating management from ownership,” says Behzad.
Bahrain’s confidence in the development of regional markets is not shared across the region. Some bankers believe that for political as well as financial reasons, many investors will prefer to keep the bulk of their funds abroad. “The traditional mix is to invest in liquid assets in Europe or the US and to invest directly in property or companies in the Middle East,” says a western banker. Others argue that it will be many years before all the Gulf accepts foreign ownership of companies and the financial openness, both for government and companies, needed for money to be raised on a regional bond market. “Ultimately the deciding factor will be their sensitivity about the idea of spivs wrecking the retail market,” says a banker.
If this analysis proves correct, it will add weight to those, including Moody’s Investors Service, who say it is “difficult to be optimistic about the future of Bahrain as a financial centre”. Moody’s points to improved global telecommunications and continuous trading in many dealing rooms in London, New York and Tokyo, and says that “homely Bahrain does not compare with picturesque Dubai, which is threatening to challenge Bahrain as the financial centre of the Gulf”.
Moody’s report concludes that “after 20 years of initial boom, followed by regional recession and the Gulf crisis, coupled with the current economic downturn and political unrest, the outlook for the banking industry in Bahrain is less than promising. Offshore banks are likely to dwindle in numbers if not in total assets and domestic banks will continue to struggle to make progress in difficult circumstances”.
This analysis is hotly contested in Bahrain. Although there is still an undercurrent of resentment from the Shia majority, which complains that it is excluded from wealth and political power by the ruling Sunni minority.
Cut and thrust
Bankers also point out that tough economic decisions, including cuts in capital spending, have enabled the budget deficit to be slashed from 7.1% in 1994 to 3.4% in 1995 and even lower last year. “We went through some tough times but that is behind us now. The thrust of new government spending towards new capital projects has also increased confidence,” says Ibrahim Abdul-Karim.
With Bahrain now receiving all the revenue from the Abu Saafa oil field it owns jointly with Saudi Arabia – equivalent to half government revenues – the long-term prospects are significantly improved. Growth is expected to rise to 5% this year and receive a further boost of $1 billion from the Hidd port, industrial free zone and causeway project. The project is being financed by a 15-year $520 million loan at 60 basis points above Libor and is being lead-managed by National Bank of Bahrain and Citibank. “We plan to go soon to general syndication and we are confident that there will be no difficulty selling it,” says Abdul Razak Hassan, general manager of the National Bank of Bahrain.
Further competition from the UAE is also likely and some banks have set up their regional hubs there, rather than in Bahrain. Banking regulation is also considerably more effective now in Abu Dhabi and Dubai than it has been for some years. A series of reforms introduced by Sultan bin Nasser al-Suwaidi since he took over as the UAE’s central bank governor in 1991 will be completed this summer, bringing banking rules into line with international practices and making the industry more transparent and accountable. Suwaidi has adopted a proactive approach, particularly on the monitoring of loan portfolios, and intends to introduce new classifications for full banking and restricted licences. His aim is to give the central bank “a clearer mandate in such areas as dealing with bank insolvencies, preventing money laundering and ensuring that accounts are transparent”.
However, some banks, such as Citibank, are using Bahrain rather than the UAE as their regional hub and most of the banking in the UAE is solely domestic. Bankers also point out that the UAE central bank has a long way to go before it can match the reputation that Bahrain has built up over a quarter of a century. According to Moody’s: “To date, the BMA’s record is a good one and it has the capacity to remain among the forward-looking central banks in the Gulf.”
Abdullah Saif says that “ultimately it is the quality and range of services which Bahrain offers which will continue to draw business our way, as has been the case in the past. As for ambitions which other banking centres may have, we do not interpret these as a threat. That will continue to be the case so long as we remain competitive”.
He is determined to reinforce further regulations which apply the Basle guidelines on capital adequacy, exposure and trading and derivatives, as well as maintaining an effective oversight of local banks by applying International Accounting Standards (IAS). Banks are also required to publish quarterly financial statements.
“We shall shortly be introducing a system of reporting accounts on a trial basis – with the objective of providing greater protection for depositors and other creditors and of strengthening the Agency’s regulatory and supervisory overview of Bahrain’s financial system,” Saif says.
He also says he wants to “deepen and expand Islamic financial activities”, and to “persuade local industry and manufacturing of the benefits of equity or fixed-rate financing through the capital market and to develop Bahrain as a regional and international fund management centre”.
Islam meets the west
Islamic banking is likely to be one of the main development areas in the Gulf and the BMA has defined rules which it believes will satisfy the religious authorities while meeting prudential financial guidelines.
The result is that already Bahrain is the base for 11 Islamic financial institutions, including one set up by Citibank – the first Islamic institution launched by a leading international bank as a dedicated and separately capitalized subsidiary. The most recently established, First Islamic Bank, is the first western-style investment bank to be established under sharia law, says its chief executive Majid el-Rifai. “We are 50% oversubscribed and may establish the bank with a capital of $60 million to $70 million. Overall we reckon that across the market we could tap totals of $600 billion. Professional Islamic banking could attract 60%-70% of that.”
The prospects for other banks in Bahrain remain less clear. The assets of the offshore banks tend to move between $60 billion and $70 billion but the BMA expects the mix of those assets to change from the 60%-70% of assets and liabilities which have been in interbank deposits. “This will happen as OBUs [offshore banking units] diversify towards participation in project loan syndications and in the provision of financing associated with regional privatization and economic restructuring. With the GCC’s infrastructure funding requirements expected to total $40 billion over the next decade, increasingly sophisticated and substantial financing packages will be needed,” says Saif.
There will continue to be doubts as to whether there is enough financial activity to justify the presence of the 46 offshore banks in Bahrain – Bahrain bankers insist some do little or no business. The market is dominated by 11 locally incorporated banks which hold 45% of the total assets between them. They are headed by Arab Banking Corporation, Gulf International Bank and Investcorp.
Bahrain bankers believe there has been a shake-out from the 1984 peak of 76 OBUs, the leading institutions have an advantage in doing business in Saudi Arabia. According to one: “There is at the present moment liquidity in Saudi Arabia, but which banks have competence and liquidity? There are only four Saudi banks with a capital size of more than $1 billion. If you then add a single customer limit of 10% you cannot satisfy all the demand.”
Some have responded by changing the emphasis of their business to investment banking. At Bahrain Middle East bank, chief executive Albert Kittaneh restructured the institution in 1993 to reduce its reliance on spread lending. “We became an investment bank to serve our clients with sophisticated products,” he says.
