Internet banking is gradually gaining momentum in the Middle East after a slow, tentative start when neither financial institutions nor customers appeared to have much enthusiasm for the concept.
Bankers are now divided between a minority who are pressing ahead as rapidly as possible and a rather larger number who are reluctantly acquiescing in an investment that they privately consider will neither generate immediate profit nor be popular with customers in the short term.
Internet banking has only scratched the surface of the potential market. The service, which has been taken up by little more than a quarter of a million customers, is available from only 18 banks in eight countries. These are Saudi Arabia, Bahrain, Qatar, Kuwait, the UAE, Jordan, Lebanon and Egypt.
However, several banks are planning internet strategies and are expected to be offering the service by the year-end. The financial conditions are right for making this investment. Higher oil prices are expected to stimulate Gulf economies, providing banks with the revenue needed to make the financial commitment to upgrade information technology.
There are also grounds for believing that there is genuine demand. Bankers point out that although comparatively few people in the Arab world are linked to the internet, a relatively high proportion of those who have logged on do use internet banking.
Internet banking will also form part of banks’ defensive strategies. In three years’ time, the four GCC states – Kuwait, Bahrain, Qatar and the UAE – which are members of the World Trade Organisation (WTO) will have to be ready for even tougher competition from global banks. This is because WTO rules compel states to open up their financial markets to foreign banks from 2003.
Arab bankers say the only way to compete is by offering comparable retail services. Some, though by no means all, bankers believe that there could be a drain of Arab funds from the region unless local banks can match the services offered by large international banks which themselves see the internet as a cheap – compared with acquisition – means of capturing market share in new countries.
Central banks will also continue to press financial institutions to invest in e-banking. Bahrain, in particular, has ambitions to become the regional internet banking centre and Dubai has poured millions of dollars into developing an international IT centre.
There are similar pressures on the corporate side where commercial trading platforms, with the capacity to advertise financial services, are already being introduced. Banks that fail to create or join trading platforms risk losing customers.
Though the retail side of internet banking has been the first to expand, the most significant development this year could be the creation by leading regional banks of a pan-Arab business-to-business trading portal.
The Arab banks, including National Bank of Kuwait (NBK), National Bank of Dubai, National Bank of Abu Dhabi, Saudi American Bank, Arab Bank, Commercial International Bank and Citibank, are completing plans for this site. This is their response to the successful launch of a platform by the US firm Commerce One.
“The purpose is to maintain our links with our customers so we are not disintermediated. Companies need a payment mechanism to carry out, for example, imports and exports, and we want to see these transactions go through the bank. Business-to-business sites like this will boom in the future,” says Ibrahim Dabdoub, NBK’s veteran chief executive.
The retail side will continue to expand. As more local banks offer internet services, their competitors will be reluctant to be left out, particularly as a large proportion of their actual and potential customers are under 25 and consequently more IT friendly.
Already, five of the leading UAE banks, headed by Emirates Bank International (EBI), which launched its own platform in 1995, offer internet services. There is considerable potential for expansion, particularly as the government has made a major commitment to investing in new technology.
“The new breed of UAE nationals are highly educated with the government emphasising IT related studies in universities, colleges and schools. This will help create the critical mass of e-banking users,” says Abdelshahkoor Tahlak, assistant chief manager e-banking at the National Bank of Dubai.
Competition is expected to be particularly intense in Saudi Arabia, which has lagged behind the other Gulf states – internet use was only permitted 18 months ago. At present only two banks, National Commercial Bank (NCB) and Arab National Bank offer internet banking in potentially the region’s biggest market.
“I believe that several other banks will come on line in Saudi Arabia this year as part of their long term strategy,” said Abdulkarim Al-Doaiji, NCB’s systems development manager.
NBK was the first Kuwait bank to offer the service with Watani Online, launched in January 2000. In its first 14 months, 24,000 customers, 8% of all its customers, had registered and the number is growing by up to 1,500 a month. Dabdoub says that the aim is to raise this to 14% by next year. NBK was also last year the first bank in the region to provide online broking.
Internet banking has played a key role in the bank’s overall strategy, which has involved halving branch numbers but has led business to grow five-fold. “It is a very important delivery channel alongside branch, ATM and telebanking,” says Dabdoub.
In contrast, Burgan Bank, which has no offices outside Kuwait, sees e-banking as a way to expand in the Gulf and has set up a separate operation, called BeeBank. “Burgan Bank will become a regional player in internet banking. We will also provide e-commerce by setting up alliances with Middle East and international companies to deliver products to this part of the world,” says Burgan Bank’s chief general manager, Rod Goom.
Even the most ardent fans of internet banking in the region accept that it will never completely replace the traditional branch network: many customers still want to use their branch and speak directly to their bank managers. “Customers will still want the bricks as well as the clicks,” says Dabdoub.
Some are even more sceptical. According to a leading Qatari banker: “Given the question of security, the relative size of the market and the expense of developing systems, I look forward to the day when the profit contribution matches the hyperbole that surrounds the subject.”
The concern about security is fairly widespread in the region and is an even more sensitive issue where there are comparatively small banks catering to local customers. “The greatest hurdle in my opinion is the security factor that is related to online banking. Many people are still not comfortable with conducting financial transactions through the internet. When this hurdle is overcome, we should expect a great surge in the number of online banking customers,” says Tahlak.
There are other short-term problems that bankers say have to be addressed before the market can achieve its potential. Although it is improving, the technical infrastructure remains poor, particularly in the last kilometre between telephone networks and houses. Some users have been deterred by the high cost of subscription to the web – a year ago rates were $100 per month and have only recently fallen to $70 a month. The lack of both Middle East content on the web and sites in Arabic has also had an effect.
As Arab banks struggle to define their internet strategies, widespread change is evident in the Arab world’s traditional banking centres, such as Bahrain.
Citibank’s brand new $30 million regional head office, located near the capital Manama’s most prestigious hotel, Le Méridien, is a significant symbol of Bahrain’s continued pre-eminence as the Gulf’s international banking centre.
The decision to build a new headquarters in Bahrain rather than join the drift of banks and other companies to Dubai has come at a crucial time for the country. The financial centre is evolving from one dominated by offshore banks to one where investment and Islamic banking are of equal importance.
Bahrain bankers are also coming to terms with the recent appointment of the third governor at the Bahrain Monetary Agency (BMA) – the central bank – in less than two years and the poor performances by some of the leading investment banks, whose funds were overexposed to US hi-tech stocks.
Major strategic changes are also being implemented in the leading regional Bahrain-based banks: Gulf International Bank (GIB) and Arab Banking Corporation (ABC). In addition, the leading retail banks, National Bank of Bahrain (NBB) and Bank of Bahrain and Kuwait (BBK), are looking to merge or form alliances with banks in other Gulf states so they can achieve a size that enables them to compete and invest in new technology.
Despite these many uncertainties, local bankers are confident about the prospects. “The outlook for the region is bright. Typically there is an upturn in this region when the western economies are having a downturn. We should have good opportunities if oil remains above $20 a barrel,” says Albert Kittaneh, chief executive of the Bahrain-based BMB Investment Bank – formerly the Bahrain Middle East Bank.
One reason for this optimism is that Bahrain is embarking on a period of political, social and economic transformation. Moves to greater democracy have been approved, the political leadership is becoming more sensitive, political prisoners have been released and economic management is characterized by a new dynamism.
Bahrain has also ended its 10-year dispute with Qatar over ownership of the Hawar Islands, with both countries accepting a decision by a tribunal at the International Court of Justice. There are already plans for economic cooperation, including the building of a causeway between the two countries.
One example of the Bahrain government’s new vigour is the readiness of the amir, Shaikh Hamad bin Isa Al Khalifa, to reshuffle his cabinet and restructure government departments. The days when ministers held office for more than a decade – sometime resulting in a dearth of imaginative policies – have gone for good. The ministerial reshuffle in April was only the fifth in Bahrain’s 30-year history, but significantly it was the second since the amir succeeded his father in 1999.
Foreign investor appeal
International bankers in Bahrain say these changes, which include a commitment to an elected legislature – approved overwhelmingly in a referendum earlier this year – and the creation of the Economic Development Board (EDB) to coordinate investment from overseas, will make the country more attractive to foreign businesses and banks. “The international community should look very positively at this period of unprecedented political change and the efforts to make government services more efficient,” says Murad Ali Murad, chief executive of BBK and chairman of the Bahrain Bankers Association.
There is no doubt that change is much needed. Bahrain, which two decades ago was the unquestioned destination of choice for foreign companies setting up regional headquarters, had been overtaken by other states, most notably Dubai which had modernised its infrastructure and marketed its services much more efficiently.
Government in Manama in recent years has been characterised by drift and indecision. The violent protests of a few years ago have been contained. But the perception among many potential investors was that serious social divisions remained with the Shia Muslims, who make up 70% of the population, having limited political power and suffering most from unemployment.
The key challenge now is for the government to turn the promises of democratic accountability and economic prosperity into reality. Expectations have been raised extremely high, particularly among poorer Bahrainis. As one western banker puts it: “They have talked the talk, they now have to walk the walk.” According to another: “My driver says he now expects the government to provide jobs and prosperity for all. They could face social unrest if they do not deliver.”
Bankers say that the early signs suggest that Abdullah Saif, the minister of finance and national economy, is addressing the structural issues facing the economy. Saif, who was appointed in May 1999 after nearly 20 years as governor of the Bahrain Monetary Agency, is already building a reputation for innovation and a readiness to make his department more publicly accountable. “The key focuses will continue to be sound public finance, an enhanced role for the private sector and continued industrial diversification while providing top-quality services to all the citizens,” says Saif.
Saif has added a new dimension to the ministry. He is a leading exponent of the openness now practised at all levels of government. Recently the crown prince, Shaikh Salman bin Hamad Al Khalifah, broke new ground for such a senior member of the ruling family by holding a public press conference that was later broadcast on Bahrain Television.
Saif himself has appeared frequently on television to debate proposals, most recently conducting a public dialogue – open to the press – with the business community on economic policy. Bahrain has also become the first Gulf state to publish regular comprehensive economic statistics and has opened up the budget-making process to popular debate.
Policy initiatives have included the region’s first anti-money-laundering legislation, a law to encourage early retirement for government employees, identifying sectors with potential for Bahrain, such as health care and information technology. Saif also commissioned the report which led to the setting up of the Economic Development Board.
The EDB, which has now been established with membership consisting of the most senior government ministers and private sector figures, is expected to give a new cohesion to investment strategy and, through a one-stop shop, make it easier for foreign investors to find their way through the government bureaucracy.
The financial sector will, though, continue to provide the foundation for the local economy. There are now more than 180 financial institutions in the country. The growing number of investment and Islamic banks has more than compensated for the decline in offshore banks, which has been caused in part by the mergers of many large international institutions. There are now 47 offshore banks (OBUs). This is only just more than half the peak number that operated in the mid-1980s, but the level of assets remains buoyant at more than $90 billion.
The new governor of the Bahrain Monetary Agency, Shaikh Ahmed bin Mohammed al Khalifa, takes over an organisation that has an excellent international reputation. Its status as an innovative institution, able to balance robust regulation with flexibility, was earned during Saif’s term as governor.
Shaikh Ahmed, aged 40, American educated, former chief executive of the Bahrain Stock Exchange (BSE) and a former director of planning at the ministry of finance, replaces Shaikh Abdulla bin Khalifa al Khalifa, who had held the post for less than two years.
Local and international bankers have welcomed the appointment. “Shaikh Ahmed is a safe pair of hands and he showed at the BSE that he is modernizer as well. He will ensure that the BMA continues to become more responsive and innovative as well as ensuring that the banks maintain a prudent approach,” says one western banker.
A local Bahraini banker adds: “He is a hard worker and an intelligent man. He needs to know a little more about banking but he is capable and I expect him to learn very quickly.”
There are important issues in Shaikh Ahmed’s in-tray. He has to rewrite banking legislation following the redrafting of the Basle capital adequacy accords and he has to defend Bahrain’s position as an offshore centre.
Some western financial administrators have tried to categorize Bahrain as a tax haven, an allegation that ministers have rebutted robustly. They point out that Bahrain does not impose any corporate or personal tax on businesses or individuals, whether they are working in or out of the country. So, they insist, there is no tax advantage in having an offshore status.
The authorities in Bahrain also moved promptly to ensure that the banking system did not become vulnerable to money laundering. Bahrain’s recently approved anti-money-laundering law is, bankers say, up to the highest international standards and builds on an earlier requirement on banks to report suspicious transactions.
Some bankers argue that Bahrain should go a step further and rename its banking categories so as to distinguish itself from those jurisdictions that give particular advantages to offshore financial institutions.
“Offshore banking in Bahrain is different to that carried out in most jurisdictions which offer a tax haven for high-net-worth individuals. OBUs here use Bahrain as a base for regional lending and their activity could much more accurately be described by international banking licence,” says one western banker.
The role of the leading offshore banks in Bahrain is certainly changing. And the pace of that change is likely to be more rapid than is usually the case in the Gulf as the financial services provisions of the World Trade Organisation (WTO) come into effect. Bahrain, along with other WTO members, will have to open up to foreign banks, which have already been winning a considerable amount of business in the region without having a local presence.
“We recognize that the landscape will change in the next three to five years as WTO rules start to take effect. There will be changes in ownership in some Arab banks and there will be some consolidation. We want to be well positioned when this happens,” says one senior banker in Bahrain.
As a result, GIB, which is owned by the six GCC states, and ABC, whose shareholders include Libya, Kuwait and Abu Dhabi with the balance quoted on the Bahrain Stock Exchange, are both radically reassessing their roles. Neither have lived up to their full potential in recent years. ABC, for example, has only been delivering an 8% return on capital, which is well short of the 15% demanded by shareholders.
Self-inflicted wounds
ABC, launched as the region’s first billion-dollar bank in the early 1980s, has, in the words of one banker, “shot itself in the foot at every available opportunity”. It grew rapidly by taking interbank deposits and lending to Latin American sovereigns in the mid-1980s before becoming a victim of the debt crisis in the region. Little more than a decade later, it faced similar problems from excessive lending to Asia before the crash there.
There has been a major strategic rethink of both sides of the balance sheet. The main focus now is on developing retail banking across the Arab world to bring access to cheaper sources of finance. The bank now has subsidiaries in Jordan, Algeria, Egypt and Tunisia and is considering purchases in Gulf states. Analysts expect ABC to sell some existing holdings, possibly starting with its Spanish subsidiary, to finance further acquisitions.
Lending strategy is also being redrawn as the bank tries to reduce cross-border sovereign risk. The focus will be on minimizing the bank’s exposure to bad debt by lending to companies doing business in emerging markets rather than taking part in sovereign loans. Geographically, the bank plans to concentrate on viable projects in the Gulf.
GIB and the Kuwait-based Gulf Investments Corporation (GIC), which owns 72% of GIB, are also at a crossroads as their boards consider whether and how to privatize the banks. Between them, the banks have a combined equity of more than $2.5 billion and total assets of more than $20 billion. Last autumn, JP Morgan, a shareholder in GIB, was asked to consider the strategic options for the banks.
Bahrain bankers say that a consensus has already been reached to press ahead with the sale of GIB though there is as yet no agreement on whether to float shares on local and international markets or sell a stake to a strategic foreign investor.
The challenge is to get political agreements between the six Gulf Cooperation Council (GCC) states – Bahrain, Saudi Arabia, the UAE, Qatar, Oman and Kuwait – which own GIC.
The case for privatizing both GIC, an investment bank, and GIB, a wholesale commercial and investment bank, is strong. Although GIB produced a 74% increase in profits to $118 million last year – the first to include full-year figures from its newly-acquired subsidiary Saudi International Bank – its return on assets and equity in the second half of the 1990s was well below that of private-sector institutions.
Saif, who is also chairman of GIB, believes that the prospects for the bank are good. “We are enhancing the group’s customer focus and increasing the range of products and services to diversify income streams and balance sheet structures. This included the opening of a branch in Riyadh, which was an important milestone for the bank,” he says.
Bahrain’s onshore banks also need to diversify at a time when market conditions are becoming more competitive and there are problems with some commercial customers – recently one jeweller fled the country, facing allegations that he owed bankers more than $13 million.
Bahrain banks, says Murad, must look at ways of becoming regional rather than local banks. He says that BBK “has decided that the only way is to build alliances and look for mergers with institutions in other states in the region.
“There has to be more consolidation to create bigger banks that can cope with international competition. It is better to do this by merging with banks elsewhere in the region because you can then cover a larger geographical area. That way you can increase the market – a merger between two local banks can only generate more profits through cost cutting.”
BBK did produce a 5% profit increase in the last financial year, which was a much better performance than shown by the investment banks which had a difficult year through their exposure to western markets.
Investment banking, which Bahrain has encouraged in the last decade, has a long-term future in the country as Arab investors, nervous about the thinness and volatility of regional stocks exchange, look to place their money in international markets. Investcorp, which invests regional money in private equity projects and property in western Europe and the US, has been one of the most successful offshore banks in Bahrain.
Even it found the going tough last year, with profits falling to $70 million – the first time in 16 years when it failed to produce increased profits. The bank attributed this to volatile market conditions and having to write off one major investment. Investcorp remains confident normal service will be resumed this year. “Our cautious approach to technology investment means we have avoided the harmful effects of falls in valuation in that sector,” says Investcorp chief executive Nemir Kirdar.
Some of the investment banks whose funds focused on international equity markets did perform well. Profits at TAIB Bank, for example, rose to $15.5 million, a tenfold increase on the previous year, even despite the difficult conditions in global markets.
However, Bahrain International Bank saw its net income fall by $30 million to only $313,000 and BMB was forced to suspend its dividend, after announcing a net loss of $57 million last year, a dramatic downturn from the previous year in which it made a $30 million profit.
The key element of BMB’s performance was the loss of $44.8 million from investments compared with a similar level of profit in 1999. The reason was the decline in technology stocks. As a consequence, its shares, which are owned by 14,000 Gulf investors, are now trading at 70% below their peak.
Even so the bank continues to be “a long term believer in the technology revolution”, according to Kittaneh, and expects to see a significant recovery later this year. “The bank was clearly exposed to the risks inherent in trading equities given the heightened volatility that markets experienced in 2000. We are confident that by implementing more rigorous controls and reducing our positions in equity investment and foreign exchange to reflect a more acceptable risk/reward ratio, the damage of 2000 can be overcome,” says Kittaneh.
Growth of Islamic banking
The increasingly diverse nature of Bahrain’s banking sector means that these results have not caused the shock waves that they would have done in the past. The continued growth of Islamic banking in Bahrain is an example of how the market has diversified. While HSBC has decided to set up its Islamic bank in Dubai, it is very much in a minority, with 17 banks now based in Bahrain.
Bahrain has made a concerted effort to attract Islamic banks, many of which are backed by Saudi Arabian money. As demand increases, with Arab investors wanting their money invested profitably as well as in line with their religious principles, international banks, such as Citibank and locally incorporated banks such as BBK, are establishing their own Islamic institutions.
“We chose Bahrain because the authorities have introduced proper accounting standards, they are creating a ratings agency and are prepared to set up Islamically compatible short-term financial instruments,” says an Islamic banker.
The BMA has also taken the lead in establishing capital adequacy requirements for Islamic banks. Details are now being finalized on these rules which will reflect the different operating methods of conventional and Islamic banks. Islamic transactions, for example, have to be asset-based. The BMA’s new regulations will take into account the related asset risk, which is not part of the new Basle proposals on capital adequacy.
