Growth in Kuwait offshore bank accounts

Recent years have witnessed a growth in both the size and sophistication of the region's banking industry. The 45 listed banks across the six GCC countries, which we are covering in this GCC Banking Sector Report, had an aggregate asset size of US$354.3bn at the end of 2004, having grown by 14.8% over 2003. These banks had aggregate net profit of US$8.9bn in 2004, having grown by a healthy 38.6% over 2003.

The major highlights of the region's banking industry are as follows:

i. Low business diversification
The business diversification of the GCC banks remains relatively poor. 'Plain vanilla' credit products and services constitute the bulk of the region's banking activities, with particular focus on short-term loans. Investment activities are almost restricted to government bills and bonds, along with investment-grade securities in mostly international markets. Trading positions are generally limited. Activities such as sophisticated structured financing, advisory, asset and fund management, fiduciary and custody services are at a nascent stage. Top-tier banks are now placing particular emphasis on the development of domestic asset management competencies. Internet banking has reached a high level of use in the GCC, compared with other emerging markets.

ii. Controlling ownership by government and influential families
The shareholding structures of the GCC banks are often dominated by two groups of owners - governments or government agencies, and influential ruling or merchant families. Government ownership enables them to intervene and support their banks during a crisis. On the other hand, shareholdings of leading business families leave banks vulnerable to potential related-party lending and shareholder meddling in credit policies.

iii. Constrained by relatively small size
While the balance sheet sizes of most banks in the region have grown in recent years, reflecting their business growth, they are still small compared to their Western counterparts. The foreign assets as a proportion of total assets have generally trended down for the GCC as a whole though Kuwait, Oman and Qatar are exceptions to this general trend. Legal barriers to entry and family ownership are certainly the main causes of the very slow emergence of a regional playing field.

iv. High concentration
Banking businesses in the six GCC countries are concentrated locally. The single notable exception to this trend has been the asset concentration profile of banks in Bahrain, thanks to the many Offshore Banking Units (OBUs) operating from that country. The aggregate foreign assets of banks in the six GCC countries, while growing at a CAGR of 4.9% during 2001-'04, have generally trended down as a proportion of the total assets of the banks during the period, indicating a larger concentration of their business in their respective geographies. The most price-competitive market is undoubtedly that of the UAE, which is overbanked, with 47 financial institutions serving a population of about 4.3 million inhabitants.

v. High capitalization
As far as capitalization is concerned, the GCC banks usually keep high capital bases as a cushion to absorb unexpected losses. The median capital adequacy ratio (CAR) for the GCC banks was estimated to be 16.5% in 2004. Banks in Oman and Qatar had a higher CAR. It could indeed be necessary for the GCC banks to maintain such high levels of capital, given the uncertain economic and geopolitical environment..

vi. High profitability
The GCC banks have shown consistently high financial performance in the past decade. They achieved an average return on assets of about 1.5%-2% during this period, which compares favorably with international standards. The most profitable banks are those in Saudi Arabia, Kuwait, and UAE. Strong profit generation has resulted from high margins, low cost of funds and labor, and the absence of income tax.

vii. Improving asset quality
Asset quality has improved in the recent years. Non-performing loans for banks across GCC have trended down in the last three years - more than halving from 7.9% of gross loans in 2001 to 3.5% of gross loans in 2004. Improving management of credit risk, limited appetite for the most risky sectors and products, satisfactory economic environment, and high liquidity of recent months have been at the root of this positive trend.

viii. Strong funding profile
The GCC banks have traditionally been characterized by strong funding profiles. The main source of funding so far has been customers' deposits. Customers' deposits have traditionally constituted a high proportion of the total liabilities of banks. The highly stable customer deposits have meant steady deposit-base and low cost of funds for the banks. But this is set to change. The banks' lending portfolios are experiencing a gradual increase in maturity following the rapid expansion of consumer loans accelerating the need for longer-term funds. Alternative funding is developing through certificates of deposits, syndication, and even international bond issues.

ix. High proportion of non-interest bearing deposits
The GCC banks have a key advantage in funding, that is, access to a large amount of non-interest-bearing deposits (NIBs). The main driving force behind the large amounts of NIBs, seems to be the religious tenets in Islam.

x. Healthy liquidity profile
The GCC banks have traditionally seen a healthy level of liquidity, partially as a result of the boom in oil prices in the 1970s, as well as a low level of leverage. Thus, the region's banks never had to compete fiercely to attract customer deposits. Another characteristic is the high stability of these deposits, despite periodic geopolitical pressures and recurrent episodes of strife in the region.

xi. Unrealized potential of corporate banking
Competition in corporate banking in GCC has been fierce for decades. But it has been a competitive, cyclical and narrow business line in the region. Consequently, the GCC banks' loan portfolios are still dominated by corporate and public sector loans. With the noticeable exception of Saudi Arabia, GCC corporate banking markets remain narrow, and attractive new deals are scarce. Despite several deterrents, there are good opportunities to provide far wider range of corporate banking products and to develop the small and midsize enterprise (SME) segment business. In their corporate banking business, most GCC banks suffer from a widening of maturity mismatches between funding and lending.

xii. Retail banking coming into its own
Banks in the GCC have benefited from the shift to retail banking on many fronts. Retail banking has been a profitable means of revenue diversification out of the more risky commercial banking, given the limited amount of risks it carries. It has also been a major stabilizer for banks' bottom lines through the business cycles, thus placing the GCC banks in a position to become more resilient to internal and external shocks. To cope with this, banks in the region have made heavy investments in conventional and electronic delivery channels, as well as in risk management systems and marketing know-how.

xiii. Mortgage lending in early stages
Mortgage credit is far less developed than other types of retail loans in GCC banks, because of the difficulties that banks have in initiating court proceedings and in foreclosing on residential real estate collateral..

xiv. Islamic banking
Islamic banks follow the Sharia principles. These banks have a clear competitive advantage over their conventional competitors. While conventional banks attract all kinds of depositors, Islamic banks' customers are more sensitive to the Islamic Sharia principles. As a result, Islamic banks have access to larger volumes of NIBs relative to their asset size, than do the conventional banks. This leads to very high spreads for the Islamic banks. The Islamic banks have also given rise to hybrid funding instruments. One such instrument is the 'profit-sharing investment account' (PSIA), which exhibits a combination of debt- and equity-like features in the same instrument.

xv. Nascent stage of capital markets
A limited role played by the capital markets, which are still at early stages of development, constraints the banks' ability to expand at a time when they must raise additional funds to meet their growing financing needs and increasing competition. Banks have so far met the bulk of the financing needs of companies active in the GCC region. Many family businesses are seeking listings on region's stock exchanges. More government companies are either being sold to the public or listed as possible candidates for privatization. In addition, new capital market laws are being implemented and existing laws strengthened to allow domestic companies to raise additional funds.

xvi. Benefit of high growth trajectory of GCC countries
All the six GCC countries have seen a high trajectory growth over the last two years. This has predominantly been on the back of high oil prices. Budget surpluses and growing populations have made the respective governments go for higher spending on infrastructure and utility projects. Big-ticket projects that have either been announced or are being executed benefit the banks in the region tremendously, as these offer the banks sizeable and profitable project financing avenues.

xvii. Strong systemic support by governments
Government support for banks is strong, reflecting the dominant role of the governments in the GCC economies. Besides the central banks offering liquidity support in times of need, the GCC governments have both injected capital and replaced doubtful loans with government bonds. This has been more so where the governments hold a major shareholding in the bank.

xviii. Poor disclosure levels
The GCC banks need to address some accounting- and disclosure-related issues. Shareholding structures are often undisclosed, details on impaired assets and provisioning policies remain limited, and Islamic banking accounting principles and practices lack regional standardization, which makes comparability with traditional banks difficult.