Bahrain: The financial hub of the Middle East

One of the first things a visitor notices driving down the streets of Manama, Bahrain's capital, is that many impressive bank buildings -- new and gleaming of marble, glass and brass - line the roads. From that observation, it's easy to figure out that Bahrain is the financial services capital of the Middle East.

Bahrain stepped in to fill the banking void that befell the Middle East when Lebanon - the banking capital of the region until the '70s - got mired in its civil war. Since then, Bahrain hasn't looked back. While planning its economic diversification, Bahrain took advantage of its position as the Gulf's central oil supplier to attract the world's leading banks and insurance companies. Bahrain is now known as an international and regional wholesale interbank money center for the Middle East and beyond.

"The Bahrainis were smart enough (during the Lebanese Civil War) to create a tax haven," said Michael Langton, director of the Bahrain Institute of Banking and Finance. "Bahrain is a platform in the Gulf, and it's definitely worth partnering with. It has the visionary leadership of the emir, the crown prince and the prime minister - all who fully appreciate globalization."

The first offshore banking license was awarded in 1975. The country now has dozens of OBU's, as well as commercial banks, specialized banks, investment banks, representative offices, money and foreign exchange brokers and moneychangers. It also has a large number of insurance companies.

"The fact that we have this excellent selection of international financial institutions operating out of Bahrain talks well of how we have worked together," said Murad Ali Murad, chief executive officer and general manager of the Bank of Bahrain and Kuwait.

"In many countries, the word 'globalization,' or 'opening the markets, probably comes as a shock or a surprise. But in Bahrain the banking center has been open to various international banks, and we have presences of a good number of banks from the United States, from Europe, from the Far East, and from the region. It is also the largest center for Islamic banking - a concept of banking that is catching up very fast and is complementing the conventional banks," said Murad.

Bahrain's ability to branch out into new economic endeavors has helped the country. According to Dr. Abdullah Dl-Kuwaiz, Gulf International Bank's general manager, "Bahrain is the most diversified economy in the Gulf, which came by both plan and default."

El-Kuwaiz said this because "Bahrain had contacts with the outside world from the very beginning, and it had the highest rate of educated people, per capita, in the Arab world. We have a 90 percent rate of literacy, so the economy benefits from this."

Bahrain realized it had to diversify "because we don't have much oil, the oil sector contributes only 25 percent of the Gross Domestic Product.

"When the economy is diversified, it is able to absorb shocks," said El-Kuwaiz. So when the price of oil dropped, we were affected, but we had so much diversification that we were not crippled.

Gulf International Bank's general manager noted the importance of Bahrain's location next to Saudi Arabia, "which is a huge economy. When you have an economic slowdown, Saudi Arabia will come to Bahrain, rather than Europe."

"It is also very important to remember that Bahrain has a transparent legal system, which you won't find elsewhere in the Arab world," said El-Kuwaiz.

Some bankers feel Bahrain may soon risk becoming over-saturated with banks.

"My own perception is that, of course, there are far too many banks, because it makes life tough," said Michael Fuller, CEO of Al-Ahli Commercial Bank. "Nevertheless, we've managed to increase our profit every year for the last six or seven years. So I guess there must be enough business to go around.

"Also, one of Bahrain's attractions is its closeness. Don't forget that one of the attractions of this country is its proximity to Saudi Arabia, and its ease of access to Saudi Arabia, which has a significantly larger economy than here."

As with real estate agents, some bankers stress the importance of "location, location, location."

"The downturn in oil prices or other strategic commodities does not by itself have a negative impact of business. Therefore, we are not dependent on oil prices, to a certain degree; however, we are involved in many oil and gas projects. We have clients who are in the business, such as commodity traders, oil services, and contractors to the global oil industry," said Ghazi Abdul-Jawad, president and chief executive of the Arab Banking Corp.

"We actually are in a win-win situation, if oil prices increase, naturally the pace of economic development in many oil-based countries would open up opportunities for our banking services. Equally, a drop in oil prices would tend to create opportunities for us.

"There are many things that augur very well for Bahrain, the banking section as a whole, has never seen or lived through a real crisis: There has been no scandal, and it has become resilient with the changing global environment in terms of international finance," said Abdul-Jawad.

Albert Kittaneh, Chief Executive Officer of Bahrain Middle East Bank agrees. “Bahrain does not have ‘boom or bust cycles.’ We did not have distrubing negative effects when oil prices declined. Even in the 1980s when the region had eceonomic troubles, Bahrain still maintained an economic equibibrium.”

Bahrain recently signed a bilateral investment treaty with the United States.

"We have set year-end 2001 as a deadline for securities staff at banks, brokerage firms, investment banks, investment advisory services and asset management firms operating in Bahrain to be certified and registered with the Bahrain Stock Exchange," said BSE Director Shaikh Ahmed bin Mohammed Al Khalifa.

Al-Ahli's CEO agrees with the BIT, and believes it is important for Bahrain to keep in step with the times as globalization is hitting its shores. "We are in the process of merging with a Kuwaiti-owned London-based bank, called the United Bank of Kuwait. All banking units in the Gulf and Middle East are far too small and in the process of consolidation and rationalization that you've seen elsewhere.

'It was always bound to hit this part of the world," said Fuller, "I'm just surprised it didn't get here sooner. Banks need a wider range of products and they need more capital, particularly as the regulatory environment becomes tougher."

 

Arab Banking Corporation and Arab Banking Corporation Islamic Bank

Arab Banking Corporation (B.S.C.) ("ABC"), established in 1980, is headquartered at ABC Tower in the Diplomatic Area of Bahrain.

ABC was incorporated as a Bahrain joint stock company on January 17, 1980 pursuant to a special decree of His Highness, the late Amir of the State of Bahrain, Sheikh Isa bin Sulman Al Khalifa, and was issued an Offshore Banking Unit license by the Bahrain Monetary Agency on April 7, 1980. Operations commenced that month.

One of the reasons underlying ABC's formation was the recognition that, despite their established presence in international financial markets, Arab banks were restricted in the volume of their activities by their comparatively small capital structures. Accordingly, ABC was established with an authorised capital of US$1,000 million of which US$750 million was issued and paid up by April 1, 1981.

The three original shareholders were the Abu Dhabi Investment Authority, Kuwait's Ministry of Finance and the Libyan Secretariat of Treasury (later the Central Bank of Libya). Each of the three shareholding groups held one-third of ABC's share capital until 1990.

At the end of 1989, ABC's authorised capital was increased to US$1,500 million. In 1990, ABC listed its shares on the Bahrain and Paris stock exchanges and increased its paid-up capital to US$1,000 million by a public offering in Bahrain and an international private placement.

ABC's strategy of diversified growth led to the development of its widespread network (the "ABC Group") of branches, representative offices, subsidiaries and affiliates in over thirty countries around the world, including most principal international financial centres. ABC's branch offices are situated in Grand Cayman, Milan, New York, Singapore and Tunis. The ABC Group provides a wide range of banking services. ABC's branches focus principally on wholesale commercial and corporate banking and trade finance services. Its subsidiaries concentrate largely on exploiting opportunities in domestic retail and merchant banking sectors. Its affiliates offer specialised financial services.

The services provided by the ABC Group include: Corporate Banking: Syndicated loans; a full range of trade finance services; project-related and bonding facilities; energy and acquisitions financing; aircraft/asset-backed finance. Treasury: Spot and Forward FX in major, Gulf and Arab world currencies; FX margin accounts; money markets in all major currencies, Currency latest rate options, Interest rate derivatives; Investment banking; securities trading; underwriting and placement; portfolio management; corporate advisory services; bridge finance; mergers and acquisitions. Islamic Banking: Islamic products include: Morabaha (Credit Sale), Mudaraba (Trust financing), Musharaka (profit sharing), Bai-Al-Salam (sale with future delivery), Al-Qard-Al-Hassan (benevolent loan), Ijara (leasing) and Istisna'a (pre-manufacturing finance). ABC Islamic Bank also offers liquidity managed funds: ABC Islamic Fund & ABC Clearing Company.

Private Banking: A range of services is available through several ABC Group units.

 

 

A Regional Leader with an International Network

ABC is regarded as the Number One bank in the Arab world," said Ghazi Abdul-Jawad, President and Chief Executive of ABC. "The nature of our business is that we are a big, offshore banking center that conducts business globally. And globally, Eurpe is our largest market - in terms of distribution of our risk assets."

Abdul-Jawad says of ABC's objective criteria "in terms of the breath of our global network, no Arab bank can match it. The closest would be Arab Bank Ltd., in Jordan, in terms of an international network.

"In terms of size, we are perhaps the largest, $26 billion bank. But size is of secondary importance. Profitability is the primary, return is equity and shareholders profit, and in those terms we are lacking. We have issues that we have come to grips with in terms of quality of business, competitive factors, because of the nature of our franchise," said Abdul-Jawad.

"In terms of capital resources, we are the 4th or 6th largest Arab bank. We are represented in Latin America, we are very active in South East Asia, we also have retail banks and subsidiaries in Hong Kong, and there is a branch in Singapore," said ABC's president.

Arab Banking Corporation (B.S.C.) ("ABC") was incorporated on 17th January 1980 by Amiri Decree in the State of Bahrain as an offshore banking unit with an authorised capital of US$1,000 million. By April 1981, an amount of US$750 million was fully paid by ABC's original three shareholders: the Ministry of Finance of Kuwait, the Libyan Secretariat of Treasury (whose shares were later transferred to the Central Bank of Libya) and the Abu Dhabi Investment Authority.

At the end of 1989, ABC's authorised share capital was increased to US$1,500 million and in June 1990, paid-up capital was raised to US$1,000 million through an international share offering. The number of institutional and individual shareholders is now around 1,560. The Bank's shares are listed on the Bahrain and Paris stock exchanges.

One of the reasons underlying ABC's formation was the recognition that, despite their established presence in international markets, Arab banks were restricted in the volume of their activities by their compartively small capital structures.

 

Islamic banks in Bahrain

Thirty years ago, the Organization of Islamic Conference recommended establishing an Islamic economic system in the Muslim world. Today, most of the Islamic financial institutions are less than 20 years old, but they are considered an emerging power in international finance.

Islamic banks, which follow instructions given in the Koran, cannot charge interest on their loans at pre-determined rates.

Unlike ordinary commercial banks whose operations are based on interest, Islamic banks operate an interest-free system, and are guided by the common principle that depositors, instead of receiving a fixed return in the form of interest, share the risk of investment and take part of the resulting profits or bear part of the losses.

As the leading regional financial hub and a major player in the global banking and financial markets, Bahrain easily had what was necessary for it to become a natural and convenient location for Islamic banks and other Islamic financial institutions.

"Islamic banks are a totally new venture," said Dr. Abdullah El-Kuwaiz, general manager of Gulf International Bank, "where you have fast-growing number of investors looking to invest their money in acceptable Shari'a methods. Banks should be loyal to customers, and therefore should find ways to hear their needs and create new investment projects for them. This is bringing new dynamism to the region, and especially to Bahrain.

"Islamic banking started as offshore banking, but when the banks became more efficient and loopholes closed, there was no need for offshore banks. Bahrain spearheaded Islamic banking, and it is replacing a temporary phenomenon with a permanent phenomenon," said El-Kuwaiz.

To date, because of the active assistance and encouragement of the authorities, Bahrain is the host of the largest concentration of Islamic banks and other financial institutions in the Middle East.

"The Islamic financial institutions are here mainly because they deal with the Islamic world and no other country has created the atmosphere, or the legal framework, for them to operate under. Bahrain is the only one who managed to do that, and therefore they use Bahrain to become established and do business with Pakistan, Sudan, Iran, etc.," said Jamal Al-Hazeem, office managing partner for Arthur Andersen.

"An Islamic offshore bank and a commercial offshore bank have the same license, but one operates under the Shari'a principle, or Islamic principles, and the other one operates under commercial principles. The license is either called an OBU, an offshore banking unit; or an IBL, an Islamic Banking License, and they are more or less the same," said Al-Hazeem.

In recent years, a number of these banks have successfully developed a range of specialized Islamic financial products, for example, in the areas of collective investment schemes, leasing and syndicated lending.

"Bahrain is one of the few countries that allows dual banking," said Al-Hazeem. "If you look at Sudan, all the banks are Islamic, and in Pakistan and Iran, banks there also are all Islamic. But Saudi Arabia has no Islamic banks, which is interesting. The only exception is Al-Rajhi, which is not considered as a bank, and there is a fatwah for that from one of their Islamic scholars.

"The Bahraini Monetary Agency decided there was room for both types of financial institutions; conventional and Islamic," said Al-Hazeem. "So a lot of Islamic banks have chosen Bahrain as their base or have their offices here, although most of them operate offshore.

'The reason why there aren't any more Islamic banks operating onshore is the fact is that the Bahrain Monetary Agency believes that there is a saturation of the market as far as commercial banks are concerned," said Al-Hazeem.

Bahrain's Islamic banks complement the activities and operations of some 173 traditional banks and other financial institutions in Bahrain - both domestic and foreign - that are licensed by the BMA.

In addition, there are 12 Islamic investment banks and two Islamic offshore banking units. In December 1999, the aggregate assets of all Islamic banks in Bahrain amounted to $4.9 billion.

The strong growth of Islamic banking and its impact on financial markets has prompted a number of traditional local and international banks to seek stronger relationships and joint project financing arrangements with their Islamic counterparts.

Citibank in Bahrain decided to establish its own Islamic investment bank in the country. This was considered a major step, both regionally and internationally, in the development of Islamic banking by otherwise traditional banking institutions.

"The Islamic bank is a locally incorporated bank that has separate capital, and a separate board of directors. It has its own Shari'a group with four Shari'a scholars that work with the bank," said Mohammed Al-Shroogi, Citibank's regional director for the Middle East.

"The mandate for the bank is a global mandate, and it covers the whole world, not just the Middle East. So our scope is bigger than just the Islamic countries,"

"That's the reason why we made the decision -- being an American bank, a foreign bank - to do the job. We created a separate vehicle, and put separate capital into it," said Al-Shroogi.

And Citibank's success here as an Islamic bank, has Al-Shroogi looking west. "There isn't an Islamic Citibank in the United States, just here and in London, but I am considering it because there are about 5 million Muslims in America."

But not everyone believes Citibank's decision was a wise move: "Citibank was very successful in providing products and services to family banks and Islamic communities," said Mahmoud Difrawy, managing director, Middle East Region, of Chase Manhattan Bank.

"They decided to go head on and compete with them on the retail side. They set up their own Islamic bank. We do not think that was the right strategy on their side. Chase will continue to provide products and services to the Islamic community and Islamic banks.

"The difference between Citibank and Chase Manhattan is that Citibank has a branch in every country where they compete with the local banks and do local business. We look at every country and find a local partner to join with, and do the business we want to do locally, if we need local support. So we are viewed as bankers for banks - for products and services that they cannot develop themselves," said Difrawy.

Other banks in Bahrain manage to satisfy the needs of American customers without opening their own branches in the States.

"Arab Banking Corporation is the biggest bank in the Arab world. And, as Bahrain is becoming the hub for Islamic financial institutions, we decided to create an Islamic bank at ABC," said Adnan Yousif, former chairman of ABC Islamic Bank. "There is no other difference, except this is an Islamic bank and ABC is a commercial bank. But it's the same bank.

"We're very active in the U.S. market -- ABC is the largest Arab bank, as far as I know, in the United States. So if anyone wants to deal with ABC Islamic Bank in New York, they will be helped because the branch there is in close coordination with us.

"In this part of the world we talk about 'Islamic' as a product. And some of our customers like to have commercial activities along with what we call 'Islamic principles.'"

In general, the Bahrain Monetary Agency's supervisory requirements on Islamic banks are similar to those of traditional banks, which include appropriately qualified and experienced management, adequate capital, liquidity and internal monitoring systems, and the proper assessment and control of risk.

However, in the case of Islamic banks, BMA tends to direct particular focus on liquidity and risk largely because of the less liquid and longer-term nature of many of the Islamic banks' assets.

The BMA feels satisfied that it has succeeded in ensuring that its supervisory and regulatory approach toward Islamic banks is fair, prudent and not unnecessarily restrictive.

Recently, the BMA became the first central bank to approve a set of guidelines on reporting and accounting practices that would bring about a measure of standardization for the Islamic banking industry as a whole.

The guidelines were produced by the Accounting and Auditing Organization for Islamic Financial Institutions, an organization set up in Bahrain under an agreement signed by a number of Islamic banks and other financial institutions worldwide for the purpose of setting international accounting and auditing standards in the area of Islamic financing, and are designed to help introduce more transparency and accountability to Islamic banks than currently exists.

Establishing an international regulatory system for Islamic banks

As with commercial banks, Islamic financial institutions need to establish an internationally accepted regulatory system to ensure continued growth, said Bahrain's banking chief.

BMA's Governor Shaikh Abdulla bin Khalifa Al Khalifa recently urged the Islamic financial community in Bahrain to accept that its institutions must be regulated and supervised to international standards.

"Ultimately, their ability to grow and compete will be dependent on international acceptance of the regulatory regime under which they operate," he said.

"Not only would it deprive those institutions of the very real financial and commercial advantages that accrue from being an integral part of an internationally approved regulatory environment, but also the existence of a secondary, unregulated market would obviously lessen the present international high regard with which Bahrain is held.

"The strengthening and development of Islamic banking has been, and remains, an important aspect in the government's policy of maintaining and enhancing Bahrain's status as the region's pre-eminent international financial center," said Shaikh Abdulla.

"It has been estimated that the asset growth of these institutions over the last five years has been around 15 percent, with an expected growth rate of 10 percent over the next five years," he said.

Transparency vital

While looking for increased foreign participation, Bahrain also wants to maintain its squeaky clean image: "Transparency is vital in an Islamic banking industry estimated to be worth $200 billion worldwide," said Shaikh Ebrahim bin Khalifa Al Khalifa, finance and national economy ministry undersecretary and chairman of the Accounting and Auditing

Organization for Islamic Financial Institutions.

The Islamic banking industry has been expanding at an annual rate of 15 percent over the past five years, with 48 developing and emerging market countries now involved, Shaikh Ebrahim said recently.

"In the light of such industry globalization, with both its benefits and challenges, the need for the development of a cohesive, uniform regulatory strategy, which can be

Islamic banking is definitely viewed as a very serious market with great potential. Minister of Finance and National Economy Abdullah Hassan Saif, earlier this year spoke on the need to formulate regulations for the Islamic banking institutions with an aim to assist the potential investors in making choices that are funded on transparency and clarity.

Regarding Bahrain's special circumstances as the Gulf's major international financial center, regulation is essential and must embrace the whole market, Saif said. Islamic institutions can't operate in a vacuum; they must become a bigger part of the wider financial world, he said. Their growing influence in their targeted markets is best illustrated by the increasing interest taken in their operations by the regulators of those markets.

"The Gulf region has more than 30 Islamic financial institutions of which more than 15 are based in Bahrain. It has been estimated that the asset growth of these institutions over the last five years have been around 15 percent, with an expected growth rate of over 10 percent in the next five years. The framework and international recognition of the BMA's professionalism as a regulator, provides the essential underpinning of Bahrain's reputation as a major international financial center," he said.

The governor said that a key issue for the regulator is the question of capital adequacy and the basis of its circulation. The international accepted view is that banks should be subjected to a common standard of circulation.

"Liquidity is another area of concern for the financial well-being of the institution. There are a number of issues to be resolved, but the basic issue is of a standard measurement of how liquidity should be managed for the funds held off the balance sheet," he added.

Secretary General of AAOIFI Professor Riffaat Abdul Karim stressed the importance of the conference, its key mission and the relevance of its launch at the commencement of the new millennium.

"At this pivotal stage of their development, Islamic financial institutions are looking forward to being perceived as an industry in the process of becoming mature. The implementation of a cohesive, harmonizing regulatory strategy is important, indeed imperative, for the Islamic banking industry in order to support its future growth and enhance its credibility and competitiveness in a global market place. By conducting such an international, high profile conference, we hope to encourage the world's leading Islamic banking industry representatives to proactively engage in meaningful debate and discussion on this most crucial topic and to disseminate the resulting information and recommendations for the benefit of the industry as a whole," he said. harnessed by the industry worldwide, has never been greater.

"The current market size of the Islamic banking industry is estimated to be $200 billion this year," said Shaikh Ebrahim.

The AAOIFI has played a crucial role in improving the transparency and the level of disclosure in the financial statements of Islamic financial institutions, he said.

 

 

First Islamic Bank expects continued growth

Atif Abdulmalik, the chief executive officer of Bahrain's First Islamic Bank, said he knew the bank had great potential "because Islamic banking, as we know it, is only about 20 to 25 years old.

"Compared to the conventional system, which has been going for more than 200 years, the industry is in its infancy. As with other new industries, it has enjoyed impressive growth in recent years, about 15 percent to 20 percent per annum, especially in the Arabian Gulf States, and this expansion is expected to continue," he said. Accurately estimating the amount of funds invested in accordance with Islamic banking principles is difficult, but industry experts estimate it to be between $150 and $200 billion.

"Although compared to the conventional system, the size of the Islamic banking industry is small, the important factor to consider is the future potential for the industry. Most funds of Muslim investors worldwide remain with conventional banks, but, if these funds can be lured into the Islamic banking industry, they could increase the size of the industry substantially. A Muslim investor will probably select a Shari 'a-compatible investment over a comparable conventional one if the risk and returns are the same.

"The trend in the Arabian Gulf countries of a transfer of wealth from the state to private hands is another important factor driving the growth of Islamic banking. As one colleague noted recently, 'money in private hands fuels Islamic banking because people go to hell and governments don't.'

"There are a lot of families, especially in Saudi Arabia, Kuwait and the United Arab Emirates, who deposit money in the conventional system, some of which is earning no return because these families do not take interest.

"We are convinced that the growth of Islamic banking will create a virtuous circle. As the industry grows, competition will force Islamic banks to provide products with risk/return profiles that are comparable to their conventional counterparts. This will create a big shift, a transfer of funds from the conventional to the Islamic system. We don't know exactly when this might happen but when it does, it will have an exponential effect on our industry."

Abdulmalik said, "Western leveraged buyout funds and regional players operating in the leveraged-buyout industry have been very successful in tapping into this source of funds in the Gulf region. That brings us to our bank. One of the critical success factors for First Islamic is how well we can tap these funds. One of the main reasons why I teamed up with a few of my ex-Investcorp colleagues to set up First Islamic was my belief that our

Islamic structures give us a competitive advantage to tap these funds.

"As earning or paying interest is forbidden in Islam, people demanded an alternative to the interest-based system, so these banks started. The difference between the conventional and Islamic modes of financing is simple - for example, instead of the bank giving you $10,000 for you to go and buy your car, the bank will instead buy the car and then sell or lease it to you with a profit margin."

Abdulmalik said a common question is whether the profit margin Islamic banks charge is similar to the interest rates charged by conventional banks.

"In fact, this is a question that I grappled with when I first became involved with Islamic banking. The best answer to this question is set out in the Koran because the same question was put to Prophet Mohammed. When the verse of the Koran forbidding interest was revealed, some people who were in the business of lending money for interest said to the Prophet that trading, that is buying and selling, was similar to borrowing and lending. Instead of taking interest, you are making a profit margin between the buying and selling price. The Koran's response to this question is: "Hallallahul baya wa harramullahur Riba", which means that "we have allowed trading and forbidden interest" i.e., God did not say that they were different but simply that he has allowed one and forbidden the other. This means that even though the two transactions may look similar, one is allowed and the other is not allowed.

"I think a good way to summarize what Islamic banking transactions are about is that the transactions must be backed by underlying assets. The asset-backed securities that are so prevalent in the U.S. market fit in well with Islamic banking principles -- as long as the assets are Islamically acceptable. The trend in the Islamic banking industry is to develop asset-backed securities as Islamic investment vehicles. In fact, the latest product that we have introduced is a liquidity management product, which is structured as an asset-backed security using U.S. lease assets," said Abdulmalik.