Banks need to diversify energy exposures



Kuwait’s banking sector, which has been built on the back of a flourishing oil sector, has been warned to better diversify its energy exposures or face the increasing threat of global oil price volatility.

Financial analysis firm Moody’s said because of Kuwait’s oil heritage it had been slower than other GCC countries to develop its non-oil sector by encouraging private sector activity and attracting foreign investment. And that banks now faced the threat of operating in an undiversified economy too highly correlated to fluctuating oil prices, Moody’s said in its first banking system profile on Kuwait.

Stathis Kyriakides, a Moody’s analyst and author of the report, said: “Despite the recent economic growth, Kuwaiti banks face some challenges relating to the operating environment in light of the country’s relatively undiversified economy, in which oil-related activities generate half of the GDP.

“This results in the Kuwaiti banks having limited non-oil related exposures and sizeable balance sheet concentrations, both to the oil sector and individual entities.”

The report said buoyant economic growth was masking challenges arising from the undiversified and volatile economy and that despite some improvements both governance and legal systems exhibit weaknesses.

“Kuwait’s banking system is one of the most robust in the Gulf, benefiting from the country’s outstanding economic performance in recent years as well as a fairly effective supervisory framework, which, despite some drawbacks, has been very successful in restoring confidence in the system since liberation and nurturing its development,” said Kyriakides.

Kuwait’s domestic banking system is relatively saturated, with 16 banks – including Islamic financial institutions, specialised banks and branches of foreign banks – competing to serve a total population of 3.4 million.

Conventional banks have historically dominated the financial system. To date, Kuwait Finance House has been their primary Islamic competitor but other Islamic financial service providers are set to pose increased competitive pressures.

Moody’s viewed the conventional banks’ position as defensible, despite the central bank restriction on them tapping the Islamic segment. “In recent years, a number of non-banking financial institutions have emerged as key market participants in Kuwait, in response to which banks have been expanding their investment banking, asset management and ancillary financial operations,” said Kyriakides.

Local banks have enjoyed the support of the regulator, the central bank, which has been unwilling to open up the market to foreign banks to an extent that would constitute a threat to the local banks, he said.

Kyriakides said: “The central bank now believes that domestic banks are ready to withstand direct foreign competition and is currently in support of amending the banking law to lift the one-branch-only restriction applied to foreign banks.”

Moody’s believes the independence of the central bank’s supervisory authority is well established, but is concerned that political pressure may have a bearing on central bank regulations. Although regulatory standards have been consistent with best common practices and the central bank has developed a prompt corrective action framework, the current regulatory burden is considerable, the report said.

“Although Kuwait’s stock market has become among the most advanced and active in the GCC, a regulatory environment governing its capital market is not in place. In particular, the market is in need of an independent regulatory body and the system lacks a comprehensive and appropriate legal framework, while there is some concern that regulatory action has until recently been politically influenced,” said Kyriakides.

He said: “Overall, the framework for banking supervision and regulation in Kuwait has proven successful in addressing the country’s needs following liberation. Nonetheless, given substantial changes over the past five years, it is still fairly new and developing and the regulator would need to ensure that it continues to adapt to changing industry demands, particularly as the sector evolves and the nature of Kuwaiti financial institutions‚ business becomes more complex.”

Over the long term, greater institutionalisation of the reforms, transparency of enforcement practices and formalisation of processes would be indicative of a more stable and mature bank regulatory and supervisory framework, the report said.

Moody’s considers systemic support expectations for Kuwaiti banks in general as high, based on the state’s ability and willingness to support the banking sector, the importance of the banking system in the country’s development, the absence of a deposit insurance scheme as well as the country’s track record of support.

The Kuwaiti monetary authorities officially opened the country’s doors to foreign banks in March 2004, following the necessary changes to the banking law, and granted the first licences to BNP-Paribas, National Bank of Abu Dhabi, HSBC Bank Middle East and Citibank. More recently, licences were given to Qatar National Bank, Al Doha Bank and Al Rajhi Bank. 

Foreign banks are limited to a one-branch presence that significantly restricts their ability to compete in the lucrative retail market. However, this may change in the not-so-distant future as the central bank has expressed its confidence that domestic banks are ready to withstand direct foreign competition, Moody’s said.

The CBK is currently in support of amending the banking law to lift the one-branch-only restriction applied to foreign banks, plus many global banks have long been engaged in asset management activities with high net worth Kuwaiti citizens, despite their lack of presence in Kuwait.

Kyriakides said: “Nonetheless, the newly licensed foreign banks are expected to challenge the Kuwaiti banks in trade and project financing, investment banking, private banking and, potentially, credit cards. All or most of which are areas that the larger Kuwaiti banks have traditionally dominated.”

Moody’s new banking system profile for Kuwait forms part of a new series of reports on banking systems throughout the world, which are designed to complement the rating agency’s banking system outlook reports by serving as descriptive reference guides to key structural factors that are reflected in Moody’s bank credit ratings.


Oil Correlation

Kuwait’s economy is dominated by the oil sector, resulting in a high correlation between the Kuwaiti economy and volatile oil exports. Because of its oil endowment, Kuwait has been slower than other GCC states to develop its non-oil sector by encouraging private sector activity and attracting foreign investment. This has led to an overburdened public sector that employs 90 per cent of the labour force of Kuwaiti nationals.