Kuwait: In Recovery Mode

The Kuwaiti banking sector is making a steady recovery from the severe problems it faced following the regional and international financial crisis of 2008 and 2009 which resulted in a sharp liquidity squeeze and a plunge in asset values for Kuwaiti investment houses, corporates and banks. Kuwait banks saw their profitability improve in 2012, and 2013 has also been a better year for most banks.

Consumers and retail customers in Kuwait were also hit by the financial crisis and many who had borrowed heavily could not repay. A new debt relief scheme was announced and approved by the Kuwaiti parliament in 2013. This scheme is intended to benefit Kuwaiti citizens who availed loan facilities before March 2008 but were not beneficiaries of any earlier debt relief schemes. Under the scheme, the outstanding principal and accrued interest, as of 12th June 2013, will be settled by the government on behalf of the approved clients from the fund. This will aid Kuwaiti financing companies and banks and should create more credit demand going forward as customers see an increase in their capacity to borrow. Financial positions of the institutions will also improve. The main pressure for consumer debt relief has come from some sections of parliament. While the intentions may have been positive, there were (and continue to be) some very obvious moral hazard risks.

The outlook for the Kuwait economy has improved. However, the effect on the government’s ability to push forward its project spending programme is still uncertain. Without such government spending on capital expenditure rather than on current expenditures, the local economy could lag behind those of other GCC states, even if GDP growth remains strong on high oil prices. This in turn would negatively impact the potential earnings of the commercial banks – such government spending tends to boost both corporate loan demand and trade finance and other off balance sheet businesses. Nonetheless, to date the picture appears more promising.

Many Kuwait banks are focusing more on retail banking. Commercial Bank of Kuwait has an increased its emphasis on retail banking. CBK’s operations are largely focussed on Kuwait itself – non- treasury international business is mainly trade finance, apart from the 32 per cent stake in Al Cham Islamic Bank in Syria – which is now a problematic investment given conditions in that country and following the large impairment provision against this investment that was taken in 2012 and Q1 2013. The remaining book value is less than KD1 million, and any further need to provide would not materially impact the bank.

From a the macroeconomic viewpoint, the Kuwaiti economy continues to do well – something that has been the case for a number of years. Governmental revenues have been strong on the back of higher oil prices as volumes are constrained by adherence to the country’s OPEC production quota.

The last three years were very good for oil producers in general – at least in price and therefore income terms (with the 2012 exception of Iran due to sanctions). It is clear that with oil prices at current levels, Kuwait will continue to post substantial budget surpluses. However, government spending has been rising – with most of the increases going on entitlements and other transfers rather than into infrastructure. This makes Kuwait more vulnerable to any prolonged period of weakness in oil prices.

Kuwait has a history of failing to follow through on previously announced projects, often because of parliamentary objections once individual projects reach the contract award stage –with build-operate-transfer (BOT) projects or projects involving foreign oil companies in actual production in particular drawing the ire of MPs.

Despite the more positive outlook, challenges remain. Kuwait is still heavily dependent on the oil sector, which accounts directly for around 50 per cent of nominal GDP, 80 per cent of budget revenues, and 90 per cent of exports. There are also significant expenditure rigidities, with the bulk of total spending geared to the payment of wages, social benefits and subsidies. The private sector of the economy is small, dependent on government spending, and employs relatively few nationals. Physical and social infrastructure is poor compared to countries with a similar level of per capita income.

The structure of the Kuwaiti economy is not sufficiently flexible to cope with mounting demographic pressures, which, if not addressed over the coming years, could potentially result in serious labour market strains and the erosion of real income per capita in the medium to long-term.

A number of Kuwaiti banks have been blighted by a high level of bad loans and need for heavy provisioning. Accordingly, provisions have absorbed a lot of operating profit over the past few years. However, with provisioning at good levels for most banks and the rise in non-performing loans slowing or stable, the outlook for net profit is now more promising.

Kuwait’s Gulf Bank increased provisioning significantly in the first half of 2013 as it continues to build its cautionary provisions. Despite this, net profit still increased. For the nine months to end September 2013, net profit was KD24.1 million, up seven per cent against KD 22.4 million for the same period last year.

Kuwait Finance House (KFH) has also recorded higher returns in 2013. KFH is not completely reliant on the Kuwaiti market (or on strictly banking activities) for earnings – being rather more international.

KFH is, however, seeing increased competition within Kuwait itself, given that Boubyan Bank is now a consolidated subsidiary of the National Bank of Kuwait while the other Shariah-compliant lenders are beginning to grow market share, albeit from relatively low bases. KFH realised at an early stage that its very size in what was (and remains) a limited domestic market would require either an acceptance of slower growth or the need to expand internationally. These pressures have more recently been exacerbated by new domestic competitors in the Islamic banking market. KFH responded by establishing Islamic banking subsidiaries in Turkey, Bahrain and Malaysia, as well as becoming active in cross border financing elsewhere in the GCC and beyond.

Kuwait’s flagship bank, NBK, remains in a strong position in its domestic and regional markets. Despite the challenges in the corporate domestic market and the political instability in some of the regional markets, the bank managed to deliver a strong set of results to September 2013 with net profits growing 34.7 per cent year on year after normalising for the revaluation gains from Boubyan’s consolidation.

NBK believes that the domestic operating environment continues to improve and the overall outlook is turning more positive, including acceleration in the tendering, award and execution of some of the large Kuwait projects. Strategically, NBK is implementing its income diversification strategy. The bank is focusing its efforts on the GCC countries to leverage NBK’s strong franchise there and to benefit from the stronger economic outlook and growth opportunities available. Moreover, expansion into Islamic banking through the acquisition of Boubyan Bank continues to pay off as Boubyan’s contribution to the group’s profitability and balance sheet increases over time.

NBK’s international presence spans many of the world’s leading financial centres and regional coverage extends to Lebanon, Jordan, Iraq, Egypt, Bahrain, Qatar, Saudi Arabia, the UAE, and Turkey.