Bahrain finance industry: A changing model

Bahrain's finance industry, both Islamic and conventional, has long been a lynchpin of the economy. Perhaps unsurprisingly, though, in the post-economic crisis environment and given the increasingly competitive regional market, changes are under way.
Combined, the Islamic and conventional finance segments represent around 26% of Bahrain's GDP. In its annual economic review for 2010, the Bahrain Economic Development Board () said that while country's economy had managed to expand in the preceding year, the financial sector had contracted slightly in 2009, with output shrinking by 1% - a result that would have been warmly welcomed in many Western markets.

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The EDB report, released on July 19, said that despite the slight contraction in 2009, the finance industry had survived the global slowdown relatively well, although it also noted that there will be changes on the horizon for the sharia-compliant and conventional segments.

"Going forward, however, it is evident that the development model for the Bahrain finance sector, which has depended heavily on the rapid growth of offshore wholesale banking, will change," the report said

According to the EDB report, some 90% of wholesale banks' assets and liabilities originate offshore. Though not setting out what specifically they will be, the report did note that, "there will be big changes in the pattern of expansion".

The report also said that growth in the Islamic finance sector would be somewhat constrained for the immediate future due to the fact that the real estate market remained sluggish. With the Islamic banking sector depending on property transactions for much of its activity, and construction and real estate representing around one-third of all banking loans, the expected weaker demand and downturn in prices is expected to have an impact on Bahraini lenders for the rest of this year and into 2011 and beyond.

While banking slowed in 2009, there was one segment of the finance industry that recorded strong growth last year, with the insurance market expanding by 6%. Though only nine of the 169 onshore insurance firms currently operating in Bahrain offer sharia-compliant products, there are suggestions that takaful, or Islamic insurance, is starting to gain a more widespread acceptance.

While the insurance sector overall grew by 6%, the seven takaful companies in the market say their gross contributions rose by 22% last year, totaling BD32.7m ($86.4m). The two retakaful, or sharia-compliant reinsurance firms, posted and even better result, seeing their combined premiums increase from BD15.9m ($42m) in 2008 to BD50.5m ($133.5m) last year, representing 217% growth.

The growing strength of the local takaful sector and the role of the Central Bank of Bahrain as industry regulator were acknowledged at the International Takaful Summit, held in London in mid-July, where Bahrain and its central bank were named as the Best Financial Centre for 2010, the third time in a row the bank has been so recognised.

According to Nader Al Mandeel, the director of insurance supervision at the , the sound regulatory infrastructure and the active dialogues undertaken by the  with the takaful industry have been recognised as key drivers in the expansion of the sector.

"The unique structure of takaful companies requires a clear understanding of the various insurance risks and, through the years, the  has been at the forefront of ensuring the sound development of its regulatory framework in this regard," he said at the International Takaful Summit on July 17. "The  does recognise that consistent application of takaful rules is a key feature in ensuring the continued growth of this industry."

Though Bahrain's Islamic insurance and banking sector has performed well over the past decade, and managed to successfully ride out the global economic crisis, it is facing a number of challenges. One of these, which is by no means unique to Bahrain, is the need for the international sharia-compliant finance industry to adopt a universal set of standards for Islamic financial instruments. The lack of such a set of regulations has to date held back the broader growth of the industry, says  governor Rasheed Al Maraj.

"The result has been that Islamic financial institutions have had a predominantly domestic focus and have not been able to achieve the scale economies that might make them viable competitors to conventional institutions which do enjoy these benefits," he told delegates attending the first Annual World Islamic Banking Conference Asia Summit, held in Singapore in June.

Bahrain has been a strong advocate of internationally accepted standards for the Islamic financial sector, along with better risk management practices, holding up the model it has developed as an example.

However, not all are prepared to accept that model, which is part of another of the challenges - increasing competition and rivalry in the industry. Though seen as the first and leading proponent of Islamic finance, Bahrain now has stiff competition as a sharia-compliant banking centre.

John Sfakianakis, the chief economist at Banque Saudi Fransi, said that Bahrain is fighting to maintain its position at the centre of Islamic finance. "Islamic banking is under a lot of competition from the regional competitors such as Dubai, Qatar, Kuwait and Saudi Arabia," he said in an interview with the Bloomberg news agency on July 19.

Having long established itself as a leading innovator in the finance industry, Bahrain certainly has experience on its side, a fact which bodes well in terms of its ability to compete in a rapidly changing landscape.

Oxford Business Group