Bahrain: Coming together in Islamic finance

The Kingdom is encouraging some of its sharia-compliant banks to join forces to be better capitalised and equipped to deal with an increasingly turbulent and competitive global market.

At the end of June, shareholders of three Bahraini Islamic lenders – Capivest, Elaf Bank and Capital Management House – approved a proposal put forward by their respective managements to merge their operations, a move first mooted at the end of last year.

Capivest’s CEO, Mohammed Ahmed Abdulmalik, joined the firm in 2010 with the mandate to either merge it or increase its capital. In his view, the economic landscape in the wake of the liquidity crisis was conducive to market restructuring. “In many ways the crisis was a blessing in disguise. It encouraged more banks to think seriously about consolidation,” he told OBG. “There are separate and unrelated activities involving about eight banks at various stages of the consolidation process.”

What will come out of the merger will not be a particularly large bank by regional or global standards, with estimates putting the new entity’s assets at around $400m and shareholder equity at $350m. However, the combined strength of the new bank will be far higher than the three individual lenders and will allow it to be more active and better insulated against risks.

Following the shareholders’ vote, Elaf Bank’s vice-chairman, Isa Habi, said, “The aim of this merger is to establish a strong banking institution that is able to compete solidly in a changing market. The merger will bring instant diversification of assets and revenues. Also, the bank will be able to capture larger projects and will be able to diversify its capital sources.”

The next step in the process, one that should be a formality, is for the Central Bank of Bahrain (CBB) and the Ministry of Industry and Commerce to ratify the decision of the three banks’ shareholders.

Currently, there are more than 25 Islamic banks operating in Bahrain, though this will change when the tripartite merger goes through. For some time, though, the CBB has maintained a position that more is not necessarily better, having on more than one occasion suggested that a round of mergers between some of the industry’s players would create a stronger Islamic financial sector.

In December last year, for example, Ahmed Al Bassam, the CBB’s director of licensing and policy, said the reserve had proposed that at least five Islamic lenders – including Capivest, Elaf Bank and Capital Management House – initiate merger proceedings. “We pushed for that because it is positive, it will strengthen their capital and balance sheets,” Al Bassam said at a meeting of the Arab Monetary Fund.

While Bahrain is seen as a leader in Islamic finance in its modern form, having introduced the concept to the market in the late 1970s, it is faced with the risk of being overtaken as the centre for sharia-compliant finance. In recent years, a number of states have stepped up their efforts to take on the mantle of leading player, with Malaysia, Dubai and Kuwait, amongst others, increasingly active in the sector.

A recent report by global management consultancy A T Kearney backs the CBB’s position for additional mergers, warning that the operating environment for Islamic banks is becoming tighter, with slowing growth rates and eroding profitability combining to put pressure on sharia-compliant lenders. In particular, the report cited Bahrain as an example of a market where the sector’s dynamics were changing, adding that Islamic banks need to seek greater efficiency across the value chain, suggesting that fewer but stronger banks could be the way of the future.

According to Alexander von Pock, Middle East principal with A T Kearney, while there are many opportunities for Islamic banks, they can also labour under the disadvantage of scale. “Islamic banks are typically at a scale disadvantage as they are often smaller in size, and this is testing their ability to remain on par with their conventional counterparts and compete profitably,” he said.

Not all of the banks the CBB urged to merge have done so, however. Bahrain Islamic Bank and Al Salam Bank, which began discussions of creating a new joint entity in August 2011, broke off talks in February. The two banks were among those the CBB had been encouraging to merge, a marriage that would have created the Kingdom’s largest Islamic financial institution with total assets of $4.5bn.

Though the Bahrain Islamic-Al Salam merger did not go through, other such deals may be around the corner, as the CBB is still keen on making the Kingdom’s Islamic financial sector even more competitive and resilient. While it can be difficult to encourage mergers by smaller family owned lenders, economic necessity in a growing market will likely make unions inevitable in the coming years, making the sector more adaptable and profitable.

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