(MENAFN - Oxford Business Group) Widely considered to be the best regulated Islamic finance market in the world, even Bahrain's sharia-compliant banks have not been able to fully avoid the knock-on effects of the global economic downturn.
Bahrain has long been a leader in the provision of Islamic finance services, being the first country to fully approve the carrying out of sharia-compliant banking activities and incorporate the sector within the wider banking industry.
One significant advantage that Bahrain enjoys, apart from its greater experience in the market, is that it has a solid regulatory framework in place to ensure proper oversight of its burgeoning Islamic finance industry. As the agency charged with regulating all segments of the Kingdom's financial sector, the Central Bank of Bahrain (CBB) has put in place regulations specific to Islamic banking. These have been refined since their introduction in 2001, and in 2005 the bank issued the first-ever comprehensive regulatory framework specific to takaful and retakaful companies.
Currently, there are some 30 Islamic banks, 15 Islamic insurance companies and one retakaful company operating in the Kingdom, while many conventional banks have also deployed Islamic finance units to complement their more traditional activities, having recognised the growing potential in the segment.
Though this potential remains, it appears to be slightly dimmed in the short term, with banks taking a cautious approach during the economic slowdown, building up deposits and liquidity but holding back on investments.
August has seen most of Bahrain's Islamic banks tabling second-quarter and first-half results, which paint a mixed picture. In mid-August, Al Salam Bank Bahrain announced a net profit of 7.3m for the quarter, down 65% on the same period last year, while ABC Islamic Bank posted a first-half net profit of 6.6m, though only 1m of this came in the second quarter of the year. Meanwhile, Khaleeji Commercial Bank's profits slipped from 36m for the second three-month term of 2008 and 69m for the first half of last year to 7.9m and 18m for the same periods in 2009.
Newly established Capinnova Investment Bank opened its doors only at the beginning of the year, with considerable outlays in start-up and initial operating costs. This, alongside a tougher economic climate, played a large part in its 2.4m loss for the half. Meanwhile, the high-profile Gulf Finance House (GFH) turned in a 54m net loss for the second quarter, to add to its 38m worth of red ink in the first three months of the year.
By contrast, the Al Baraka Banking Group, Bahrain's largest Islamic bank by market value, posted a net profit of 49m, a 14% increase for the second quarter over the first. Though the strong result took the bank's profits for the first half of the year to 92m, this was still down by 14.8% for the same six months of 2008.
Al Baraka's deputy chairman, Abdulla Ammar Al Saudi, said the results were pleasing, given the impact of the financial crisis and the prevailing conditions in the regional and international financial markets.
"We are pleased that the plans we put in place to deal with this situation and exploit the opportunities that may arise under the current circumstances have achieved the results that we hoped for," he said on August 10.
Amidst the flurry of first-half results, financial ratings agency Moody's issued its latest outlook for the Bahraini banking system, warning that the fundamental credit outlook on the sector was negative. The report reflected the company's expectation that difficult credit and business conditions will continue over the next few months.
"This expectation is driven by the ongoing economic slowdown within the Gulf Cooperation Council (GCC) region, which although less severe than in other parts of the world is exerting pressure on asset prices and business volumes," according to George Chrysaphinis, a vice-president and senior analyst at Moody's. "The negative outlook is also driven by the more challenging wholesale funding conditions in the GCC within the context of the global financial crisis and consequent risk repricing."
While the Moody's report focused on Bahrain's retail and wholesale banking segments, rather than on the country's Islamic financial sector, some parts of the message were applicable across the board, and reflected the views of some senior officials with the Kingdom's Islamic banks.
According to Esam Janahi, the chairman of GFH, the continuing caution in the investment community has put a brake on activity.
"Unsurprisingly, given prevailing global economic conditions, raising funds for any financial institution has remained extremely challenging in recent months," he said on August 11.
For Mohammed Alabbar, the chairman of Al Salam Bank Bahrain, caution was also the watchword.
"The current difficult market conditions were not favourable for expansion of credit or for exit of investments, hence the bank has chosen to preserve its liquidity, awaiting markets to improve," Alabbar told local media on August 13. "Considering the prevailing market conditions, the bank is pursuing an extremely cautious approach to building assets."
There could be a downside to this careful approach, warns Anouar Hassoune, a Moody's vice-president and senior credit officer analyst, as Islamic financial institutions (IFIs) have traditionally demonstrated low leverage for religious reasons, but also because of their very profitable assets, cheap deposits and high levels of core capital.
"IFIs benefit from abundant liquidity, which is a very positive factor in an economic downturn. However, if such excessive liquidity is left underutilised, the lack of an innovative range of assets could slow growth during an economic boom," he said in mid-August.
The challenge for Bahrain's Islamic lenders is to time their return to the market and best take advantage of improving conditions, while at the same time developing more medium- to long-term funding instruments. Having led the sector for so long, it is likely that they will make the most of the opportunities when they arise.