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Bahrain banking works to scale up

7 November 2024

 

Bahrain’s banking sector is getting more concentrated. Earlier this year, the local Islamic lender Al-Salam Bank announced the completion of its acquisition of the Bahrain subsidiary of Kuwait Finance House (KFH Bahrain, also sharia-compliant).

Another big merger is in the works in Bahrain. National Bank of Bahrain (NBB), which has a $3.2bn market cap, has been conducting evaluation studies on a proposed merger with its rival Bank of Bahrain & Kuwait (BBK), the latter valued at $2.4bn.

The kingdom’s sharia-compliant sector has been the focus of much of this merger and acquisition (M&A) activity, with NBB getting the ball rolling in 2020 with its acquisition of Bahrain Islamic Bank.

At the end of 2023, KFH and Bahrain-based Ahli United Bank (AUB) completed their union, with the latter’s balance sheet converted to Islamic banking operations, thereby increasing the industry’s market share in Bahrain.

Analysts see these moves as a positive for a sector that has too many lenders relative to the size of the market.  

“We see ongoing consolidation in the banking sector as an opportunity to create fewer and stronger banks, which could reduce overcapacity in the system and support profitability,” says an S&P Global Ratings analyst.

“With close to 30 retail banks serving a population of 1.5 million, we believe the system is overbanked, which is one of the main reasons Bahraini authorities have been encouraging banking consolidation.”

Overbanked market

The Bahraini banking system is smaller and relatively more overbanked than its GCC counterparts, with a larger number of domestically incorporated banks relative to its population.

“It wouldn’t be surprising to see more banks joining forces to build scale, creating opportunities whether domestically or regionally,” says Lea Hanna, lead analyst, Financial Institutions Group, Moody’s Ratings.

Consolidation should help Bahraini banks strengthen, building up their balance sheet prowess and improving efficiency by eliminating duplication.

Having another Bahraini bank join the Gulf’s top tier of banks – as the planned NBB-BBK tie-up would do – would also be another big win for the country’s banking sector.

“One key driver for M&A is about achieving scalability. We have seen in multiple GCC systems banks joining forces to create a national champion, allowing it to scale up its operations,” says Hanna.

Local banks are already showing decent metrics, even if not on the scale of the GCC’s more dynamic banking sectors of Saudi Arabia, the UAE and Qatar. Profitability remains strong for most retail banks, supported by higher margins and moderating credit losses.

As S&P notes, some Bahraini banks have seen an increase in their credit losses, but this is related to their activities outside the country.

However, the agency’s analyst notes that margins are likely to moderate in line with interest rate cuts similar to those in other GCC countries. As such, it forecasts a systemwide return on average assets to drop 90-100 basis points (bps) from 110bps in 2023.

“In Bahrain, we expect credit growth to average 3% during 2024-26 as compared to an average of 2% in 2022-23,” says the S&P analyst.

“With the expected decline in interest rates (we expect a total of 225bps cut from the Fed by the end of 2025 inclusive of the 50bps already delivered in Sept), we expect retail sector demand – mainly subsidised housing finance – to support private sector lending growth.”

At the same time, higher non-oil growth is likely to result in some opportunities in corporate lending. According to S&P, Bahraini lending growth is comparable to Kuwait’s, but below that of other GCC countries.

Moody’s expects loan performance to remain relatively unchanged. The ratings agency sees the government’s role as the primary employer maintaining low unemployment levels and supporting asset quality. 

“Bahraini banks’ financial performance has been sound and broadly stable across solvency and liquidity indicators. We have a stable outlook assigned to the overall banking system, and that still holds,” says Hanna.

“One area of slight pressure we’re seeing is on profitability. Banks have enjoyed higher margins on the back of rate hikes, and now, with the reversal of the rate cycle, we can expect a bit of margin pressure, even if the easing is really a gradual return to the historical level.”

Emerging challenges

There will be risks to the outlook.

According to S&P, Bahraini banks are mainly funded by domestic deposits, as are their GCC peers. At the same time, Bahraini retail banks’ net external debt more than doubled to 33% of systemwide domestic loans by 31 July 2204, compared with 14% at the end of 2021.

However, with a large portion of the banking sector’s external debt coming from GCC countries – and thus remaining stable – this reduces the risk associated with external debt.

Real estate exposure is one risk facing retail lenders. According to S&P, this segment contributed approximately 1% of total lending, including real estate and construction, or 30% of corporate exposures at the end of August 2024.

“Based on the performance of top retail banks, we expect non-performing loans (NPLs) to increase to about 5.2% in 2024 compared with 4.8% in 2023 due to still high interest rates and subdued real estate demand,” says the S&P analyst.

The agency expects NPLs to moderate slightly in 2025 from an average of 5% in 2023-24, aided by interest rate cuts, a small uptick in real estate transactions and improving hospitality sector performance.

Similarly, under base-case assumptions, credit losses will hover at about 70bps in 2024, up from about 50bps in 2023, and then decline to about 50bps by 2026.

One challenge is related to the limited opportunities in the domestic market.

“On the lending side, the economy is not growing at a pace where banks are provided with huge opportunities. It’s a small and saturated market compared to Saudi Arabia, for example, where the big government-led projects are under way and banks are benefitting from the high credit demand,” says Hanna.

And this is where the M&A activity ticks some important boxes.

Larger entities will have greater reach beyond Bahrain’s borders, giving them a better chance of gaining exposure in larger banking markets across the Middle East and North Africa.

All eyes will be on the NBB-BBK merger and potentially others to follow in 2025.

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James Gavin

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