Global Economic Effects in Bahrain

¶ … New International Banking Regulations on Bahrain Banking Sector Major International regulatory developments that impacted banks in Bahrain for the past five years Current Regulatory Trends Impacting Regulatory Activities in Banks in Bahrain Top Three Risks Facing Banks in Bahrain & how it can help Develop Regulatory Environment Following the global financial crisis of 2008-2009, there has been a worldwide debate about better regulations in the world banking systems which has impacted banks all across the globe.

The global crisis led to, many banks all over the world reporting a financial loss in their financial report primarily due to connections with subprime mortgages in the United States or they were simply affected by the acute liquidity and credit crunch following the crisis of by the ensuing economic recessions in their own countries and regions.

However, since the economic crisis, there has been enhanced public's interest in the Islamic banks primarily located in the Gulf Countries as they were believed to have been relatively much less impacted by the crisis. The very nature of the functioning of the Islamic banks, which requires all financial transactions to be traded-based and linked to some form of an asset as the primary reasons for them not being affected.

Some even go to the extent to argue that had the principles of Islamic finance been applied to conventional banks, then the financial crisis would not have happened. At present, while the major concentration of Islamic banks is in the Gulf Region, they have essential spread to all regions of the world and are operating in Muslim and non-Muslim countries. Bahrain is one of the countries that have traditionally played a very important role in the development of Islamic banking and finance.

The country is also considered to possess the most developed Islamic finance infrastructure among the Gulf Cooperation Council countries. However, the worldwide regulatory changes and development of certain events in the recent years have put the banks in Bahrain in a position of some discomfort. One of the major regulatory changes that have affected banks in Bahrain is the announcement and the imposition of Basel III requirement introduced in latter half of 2014.

These regulations were imposed to ensure better management of banks and create a strong framework to avoid an economic crisis like the one of 2008. The primary requirements of Basel III are certain standards set out for the creation of a supervisory framework which measures and controls large exposures of banks and is set to come into effect from 1st January 2019. The regulations stipulate that large exposures, or those linked to a group of connected counterparties, should not be more than 25% of the capital base of the bank.

This is the problem for Bahrain banks as most of their investments and risk exposure is related to the oil sector and to significantly large but single groups in the sector. Another problem is the perceived use of banks in the region for terror funding and the U.S. has put in several regulations that impact the ability of banks to exchange local currency for dollars. These factors have put the banks in Bahrain in a position of discomfort in recent years.

Major International regulatory developments that impacted banks in Bahrain for the past five years The banks in the GCC region seemed to have been less affected by the 2008 global economic crisis compared to counterparts in the advanced economies. The primary reasons, according to the World Bank for this is their limited exposure to the sub-prime assets that triggered the crisis in the first place, the focus on traditional lending and the mobilization of savings and their less dependence on the global financial markets.

But in recent years, these banks, especially the banks in Bahrain, considered to be among the soundest financial systems in the GCC, are faced with problems arising out the changes in the international regulatory framework for banks. While addressing a seminar about the changing banking regulations following the global financial crisis on June 19, 2014, Mr. Hassan Jarrar, the CEO Standard Chartered Bank of Bahrain said: "ever since the 2008 global financial crisis, the banking industry worldwide has seen nothing short of an avalanche of new regulations.

Such regulations, though mostly originated in the U.S. and Europe, have, and will continue to have direct implications for the rest of the world, including Bahrain and the region at large.

As a result, the banking industry has been undergoing a significant transformation the likes of which has not been seen since Dodd-Frank" One of the regulatory changes that have impacted the banking sector globally as well as the banks of Bahrain is the enactment of the new Basel III compliance regulations that are to come into effect from January 1, 2019. The new regulations for Basel III are aimed to regulate the environment that international banks operate in.

The other aims of the new regulations are to create specific roles for the banks for self-monitoring and for the powers to monitor and enforce the capital requirements and the above the minimum level of capital that banks need to hold at all times. These regulations also aim at early interventions to prevent crises. Transparency in operations through the implementation of a formal disclosure policy about the risky products and operations of the bank is also requirements for the new regulations.

The problem for the Bahrain banks is too fast integrate their most successful yet somewhat different banking and financial systems, according to the Basel III requirements that also include the minimum capital requirements and the additional rules and regulations for the measurement of credit risk, operational risks, and market risks. The own regulatory funds of the bank have to cover the requirement of capital and not borrowed money is one of the major requirements of the new regulations.

Furthermore, one of the major problems for the Bahrain banks in adhering and adapting to the new regulatory norms set for international banking and finance activities is the reduction of risk exposure. The Basel III regulations require all banks to maintain a maximum exposure of 25% of their capital to any one industrial sector. But Bahrain is a country that has a very large oil economy and it is also among the region whose economy is almost entirely dependent on oil.

Hence, most of the risk exposures of the banks are in this sector. Moreover, the players in the oil and petroleum sector are large players and often they are large groups or companies with few but large players comprising the market. Basel III regulations require that Bahrain banks do not over expose their risks to any one company or group of companies.

But this is exactly what the case is for the Bahrain banks who primarily lend to the oil sector with a limited number of players, therefore, it would be difficult for the Bahrain banks to comply with these two very requirement requirements of the new regulations. Further, the new regulations stipulate that the Bahrain banks need to report to the supervisor and make public the risk exposures that are equal to or more than 10% of the capital base.

This means that most of the risk exposures of the banks of Bahrain would be liable for scrutiny by the supervisors and the banking community as a large part of the risks that these banks undertake, exceeds 10% of their capital base. There are other problems too for the Bahrain banks. Tighter banking norms imposed by the U.S. have created trouble for the banks of Bahrain. Formulated as a part of the new regulations prepared by the U.S. banking sector after the 2008-09 financial crisis, these U.S.

regulations primarily include tougher scrutiny of the incidents that could potentially lead to tax avoidance and thorough checking of the anti-money laundering activities with new rules and regulations for both. These regulations applicable internationally for all U.S. banks have in turn imposed additional costs on the U.S. banks and have thus prompted many of the banks to many to reduce their number of foreign institutions that they used to do business with.

This has made international banks that are operating in the United States warier about the ties with the banks in the Gulf countries including with those of Bahrain. This has resulted in the curtailment of their corresponding services by many of the international banks with the regional and local banks. Some of the banks have also refrained themselves from dealing with the exchange houses. These consequences of the new U.S. regulations have affected a large section of the banks and the population in Bahrain and abroad, especially the expatriates.

The issue of Islamist militancy and the flows of money to Iran has put some Gulf banks under enhanced scrutiny by the U.S. regulators. The problem has assumed such significance that the Bahraini authorities approached the U.S. Treasury to discuss the problem in the month of February 2016. The governor of the central bank of Bahrain himself was present at the meetings to discuss how the problem of international banks' reluctance to deal with banks in Bahrain be solved.

Current Regulatory Trends Impacting Regulatory Activities in Banks in Bahrain The impact of the new international banking regulations on the banks of Bahrain and the pressure that the banks there have been faced with was evident in a note from the rating agency Moody's. On July 9, 2015, the Moody's Investors Service decided to change the future outlook for the banking sector and system of Bahrain from stable to negative.

This change in the rating was partly due to the presumption by the rating agency that the banks would not be able to comply with the new international regulatory requirements of the banking sector as well as due to the worsening economic condition of the country due to the fall in the prices of oil.

The agency noted that these factors would tend to weigh down on the banking sector in Bahrain in the next one year -- till 2016 or till such time that the international oil prices rise again or get stabilized at a rate close to the levels before 2014.

Moody's made this note and changed its outlook for the banks in its report entitled "Banking System Outlook: Bahrain." " Hence, the banks of Bahrain are entrenched in a vicious circle where a number of factors that are interrelated seem to be affecting one another and weighing down on the banks. With the new banking regulations set to be introduced from January 1, 2019, there is not much time at hand for the banking sector of Bahrain to get ready to comply with them.

One of the major requirements is to reduce exposure of the banks to any one sector. In Bahrain, the banks have very high exposure to the oil and petroleum sector and hence changing the exposure levels so fast could prove difficult for the banks. Secondly, the international oil prices continue to be very low, even almost a year after Moody's note and downgrading of its outlook of the Bahrain banking system.

Therefore, the banks continue to suffer from the low oil prices and their risk from the over exposure to the oil sector continues to provide strong headwinds in its path to comply with the new international banking regulations. Thirdly, with the U.S. imposing new regulations on U.S. banks' dealing with other foreign banks has reduced the capacity of the Bahrain banks to gain access to dollars. This has also impacted the operations of banks of Bahrain operational in the U.S. as well as with U.S.

banks operating in Bahrain or having ties with Bahrain banks. All these factors are interrelated and hence continue to pull the other forcing the Bahrain banks into strong headwinds. Other new banking related regulatory problems for the banks of Bahrain is induced by the slowing economy of the country which grew at about 2.7% in 2015, down from 4.5% growth in 2014. This has been due to reduced government spending induced by the impact of lowering of oil prices.

This has, in turn, dampen the operating conditions of the banks and has weighed modestly down on the banks' funding and profitability. The credit profile of the banks would also be a question that the government in Bahrain and the banks have to deal with. New international regulations stress on a certain level of credit profile for banks and the Bahrain banks, instead of getting better on credit profiles, have worsened them as they are closely linked to the worsening fiscal position of the Bahrain government.

The government's direct holdings of securities and loans would get worse and these comprise a significant portion of.