Impact Of Financial Crisis Bank In Bahrain

Published Date: 02 Nov 2017

Introduction

The main purpose of the study is to understand the problems faced by bank in Bahrain as a result of the financial crisis. After a lasting time of instability, the global economy finally started to stabilize in 2009 with the assistance of a considerable amount of intervention from the public which resulted in a mount in output and financial market bounce back amidst superior levels of confidence and certainty. All through 2009, world output decreased by 0.6% and was predicted to pick up during 2010 to 2.3% and developing economies by 6.3%.

With inflation issues controlled and commodity prices rebounding from the previous low levels, the globe recovery was expected to continue in 2010, even though at varying speeds around regions. During 2009, inflation for highly developed economies recorded a minor 0.1% growth, in spite of slack monetary policy and near zero interest rates. Consumer prices in emerging and developing markets had an inflation of 5.2% during the same year (2009).

Background of the study:

The impacts of the financial crisis on the Bahraini economy were more visible in 2009. The GDP recorded negative growth. Moreover, real GDP growth decreased to half the rate attained in 2008. On the other hand, in real terms, GDP sustained to rise during 2009, even though at half the speed compared with 2008. Real GDP recorded a growth rate of 3.1% back in 2009, down all the way from 6.3% in 2008. Regardless of the slowdown in the financial sector, it remains one of the largest single contributors to GDP. By the end of the year 2009, the financial sector accounted for 25.1% of real GDP, down from 26.6% in 2008.

As a result of the intervention procedures taken by the authorities to sustain growth, the overall fiscal balance of the GCC countries reduced rapidly during 2009 to achieve an estimated 5.3% of GDP.

Barrel in 2010. Statement of the problem:

The motto of the study is to understand the impact of global financial crisis on Bahrain banks. This can be understood from the answer to three key questions:

What impact did the bank face due to the crisis?

How is it affected their investor base?

What are the steps taken to ensure stability during such crisis?

Definition of the problem:

Global crisis began in the late 2008 owing to drastic rise in the defaulter numbers to housing loans in US. This shattered economies everywhere as investors in housing and real sector found their land values depreciating due to the depreciation of dollar. In order to clear debts, many companies were granted aid which finally resulted in banks requiring bailout from the crisis. On the contrary very few economies survived the crisis with proper hedging of funds via bonds, shares, debentures, etc.

Hypothesis of the study:

The study will help analyze the steps to be taken in order to withstand and ensure stability in times of crisis in Bahrain banks.

Significance of the study:

The study is essential in the face of global crisis which had doomed many companies and moreover banks too. Bank in Bahrain too did not miss to be a target of this crisis. By the end of 2009 fiscal, the bank had been exposed to various challenges of crisis like drying up of credit, drastic fall in its corporate earnings and moreover failure to lure investors out of their market owing to price volatility after the dollar depreciation. The bank however worked on its strategies for crisis like focusing on matching its liabilities to maturity profile of assets thereby protecting their balance sheets. The bank moreover started supporting the financing needs of the portfolio owing to banks pulling out from the system.

Major factors that act as an immunity in times of crisis include proper governance, timely action to identify defaulters and effective tactics to identify genuine investors. The strategies used by banks in their core areas to fight crisis gives an idea as to how to tackle the crisis challenges.

In 2009, the financial sector sustains to be the major contributor to Bahrain’s economy, accounting for 25.1% of real GDP. The total assets of retail banks stood at BD 22.5 billion as at 31 of December of the same year. Total outstanding credit facilities enlarged by retail banks to the diverse sectors of the domestic economy continued to be stable and amounted to BD 5,884.9m at end-2009, compared to BD 5,887.6 million at end-2008.

Even without the financial crisis, the real estate and construction sector remained embarked on and persisted many projects with a total of 9,928 construction permits issued in the same year. Several real estate projects continued to grow in 2009 Diyar Al Muharraq, Amwaj Islands and Durrat Al Bahrain.

The root for all these success in handling the crisis can be attributed to the carefully cultivated corporate culture that supports teams to work with quality, dedication, innovative thinking and coordinated decision-making. This has helped the bank to develop and maintain a conservative capital thereby helping mitigating risks.

Scope and limitations:

A major part of the study was based on the strategies to be undertaken in the wake of economic crisis. The strategies used by few banks are also applicable to other banks. Moreover effective co-ordination among investors and employees help ensure stability in operations. The study also focuses on strategies focused by banks on each of its diverse business areas with the advantage of giving diverse investment options to customers.

Major limitation included considering only bank in Bahrain for the impact of global crisis on banks in Bahrain. Another limitation is the timing. The researcher has limited time to fulfill this research and deliver it to the course mentor to pass the requirement of the degree. Hence the researcher will try to get as much related data as possible.

2Chapter

Literature Reviews

1. Introduction:

This chapter gives an overview of previous studies related to bank behaviour in difficult economic crisis. The chapter begins with a brief outline of the current financial crisis and its consequences. Than an explanation of consumer behavior during uncertain times is provided. The chapter continues with an overview of the banks selection criteria that will be investigated, based on selection criteria used in previous studies, followed by a discussion of some external influences on bank selection.

1.1 History of banking and its growth:

Bahrain is a tiny island kingdom in the Middle East. Beside the oil and gas sector, the financial services sector is among the highest contributions to the country’s overall GDP. According to the Central Bank of Bahrain’s (CBB) annual report 2011, the sector contributed 25% to GDP of the country in 2010. The number of the financial institutions in the country is 411 and the total financial sector workforce is 14,137. The banking system in the Kingdome of Bahrain is considered as being the largest component of the financial system. Bahrain’s banking sector has remained to be a cornerstone for growth of the domestic economy. The banking sector represents over 85% of total financial assets. Furthermore, the banking system compromises both Conventional and Islam banks. The Conventional sector includes retails banks, specialized banks, wholesale banks and representative offices of overseas banks. On the other hand, the Islamic sector consists of retail banks and wholesale banks which offer as host of Sharia compliant products and services. The sole regulator for financial system in Bahrain is the CBB.

Hassan and Dridi (2010) compare the performance of Islamic Banks (IBs) and conventional banks (CBs) during the recent global crisis by looking at the impact of the crisis on profitability, credit and asset growth and external ratings in a group of countries where the two types of banks have significant market share. The study suggests that IBs have been affected differently than CBs. Factors related to IBs business model helped limit the adverse impact on profitability in 2008, while weaknesses in risk management practices in some IBs led to a larger decline in profitability in 2009 compared to CBs. IBs’ credit and asset growth performed better than did that of CBs in 2008-09, contributing to financial and economic stability. External rating agencies reassessment of IBs risk was generally more favourable.

1.2 Background of the financial crisis:

The 2008 global financial crisis that started in the U.S. in the 2007 has given a wide array of impacts to the operating and financial performance of many banks all over the world (Ellaboudy, 2010; Smolo and Mirakhor, 2010; Kassim and Majid, 2010). As one of the results, the financial crisis has raised public’s interest on Islamic banks since they are said to be relatively much less affected by the crisis. A number of experts and officials of Islamic banks have even claimed that Islamic banks are either not or less affected by the global financial crisis than conventional peers due to the nature of Islamic banking in which all financial transactions must be trade based and asset linked.

With a long history of banking industry, particularly Islamic banking industry, the impact of financial crisis towards Islamic banking performance in Bahrain. To significant contribution towards the existing literatures on the relationship between financial crisis and banking financial performance, particularly in the Islamic banking industry of Bahrain.

Beck et al (2010) compare the performance of conventional and Islamic banks during the recent global crisis by looking at the impact of the crisis on business orientation, efficiency, asset quality and stability in countries with data on at least four banks. The study suggests that Islamic banks seem more cost-effective than conventional banks in a broad cross-country sample. On the other hand, conventional banks seem more cost-effective than Islamic banks in a sample of countries with both Islamic and conventional banks. However, conventional banks that operate in countries with a higher market share of Islamic banks are more cost-effective but less stable. There is also consistent evidence of higher capitalization of Islamic banks and this capital cushion plus higher liquidity reserves explain the relatively better performance of Islamic banks during the recent crisis.

1.3 How the financial crisis affected the banks performance:

Many banks across the world reported financial loss on their financial report due to their connections with subprime mortgage in the U.S. or were simply affected by economic recession in their own countries. The impact of the crisis have even forced around 123 banks in the U.S. to file for bankruptcy in the year, including American giant bank Lehman Brother that was never been expected to fail. The financial crisis has raised public’s interest on Islamic banks since they are said to be relatively much less affected by the crisis.

Financial performance of institutions can be affected by the complexity of managing large sized financial transactions. The leverage may be a good position but profitability may show a decline trend due to poor management or due to external factors.

Banks in the Kingdom of Bahrain should focus on factors such as costs and provisions, which influence profit margins. The decrease in Return on Equity ultimately affects the interest shareholders. The risk of fluctuations in interest rates penetrates the interest incomes, which affect the overall income of the bank. If the banks increase their income by other means such as free income, profit sharing, sharing, investment activities, which have the lowest income expenses, it would increase the overall profitability.

1.4 Effects of the financial crisis on Bahrain:

Bahrain has the freest and the most diversified economy in the Persian Gulf. Bahrain offers excellent investment opportunities and unraveled access to the Middle East and the North Africa Markets. Bahrain, a financial and business centre, is just one hour away from the Gulf’s largest economies and markets such as Saudi Arabia, the United Arab Emirates and Qatar. Bahrain’s natural resources of petroleum and natural gas make Bahrain very attractive place for foreign investors. Tourism is another significant incentive to attract foreign investments. What makes Bahrain more special is that the country allows 100% foreign ownership and control of company assets and enforces no personal, corporate or withholding taxes.

However, the latest unrest which started with Tunisia to have a domino effect in the other countries in the Middle East seems to damage Bahrain’s economic and political reputation. This fear of uncertainty could potentially affect the country’s credibility among foreign investors and its financial system. The cancellation of the Bahrain Grand Prix, the fall of Bahrain stock market, rising insurance can be seen as the most immediate impact on Bahrain’s economy.

Microeconomic Stability: According to the World Economic Forum, Bahrain’s economy is one of the most stable. The global financial crisis had an effect on Bahrain’s economy which resulted on slow economic growth during 2009. According to IMF, the economy of Bahrain managed the financial crisis well. As a result of financial crisis Bahrain experienced a sharp fall in oil prices, a tightening of global capital markets and decline in regional and local real estate markets. During the 2010 according to IMF, Bahrain’s GDP has grown up to 4% in sectors such like hotels, restaurants, manufacturing, financial corporations, transport, communication, construction, wholesale and retail trade. According to Arab World Competitiveness Review 2010 Bahrain maintained positive growth rates by mitigating the effects of the economic crisis through expansionary fiscal policy at the expense of macro-economic stability which dropped from the 6th place to 11th. Bahrain commitment to structural reforms and its openness to global markets have transformed the country into a financial hub and regional leader in the economic freedom. As one of the least oil dependent economies, according to the Index, Bahrain benefits from a competitive tax regime and a sophisticated financial sector that facilitate the free flow. Its financial regulation has become more flexible and comprehensive. The financial services industry is regulated by the Central Bank of Bahrain.

1.5 Financial performance of Banks:

The performance of a group of banks in the Kingdom of Bahrain, depending mostly on their published financial statements and applying certain financial ratios as an indicator of financial management and evaluating financial performance.

Financial performance of institutions can be affected by the complexity of managing large sized financial transactions. The leverage may be a good position but profitability may show a decline trend due to poor management or due to external factors.

The financial ratios are prepared on the basis of historical financial statements and they are useful indicators of a firm’s current financial performance and current financial situation. These financial ratios can be used to analyze current trends and to compare the firm’s financial position to those of others. They can predict future bankruptcy. The impact of financial ratios on the financial performance of Bahraini commercial and Islamic banks. The financial performance of banks was strongly and positively influenced by their operational efficiency, asset management and their size. However, ratios themselves cannot indicate the size of the banks, which means that banks can only be measured by their overall financial performance.

2. Financial performance of Banks:

2.1 How they measured performance:

The ratio analysis involves method of calculating and interpreting financial ratios to assess bank performance. Financial ratios are the indicator of financial performance of bank. In order to compare performance of Islamic banks and Conventional banks for the period of the study uses inter-bank analysis. The study evaluates inter-bank performance of Islamic and Conventional banks in term of profitability, liquidity, risk and solvency, capital adequacy, operation and resource allocation efficiency. Financial ratios are applied to measure these performances.

Liquidity Ratios: Liquidity ratios measure the bank ability to meet its short-term obligations. Banks face liquidity problem due to excess withdrawal from current and saving account. There are several measures of liquidity. Iqbal (2001) used current ratio as liquidity measure. Samad & Hassan (1999) used two more measures which include Loan/deposit ratio (LDR) and Current asset ratio (CAR) to evaluate the performance of Islamic bank. Liquidity position of banks is measuring by using four ratios.

Current Ratio (CR) = Cash and accounts with banks / Total deposits

Current Assets Ratio (CAR) = Current asset / Deposits

Loan Deposit Ratio (LDR) = Loans / Deposits

Net Loan / Total Asset Ratio (NLTA) = Net loans / Total assets

Risk and Solvency Ratios: Solvency ratios give a picture of a bank’s ability to generate cash flow and pay its long-term financial obligations. If the total value of bank assets is greater than its equity then the bank is solvent. Samad & Hassan (1999) used three risks and solvency ratios in their study. These ratios included Debt equity ratio (DER), Debt to total asset ratio (DTAR) and Loan Deposit ratios (LDR). This study uses the same hold to measure risk and solvency of banks. The above mention ratios are calculated with the help of following formulas.

Debt Equity Ratio (DER) = Total Debt / Shareholder Equity

Debt to total asset ratio (DTAR) = Total Debt / Total asset

Loan Deposit Ratio (LDR) = Loan / deposits

Capital Adequacy Ratios: Capital ratios indicate the healthiness of financial institution to shock withstanding losses. These ratios identify the already existing banking problems. Adverse trends in these ratios may increase risk exposure and capital adequacy problems. CAR used Equity/Liabilities ratio to measure capital adequacy.

Equity / Liquidity ratio = Average equity / Average liabilities

Capital Risk Asset ratio = Total Capital / Risk weighted Assets

Operational Ratios: Operational ratios show how efficient a company is in its operations and use of assets. There are several ways of measuring operations. Iqbal (2001) used cost to income ratio to evaluate the operational efficiency of banks. This study uses Net Interest Margin (NIM), Other Opt Income / Average Assets, Non Interest Exp / Average Assets and Cost income ratio to measure bank efficiency in its operation and use of assets. The following formulas are given to calculate these ratios:

Net Interest Margin = Net markup & interest income / Average assets

Other Opt Income / Average Assets = Other operating Income / Average Assets

Non Interest Expense / Average Assets = Non interest expenses / Average Assets

Cost / Income ratio =

Markup & interest expense + Non-markup & interest expense + provision for losses + Bad debts write off

Markup & interest income + Non–markup & non-interest income

Deployment Ratios: Deployment ratios are used to evaluate how well bank is using is resources. Iqbal (2001) used two deployment ratios to evaluate the Performance of Islamic and conventional banks in 1990s. This study uses the same deployment ratios to evaluate bank efficiency in resources allocation.

Investment / Equity & Deposit = Total Investment / Total equity + Total Deposits

Investment / Liabilities = Total Investment / Total Liabilities

Bank Performance:

The measurement of bank performance particularly commercial banks is well researched and has received increased attention over the past years (Seiford and Zhu, 1999). There have been a large number of empirical studies on commercial bank performance around the world. However, with the deteriorating health of the banking institutions and the recent surge of bank failures as a result of the current global financial crisis, it is justified that bank performance receives increased investigation from both scholars and industry specialists.

There are two broad approaches used to measure bank performance, the accounting approach, which makes use of financial ratios and econometric techniques. Traditionally accounting methods primarily based on the use of financial ratios have been employed for assessing bank performance (Ncube, 2009).

Berger & Humphrey (1997) assert that the whole idea of measuring bank performance is to separate banks that are performing well from those which are doing poorly. They further indicated that, evaluating the performance of financial institution can inform government policy by assessing the effects of deregulation, mergers and market structure on efficiency. Bank regulators screen banks by evaluating banks’ liquidity, solvency and overall performance to enable them to intervene when there is need and to gauge the potential for problems. On a micro-level, bank performance measurement can also help improve managerial performance by identifying best and worst practices associated with high and low measured efficiency.

3 Chapter

Studies and Discussions

3.1 Related Studies:

The effects of the global financial turmoil on GCC countries are manageable compared to other parts of the world thanks to the fundamental strength of the Gulf States, according to the Bahrain-based Islamic investment bank, Global Banking Corporations (GBCORP).

The tremors of the financial quake in the US have also had an impact on the GCC in terms of reduced oil prices, financial liquidity and the drop in share values of companies listed on the GCC stock markets. These effects are manageable when compared to the retrenchment and recession experienced elsewhere in the world and when seen in the context of the fundamental strength of the GCC economies.

This event is happening at a time when the world economy is in grave crisis and we are staring in the face of a global recession. These are indeed very challenging times and like the old saying, ‘when the going gets tough, the tough get going’, the challenge now is to look deep into the heart of the crisis and find ways and means of addressing the issues and also look at the opportunities that such challenges throw up.

The GCC Euro is a premier event facilitating trade and investment opportunities between the GCC countries and Europe. The event is sponsored by the Bahrain Economic Development Board (EDB).

The current crisis and how Islamic banking is suddenly the cynosure of the global banking community in terms of the opportunities it offers as a true complement to conventional banking system. Focus on the challenges faced by the Islamic banking and finance industry, the positive and diverse aspects of Sharia compliance and the way forward in the face of the global financial crisis. The effects of the financial crisis on the economies of GCC countries are multifaceted and include:

Decreased oil prices and its effect on the status of the public budgets of these countries, and consequently on investment and development programs.

Decreased international demand for GCC exports as a result of the economies recession whose effects began to appear.

Increased unemployment as a result of productive institution decreasing the size of their work force and a decreased demand affecting gulf financial markets.

These effects are further proliferated with the maximization role of the financial sector in the economy, on the one hand, and the degree of economic openness to the world on the other hand. This research, therefore, aims to analyze the effect of the financial sector in GCC countries and the extent of these effects on the national economy.

Measuring the extent of the effect of the financial crisis on GCC countries

The negative effects of the financial crisis on a certain country depend on two major factors:

The extent of the role of the financial sector in the national economy; the greater this role, the greater is the effect of the crisis on the sector and the transfer of these effects to the real sector in the economy.

The degree of openness of the national economy, the more the degree of openness, the more the economy is affected by the crisis through its relations with world countries.

3.2 Discussion

In this study, we also seek to analyze the degree of openness in these countries and the extent of their being affected by international economic variables and events. In the next section, we present the concept and evolvement of the current global financial crisis. Then we measure the extent of the effect of the financial crisis on GCC countries by analyzing the role of the financial sector in GCC countries economies and the degree of openness of GCC countries. The policies followed by GCC countries to delimit the effects of the international financial crisis on these economies. It is devoted to analyze the effects of the international financial crisis on GCC countries.

The impact of the global financial crisis in Bahrain and the implications that it has for our approach to reserves management. Throughout the difficult period at the end of 2008 and the first half of 2009, our financial markets continued to function normally and the Government of Bahrain did not consider it necessary to take some of the extraordinary measures, such as the recapitalization of banks and providing blanket guarantees that had been adopted in other parts of the world. Although we needed to place two wholesale banks into Administration in the course of 2009, these events did not have a spill-over effect to the wider financial system. In fact, financial markets seem to have taken comfort from the prompt and effective action taken by the CBB in dealing with these two problem banks.

In Bahrain, as in the rest of the world, the impact of the financial crisis was felt first through a withdrawal of liquidity, a situation that was reinforced by our currency peg to the US dollar. In the final quarter of 2008 we faced a situation in which our financial institutions were facing liquidity pressure, owing to the market reaction to the Lehman Brothers failure. To offset the liquidity outflow that had taken place after the bankruptcy of Lehman Brothers, the Central Bank instituted a new swap facility that permitted banks to exchange US dollar for Bahrain Dinar without a penalty fee. This helped greatly to ease liquidity conditions in Bahrain’s money markets and allowed the 2008 year-end to pass without any significant market disruptions.

In the course of 2010 the pattern has been on of relatively modest recovery. While credit growth remains subdued, systematic liquidity pressures have abated, and the banking system has become highly liquid. Although the swap facility remains available for banks to use at their discretion, no bank has accessed the facility since the early part of this year. Deposits with the central bank have grown to comparatively high levels and bidding in Government bond auctions, which the CBB manages on behalf of the Kingdom of Bahrain, remains very strong with coverage levels often in the 300-400 percent range, and with interest rates trending downwards for much of the year.

The need to have liquid assets readily available represents a major difference between a central bank’s reserve management policy and that of a Sovereign Wealth Fund. Whereas a Sovereign Wealth Fund can take long-term investment horizon and therefore move up the risk/return curve, the need for liquid means that a central bank inevitably has to be at the lower end of the risk/return trade-off.

A final consideration is that central banks must also now pay greater attention to credit risk in their reserve management strategy. They need to think hard about the types of counterparties and clearers with which they are prepared to deal and to set out a clearly articulated profile for their acceptable range of counterparties. As with their decisions on liquidity, their need for prompt and unencumbered access to reserve assets means that central banks must err on the side of conservatism in their assessment of their counterparties and reserves managers.

CONCLUSION:

This study is aimed to investigate the impact of the changes in internal bank-specific variables and external macroeconomics variables towards Islamic banks’ financial performance in Bahrain during and after the global financial crisis. This shows that Islamic banking industry is not totally crisis proof. Financial crisis does give an impact upon the Islamic banking performance, particularly in Bahrain, but the effect comes after the crisis period.

As one of the fastest growing segments in global financial services, Islamic finance has become systematically important in many markets and too big to ignore in others. While conventional intermediation is largely debt-based and allows for risk transfer, Islamic intermediation, in contrast, is asset based and centers on risk sharing. In addition to providing IBs (Islamic Banks) with additional buffers, these features make their activities more closely related to the real economy and tend to reduce their contribution to excesses and bubbles.

Our analysis is suggests that International Banks (IBs) fared differently than did Conventional Banks (CBs) during the global financial crisis. Factors related to IBs business model helpoed contain the adverse impact on profitability in 2008, while weakness in risk management practices in some IBs led to larger decline in profitability compared to CBs in 2009. In particular, adherence to Shariah principles precluded IBs from financing or investing in the kind of instruments that have adversely affected their conventional competitors and triggered the global financial crisis. The weak performance in some countries was associated with name concentration and in some cases, was facilitated by exemptions from concentration limits, highlighting the importance of a neutral regulatory framework for IBs and CBs and strengthening risk management in some banks.

IBs credit and asset growth were at least twice higher than that of CBs during the crisis, suggesting a growing market share going forward and larger supervisory responsibility. External rating agencies re-assessment of IBs risk was generally more favorable or similar to that of CBs. Higher solvency has facilitated meeting the relatively more robust demand for Islamic banking finance and maintaining stable external ratings. Lending to the less affected consumer sector has helped support strong credit and asset growth.

While the global crisis gave IBs an opportunity to prove their resilience, it also highlighted the need to address important challenges. The crisis has led to greater recognition of the importance of liquidity risks, and the need for efficient bank resolution framework. Hence, building a well-functioning liquidity management infrastructure is a key priority. Moreover, regulators and standard setters for IBs should ensure that the supervisory and legal infrastructure, including for bank resolution, remain relevant to the rapidly changing Islamic financial landscape and global developments. Reform efforts in this regard should interface with the global reform agenda. Greater convergence and harmonization of regulations and products is needed to facilitate an efficient and sustainable growth of the industry. Addressing the above challenges will require that Islamic Banks and supervisors work together to develop the needed human capital.