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Mergers push Islamic banking forwards in Bahrain

Ahli United Bank Manama Reuters
Kuwait Finance House's acquisition of Ahli United Bank has made it the world’s second-largest Islamic bank by assets
  • Kuwait Finance House bought Bahrain’s Ahli United Bank for $11.6bn
  • AUB’s share of domestic banking assets was 13% in 2022
  • KFH converting AUB and subsidiaries into fully sharia-compliant banks

Hundreds of Islamic banking executives are descending on Bahrain next month for the Islamic Finance Innovation Day on May 30.

Under the patronage of the Central Bank of Bahrain, it will focus on embedding environmental, social and governance (ESG) investing into Islamic finance.

The event comes as analysts predict that Islamic banking’s market share will exceed half of Bahrain’s total domestic banking sector assets in the short to medium term. 

The summit follows the $11.6 billion acquisition of Ahli United Bank (AUB), a Bahrain-based conventional bank, by Kuwait’s largest Islamic lender Kuwait Finance House (KFH).

Experts say that the purchase is expected to majorly boost the kingdom’s Islamic banking sector – KFH plans to convert AUB and its subsidiaries into fully sharia-compliant banks.

AUB had a 13 percent market share of the Bahraini domestic banking sector assets as of the end of 2022, according to Fitch analysts, making the combined entity one of the largest domestic banks in Bahrain with total assets of $118 billion. 

The acquisition, completed in October, has resulted in KFH becoming the world’s second-largest Islamic bank by assets. Experts expect the sharia conversion to be completed by the end of the first quarter of 2024.

Fitch said it sees further mergers and acquisitions as well as “sustained demand” for Islamic products driving growth in Bahrain’s Islamic banking market.

Other sharia-compliant acquisitions completed last year in Bahrain include Al Salam Bank Bahrain’s purchase of Ithmaar Bank’s consumer banking business. GFH Financial Group also increased its stake in GB Corp to almost 63 percent.

“Rising rates should also support Islamic and conventional banking sector profitability, with reasonable liquidity and capital adequacy buffers expected to be maintained in 2023,” analysts added in a research note.

Islamic banking already has significant importance in Bahrain, comprising 38 percent of domestic banking system assets at the end of 2022. 

Islamic banking assets – including Islamic banking windows available at conventional banks – increased by more than 7 percent last year, a faster pace than the 2 percent asset growth of conventional banks.

Growth of sharia-compliant banking

Saudi Arabia has the largest proportion of Islamic banking assets of any country that allows conventional banks to operate alongside Islamic banks. Bahrain’s Islamic banking market is the seventh largest globally, with total assets of nearly $42 billion. 

Fitch analysts said the sector’s growth is supported by enabling regulations for Islamic finance, demand for Islamic products from Bahrain’s Muslim-majority population and the presence of a skilled workforce.

More favourable prudential requirements are also supporting Islamic banking growth, they added. The Central Bank of Bahrain, for example, grants Islamic banks a 30 percent 'alpha-factor' – a discount in the calculation of risk-weighted assets. Conventional banks are not granted this discount. 

According to Fitch, this provides a sizeable uplift to Islamic banks’ capital ratios, allowing them to grow and capture market share with less capital constraint.

In 2022, Islamic retail banks’ profitability and asset-quality metrics improved, though they lagged the performance of conventional retail banks, analysts noted. The liquidity profile of Islamic banks was also adequate, albeit weaker than conventional banks.

Despite the growth, Bahrain's share of global Islamic banking assets remains small at just over 3 percent, according to the Islamic Financial Services Board, mainly due to the economy’s small size. 

However, it was higher than the shares of both Indonesia (1.9 percent) and Turkey (2.9 percent), despite the economies of both countries being more than 10 times larger than Bahrain’s.

The Fitch outlook follows data from S&P Global Ratings that forecasts the global Islamic finance industry will expand by 10 percent in 2023 thanks to strong economic growth in core markets including the GCC, high commodity prices and relatively little impact from the Russia-Ukraine war.

However, it also showed that the sector has struggled to make inroads in non-traditional markets outside the Gulf.

Two thirds of the industry’s assets were based in the GCC region as of 2021 and around 80 percent are in oil-exporting countries.

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