Troubled banks swing spotlight on to Bahrain

When Saad Group, a troubled Saudi company, blamed its woes on a liquidity squeeze and singled out recent events affecting the Bahraini banking sector, it met with a furious response from the kingdom's regulator.

In a rapid turnround the conglomerate, owned by Maan al-Sanea, issued a fresh statement the next day that lavished praise on the central bank, saying its "prudent oversight reflects the commitment to firm governance in Bahrain".

The troubles of Mr Sanea, who has had his personal accounts frozen in Saudi Arabia, as well as those of Algosaibi group, another Saudi conglomerate, have rattled bankers and investors across the Gulf. It has also swung the spotlight on to Bahrain, which claims to have the Gulf's oldest and best regulated financial centre and has long been an offshore base for banks doing business in Saudi Arabia.

The first signs of difficulties among the Saudi entities surfaced when Bahrain-based The International Banking Corporation (TIBC), which is owned by Ahmad Hamad Algosaibi & Brothers Company, one of the most powerful Saudi merchant families, defaulted last month.

Then Mr Sanea's accounts were frozen on orders of the Saudi central bank. He also owns a Bahrain-based bank, Awal, and there was much market speculation that he may have been involved in TIBC. He is married to a member of the Algosaibi family, but Saad Group has denied that there are any direct business connections between the two groups.

The turn of events appear to have surprised Bahrain's central bank. It is trying to establish "how the reported liquidity position of these banks could have deteriorated so suddenly", says Rasheed al-Maraj, its governor. The most recent reports submitted by TIBC and Awal before the problems emerged had indicated that their liquidity position was normal, he adds.

He says the problems with TIBC and Awal are not part of a "general problem," and are instead "specific to those particular banks".

But as the kingdom is home to more than 400 financial institutions and is one of the region's most long-standing banking centres, Mr Maraj is aware Bahrain's reputation is again being tested.

But it is not the first time Bahrain-based banks have suffered. Gulf International Bank (GIB) is one of the Middle East financial institutions worst hit by the subprime crisis, to which most banks in the region had little or no exposure.

In March, its government shareholders bailed out the bank by buying some $4.8bn of toxic assets.

Mr Maraj says the challenge for regulators is to allow banks to function while providing enough regulation to prevent their worst excesses. "It is not an easy balance to strike, as regulators in Britain and the US have found," he says. "We believe that the best way to strike this balance is to adhere closely to international standards."

Analysts say the structure of the banking industry protects it from the specific problems of TIBC and Awal, which had assets of $3.8bn and $7.6bn respectively at the end of 2008.

Of the 124 banks licensed to operate in Bahrain, there are some 24 retail banks and 64 wholesale banks, as well as 26 Islamic banks. The division between retail and wholesale institutions broadly follows an older classification between onshore and offshore banks.

"It is important to distinguish between wholesale and retail banks," says Tristan Cooper, senior sovereign risk analyst at Moody's. "GIB as a wholesale bank had exposure to western toxicity that is quite rare in the Gulf. Not only did it manage to recapitalise pretty swiftly, but like other wholesale or offshore banks it is fairly well separated from the Bahraini economy in terms of systemic risk."

Capital adequacy ratios in Bahrain also remain among the highest in the region at 12 per cent. The country also has a strict loans-to-deposits ratio of 70 per cent.

Still, Gulf bankers have expressed concerns about the exposure the region's banks have to the Saad and Algosaibi groups, including Bahrain-based banks given their traditional links to Saudi Arabia.

Bahrain does not enjoy the oil wealth of its neighbours should it need to bail out any institution. The combined assets of the banking sector stood at $241.1bn at the end of April, more than 19 times Bahrain's gross domestic product of $12.6bn.

In January, Moody's downgraded its sovereign ratings outlook for the kingdom to negative from stable, citing deteriorating public finances. And some financiers say that, although Bahrain has the most stringent rules on disclosure in the Gulf, there is room for improvement.

"Transparency is a very good concept in principle, but in reality it is driven by compliance," says Sat Paul Parashar, head of banking at the Bahrain Institute for Banking & Finance. "No bank is going to admit they have skeletons in their cupboard unless they are forced to."