The banking industry during an extended financial crisis: an empirical assessment of Kuwait Banks.

Author:AlKulaib, Yaser A.
Position::Abstract
 
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INTRODUCTION

After the financial crisis of 2008 and its negative impact on the banking industry, many investors and depositors began to worry about their investments and deposits. Currently, the European debt crisis that began in July 2011 is making headlines. Such negative economic news and negative bank performance attracts the attention of investors, raising questions such as whether the banks in which they have invested can continue operations and which banks will face hard economic conditions. Therefore, the evaluation of bank performance is important for depositors, investors, managers, and regulators. The impact of the financial crisis that originated in the United States and the euro zone has hit the rest of the world. The Gulf Cooperation Council [GCC, made up of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)] was one region affected by this crisis, which had a negative impact on GCC banks in terms of non-performing loans and a decrease in profits. In the GCC, banks can be divided into two categories: conventional banks and Islamic banks.

The Kuwaiti banking system began in 1941, when the first banking and financial institution in Kuwait, a branch of the British "Iranian Imperial Bank" (as it was known at the time) opened. On May 19, 1952, the first Kuwaiti bank, the National Bank of Kuwait (NBK), was formed; NBK began operating on November 15, 1952. In 1977, Islamic banking was launched in Kuwait with the establishment of the first Kuwaiti Islamic bank, Kuwait Finance House (KFH).

Currently, there are 21 banks operating in Kuwait, of which 11 are Kuwaiti banks and 10 are foreign. Competition in the banking industry has a direct effect on the efficiency of financial services, the quality of financial products, and the degree of innovation and stability. This competition has led to the development of high-risk instruments with a high level of risk exposure that allow banks to gain a high level of profit. Therefore, banks in Kuwait have high credit exposures to real estate and investment companies, which means that they are exposed to significant risk. Real estate and investment companies are considered high risk because they are highly volatile given the limited diversification of the economy.

In this paper, we focus on two main questions involving the Kuwaiti banking sector and the GCC state: (1) Have Kuwaiti banks been affected by the financial crisis? and (2) Is there any difference in the effect of the financial crisis between conventional and Islamic banks? This paper examines the effect of the financial crisis on Kuwaiti banks. We will examine the differences between Islamic and conventional banks' performance after the financial crisis during 2007-2010 using financial ratios and a t-test.

Our analysis incorporates the extended bear-period beginning with the start of the financial crisis in 2008. Our study extends the literature by presenting evidence using data from Kuwait, which is a frontier market that has not been previously covered in terms of bank performance during the global financial crisis. The results of our study should be beneficial to individual investors, institutional investors, and portfolio managers interested in investing in the banking industry as well as to governments.

The paper is divided into four parts. First, the literature review discusses previous studies conducted on this topic, outlines the beginnings of the Kuwaiti banking industry, defines Islamic banking, and explains the differences between Islamic and conventional banks. Second, we explain the data set and methodology. Third, we undertake the analysis of our empirical results and discuss it from the perspectives of Kuwaiti and global investors and governments. Finally, we offer a conclusion.

LITERATURE REVIEW

Although a large number of empirical studies have been conducted on developed and developing countries, few empirical studies have addressed the GCC or Kuwait. The papers that do examine the banking industry in Kuwait and the GCC do so in terms of competition within the industry. Few empirical studies have been conducted regarding performance differences between Islamic and conventional banks. We did not find any papers covering the financial performance of Islamic and conventional banking in Kuwait.

In this section, we will shed light on the banking industry in Kuwait. In addition, we will explain what Islamic banking means. In addition, we will discuss the differences between conventional and Islamic banking and explain some of the terms of Islamic banking. Finally, we will review the important previous research about banking performance.

Banking Industry in Kuwait

The Kuwaiti banking system began in 1941 with the opening of a branch of the British Iranian Imperial Bank. The first Kuwaiti bank was the NBK, which was established in May 1952 and started operations in November 1952. In 1977, Islamic banking began in Kuwait with the establishment of KFH.

Since KFH was launched, there has been high demand for Islamic finance by individuals and institutions. The Central Bank of Kuwait (CBK) prohibited conventional banks from engaging in any activities based on Islamic finance, and the demand therefore led to the establishment of two new Islamic banks and led two conventional banks to transfer to full Islamic banking licenses.

Before 2004, only one foreign bank operated in Kuwait. However, in 2004, the national assembly passed an amendment allowing branches of foreign banks to operate in the domestic market, although only one branch would be allowed for each foreign bank. As a result, nine new foreign banks have opened since the new law. In this paper, we focus on listed Kuwaiti banks because their financial information is available.

Table 1 shows that four out of the nine listed banks are Islamic. The market capitalization (market cap) of conventional banks is almost double that of the Islamic banks due to NBK's market cap. NBK is the largest bank in Kuwait in terms of market cap and net income. It was the first national bank in Kuwait and has the largest network of branches. In the late 1990s, NBK began to show interest in Islamic banking because of client demand and business growth in the Islamic banking sector. NBK started buying shares of an Islamic bank and now holds more than 45% of Boubyan Bank shares, with plans to increase ownership in 2012. Islamic banking

In the early 1970s, Islamic banks were started in some Arab countries such as Egypt, Saudi Arabia, and Kuwait, and the interest in Islamic banking extended into Western financial institutions. In the early 1990s and 2000s, the Islamic banking industry attracted a number of Western multinational financial institutions, such as Citigroup and HSBC, which started offering Islamic financial products in some Arab countries, such as Bahrain, Kuwait, and the UAE.

Islamic banking is based on the principles of an Islamic economic framework in accordance with Islamic law (Sharia'h). Sharia'h deals with many topics addressed by secular law, including crime, politics, and economics, as well as personal matters such as sexual intercourse, hygiene, diet, prayer, and fasting. There are two primary sources of Islamic law: the precepts set forth in the Quran, and the example set by the Islamic prophet Muhammad in the Sunnah. All dealings, transactions, products, investments, and responsibilities in Islamic banking institutions are derived from Sharia'h law, which leads to significant differences...

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