Surrounded by larger neighbors, Kuwait is no minnow in Islamic finance. SCOTT WEBER identifies the reasons behind Kuwait continually mixing with the bigger players in the Industry.

Kuwait’s strong external financial position and active fiscal programs have significantly mitigated the effect of the global financial downturn on its economy. The crisis’ impact has served as stark reminder to the country that primary reliance on a single commodity, oil, cannot continue to guarantee its economic wellbeing.

The state’s association with Islamic finance dates back to 1977, when the first Islamic bank, Kuwait Finance House (KFH), was established. However, in 2004 a government decision meant that KFH lost its monopoly as several other players entered the Islamic financial sector to actively compete with their conventional counterparts.

Receptive audience
Kuwait’s Islamic finance industry has grown to become an increasingly important segment of the country’s financial sector, gaining considerable interest as a practical alternative model, sustained by increasing demand and a growing awareness in the domestic market for finance that is in accordance with Shariah principles.

However, it is essentially Islamic finance’s increasing profitability that has guaranteed its success. Overall preference for Islamic investment instruments and banking has spurred the Kuwaiti marketplace with Shariah compliant financing gaining an increasing market share against conventional products.

The eruption of the global financial crisis caused a market fallout in the industry throughout 2009. Kuwait fared better than most with a GDP decline of only 1.5%, according to Faisal Hasan, head of research at Global investment House, with its financial sector suffering heavy losses.

Declines in the key real estate sector were compounded by declines on Kuwait’s stock market, with the market capitalization retreating by over 50% whilst Islamic banking profits saw a 42.7% decline.

Regulatory measures
On the regulatory front, the Central Bank of Kuwait (CBK) has embarked on a proactive expansionary monetary policy to revive stagnant credit markets to counteract the recessionary pressures resulting from the crisis. These measures reduced discount rates and provided a significant stimulus package, bringing short-term liquidity back to the economy and the heavily-hit financial sector.

The financial crisis also prompted CBK to increase regulatory measures, instructing banks to conduct stress tests and imposing strict guidelines on loans to investment banks and the real estate sector as the insolvency fallout increased. Investment companies were also hit hard, resulting in CBK introducing proactive measures to restructure and reschedule debt and payment plans.

Sukuk underutilized
The Islamic finance industry in Kuwait should also tap into the essential Sukuk market, having been absent from the segment throughout 2009 and providing only a single issuance in 2008. Whilst not a common tool for funding projects in Kuwait, as the government remains the key financier of all service sector projects especially in relation to infrastructure and oil projects. Sukuk issuance is further hampered by a lack of appropriate legal mechanisms and regulatory framework for it.

Nevertheless, the potential Sukuk market in Kuwait remains large and would help to develop a local capital market as well as attract significant levels of direct foreign investment.

Outlook
The Islamic finance industry in Kuwait is set to show a return to relative normality. According to KFH research, the sector’s growth is set to continue, with predictions of double digit growth in 2010, underpinned by aggressive market strategies and continuing strategic relationship-building. The market will be assisted further due to increased competition in the marketplace, with the introduction of new products and services to the market.

Given the recent challenging economic environment, Kuwait looks set to further increase its Islamic capital base, posting slow yet positive growth across all sectors. Further growth is almost guaranteed, riding on a wave of oil revenue. However, reduced state influence on corporate decision-making processes and greater privatization of upcoming infrastructure projects would further guarantee Kuwait’s success and long-term viability.