This article is a chapter out of the e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" that is available as a pdf download from HERE. Read the article in the e-book for the complete set of tables, charts and references.
The novel coronavirus COVID-19 whose first case was reported in China at the end of 2019 has since spread to the rest of the world. Bahrain saw its first reported case on February 21, 2020, that of a school bus driver who returned from overseas. As a result, the government of Bahrain took an active step to close academic institutions, including schools and universities, immediately throughout the Kingdom first for two weeks and then for an indefinite period. All new cases were imported, that is to say that they came from overseas and were brought into the Kingdom from abroad. As a result, Bahraini authorities acted promptly to limit incoming flights, introducing scanning at the airport and suspending flight operations.
Since then, cases related to COVID-19 have steadily increased to 3,356 including 8 deaths as of May 3, 2020.
On a positive note, Bahrain is among the countries with the highest recovery rate of the COVID-19, with more than 51% as of May 3, 2020.
Bahrain was among the last countries within the GCC to introduce a partial shutdown of non-essential businesses. In addition, various precautionary steps have been introduced, including 14 days compulsory quarantine for incoming travelers, social distancing and stay-at-home measures imposed by authorities, closing educational institutions, retail shops, restaurants and cinemas; suspending flights to infected areas; suspending prayers in mosques; rescheduling major events (including the annual Formula 1 race); restricting gatherings to a maximum of 5 people; and switching to remote working at public entities and introducing mobile applications that allow residents of the country to monitor proximity of recovered COVID-19 patients.
COVID-19 AND BAHRAIN'S ECONOMY: SOME POLICY RESPONSES
The outbreak of the COVID-19 has already and will continue to disrupt economic activities of the global economy after having experienced a 2.9% GDP growth in 2019. While the IMF earlier forecasted a growth of 3.3% in the global GDP in the year 2020, it has now revised its forecast to 3% decline in the GDP for the year 2020. Most businesses and companies in services, tourism, retail, transportation, and industrial sectors have been interrupted since the viral outbreak emerged.
In the Middle East and North Africa (MENA) countries, the COVID-19 pandemic has increased stress in the markets as reflected in a downward revision of MENA economic growth in 2020. Table 2 shows the declining projections of GDP growth in MENA countries due to COVID-19.
According to the World Bank (2020), the economic growth of MENA countries in 2020 would be revised down from 2.6% to -1.1% due to coronavirus pandemic. The COVID-19 outbreak may severely hit economic activities and trade across MENA countries to varying degrees for 2020 and accordingly Bahrain will also face pressure on its economy as the coronavirus spreads.
Bahrain’s economy is expected to grow in 2020 by -2.5%, down by 4.6 percentage points as compared with the earlier forecast (World Bank, 2020). Moreover, as a regional oil producer, Bahrain will also face fiscal pressures from lower oil prices, limiting government spending and hence dragging on nonoil economic activities.
The government response with restrictions on travel, events, and business activities will certainly hit hard domestic consumption, businesses, and investment in the Kingdom. Bahrain’s economy after oil and gas (17.8%) is dependent on financial services (16.5%) based on the Bahrain Economic Report 2019, followed by the manufacturing sector (14.5%).
Nevertheless, it is important to highlight that Bahrain has been leading on economic stimulus packages in combating the impacts of COVID-191. The Kingdom has launched economic relief packages of almost 30% of GDP in response to impact of the pandemic. The huge stimulus packages of $11.4 billion (4.3 billion Bahraini dinars) will play a crucial part in cushioning the fall in economic activities. Under this relief package several important commitments are made by the government for residents and nationals of the country. Among others, they include:
- Postponement of all loan payments for six months – both principal and profit;
- Paying the salaries of all private sector employees for three months from April 2020 from the unemployment fund, this adds up to $ 570 million (BHD 215 million);
- Paying individuals’ and businesses’ electricity and water bills for three months from April 2020 (up to the costs incurred during the same period in 2019);
- Exempting all individuals and businesses from municipal fees for three months from April 2020;
- Exempting all businesses from industrial land rental fees for three months from April 2020;
- Exempting all tourism-related industry from tourism levies for three months from April 2020;
- Doubling the Liquidity Support Fund to $530 million (BHD 200 million);
- Increasing the Central Bank of Bahrain’s loan facilities to $9.8 bn (BHD 3.7 billion) to allow debt instalments to be deferred and extra credit to be extended;
- The redirection of all Tamkeen programmes (semi-autonomous government agency that provides loans and assistance to businesses) to support adversely affected companies, as well as the restructuring of all debts issued by Tamkeen.
The above measures introduced by the Government of Bahrain are very timely and may have a short-term positive impact on residents and the Bahraini economy in general.
IMPACTS ON ISLAMIC BANKING AND FINANCE
The COVID-19 pandemic has undeniably increased stress on the banking and financial sectors in many jurisdictions. One of the key questions yet to be assessed is how and to what extent the Islamic financial services industry will be impacted by the coronavirus pandemic. The banking sectors in Bahrain, both conventional and Islamic, have already taken a series of actions as a result of the spread of COVID-19 to meet the needs of customers. Among the initiatives, inter alia, are encouraging customers to use digital or online banking to manage their accounts, and retail customers who have received financing in the form of personal, mortgage, and car financing will receive six months’ postponements of instalments without incurring any fees. The Central Bank of Bahrain (CBB) has cut the interest rate by 1.55% from 4% to 2.45% in response to economic repercussions of the pandemic in the Kingdom.
Nevertheless, we anticipate that COVID-19 could potentially impact Islamic banks in several dimensions, including revenue, fee-based income, asset quality, and liquidity coverage.
Profitability : The profitability levels of Islamic retail banks remain stable at 0.3% while the profitability of Islamic wholesale banks slightly decreased from 0.6% in June 2018 to 0.4% in June 2019, according to the central bank’s Financial Stability Report 2019. However, credit ratings agencies such as S&P Global Ratings project that the Islamic banking sector will experience a dramatic drop in revenue for 2020. A lower interest rate environment with the CBB cutting the lending rate by 1.55% will potentially lift funding costs if liquidity shrinks, and margins are likely to come under pressure.
Fee-based income : The coronavirus crisis will weaken customer spending in retail, and force investors to hold cash due to economic instability, a move that may lower assets under management in asset management divisions. The pandemic looks likely to slow down Islamic investment banking activities. The crisis could put pressure on fee-based services offered by Islamic banks, such as fees/commissions for providing a bank transfer service (outside the country), commissions for issuing Islamic credits, and safe custody services. The diversification of revenue that includes feebased income is of utmost importance. This could be challenging for Islamic banks if the outbreak deepens further or carries on, leading to prolonged disruptions. With reduced economic activities in the country and an expected increase in unemployment, especially for the expatriate community, it is expected that annual remittances, which were around $3.3 billion in 2018 will be affected. The extent of the impact will be known in due course.
Asset quality : The deadly coronavirus, coupled with the oil price drop might raise asset quality risks for Islamic banks in Bahrain. This could lead to pressure on capital adequacy. The asset quality ratio for Islamic retail banks deteriorated as their non-performing facilities (NPF) ratio increased from 9.5% in the fourth quarter of 2018 to 10.4% in the last quarter of 2019, according to the CBB Statistical Bulletin. For the Islamic banking and finance industry, there is a greater probability that the deferment of loan payments will have a positive impact on the asset quality (NPF) of banks in the short run as it will shield against the involuntary defaults owing to COVID-19. In addition, the government’s initiative to pay salaries of the private sector, land rental exemptions and tourism-related organizations will assist in reducing the operational costs for the Islamic banks and financial institutions and their clients by lowering their operational expenses. This may also indirectly lower the overdue / default probability. However, in the long-term, it is anticipated that Islamic banks in Bahrain are likely to witness an increase in NPF (% gross facilities) if the virus continues to disrupt the economic activities as the crisis could affect the ability of companies to meet their financial obligations due to subdued demand, that could elevate their NPF levels. The wider benefits from huge economic policy stimulus launched by the government are unlikely to be seen until the health crisis subsides.
Moreover, the pressure on asset quality could worsen Islamic banks that have higher impairment on transportation (34.6%), construction (30.7%), and trade (19.5%) (CBB Financial Stability Report, 2019). Islamic banks with high proportion of financing facilities in these sectors are likely to have substantial asset quality deterioration. The government introduction of the financial relief packages by giving six months credit extension will not suffice if pressure on those sectors persists for a prolonged period.
Liquidity coverage: Doubling the liquidity support fund will most probably enable the banking industry, including Islamic financial institutions, to enhance their financing capacity, which may contribute towards economic growth by stimulating demand in the short-term. Bahraini banks are among the most active issuers of Islamic fixed-income instruments (sukuk) in the GCC region. According to Refinitiv data (2019), Bahrain recorded a $2.2 billion increase in sukuk issuance from $6.4 billion in 2018 to $8.6 billion in 2019. Islamic banks in Bahrain are also dependent on non-domestic funding, accounting for around 26% of total funding and 38% of deposits (CBB Statistical Bulletin, 2020). The obligations on foreign exchanges will put Islamic banks in Bahrain in a riskier situation. In addition, global markets volatility and concerns over liquidity tightening could hamper Islamic banks to access global markets and would also drive non-domestic deposits withdrawals. In this situation, the liquidity coverage would be deteriorated if investor confidence is not restored and non-domestic deposits are withdrawn and not replaced. Aside from that, Islamic banks should reassess the risk profiles of their customers, typically by classifying customers who are impacted by the COVID-19 as high risk.
Credit Ratings: As a result of low oil prices and COVID–19, credit ratings agency Moody’s downgraded the GCC banking system from a stable outlook to negative for all countries except Oman. In the case of Bahrain, additional factors include the government’s weakening fiscal position and lower activity in the real estate sector7 as well as frequent travelers and freight movement between Saudi Arabia and Bahrain, both of which have significant impact on banking firms in Bahrain.
Furthermore, the COVID-19 pandemic has caused stock market indices to plummet around the globe. On March 12, 2020, the Dow Jones, S&P 500 and FTSE 100 saw their biggest one-day decline since 19878. According to Baker et al., the stock market reaction is an early signal of economic repercussions of the COVID-19 outbreak. The disruption on global supply chains, the temporary halt in manufacturing, and the fears of getting infected by the deadly COVID-19 could reduce the volume of stock market activities.
In Bahrain, the main index BAX decreased by about 20.52% to close at 1,279 points as of May 7, 2020. Meanwhile, the Islamic indices of S&P Bahrain Shariah Index fell about 32.14% to close at 171.45 points, as of May 8, 2020). It was evidenced that the S&P Bahrain Shariah Index started to fall as the COVID-19 emerged in the Kingdom at the end of February 2020, and since then, the Bahrain Islamic stock market witnessed sharp declines.
The COVID-19 pandemic is still unfolding. It is expected that the world post COVID-19 will be a different one.
Many businesses are likely to face severe challenges in the coming weeks and months as they get used to a new norm. In line with the reduction in economic activities, it is expected that the affiliated industries like Islamic banking and finance will experience lower than expected growth.
However, the COVID-19 crisis coupled with low oil prices may be a blessing in disguise for the Islamic finance industry, in particular in the GCC and Bahrain, which is historically a hub for Islamic finance in the region. This is due to the fact that lower profit rates might be an opportunity for investors, sovereigns and corporates to tap into the market and raise funds by issuing sukuk, thereby growing assets under management of the Islamic finance industry in the country.
RECOMMENDED MEASURES TO BE TAKEN BY THE ISLAMIC FINANCE INDUSTRY
A weak demand and prolonged disruption due to the fragile situation would impose a shock to Bahrain’s economy. Nevertheless, it is important to appreciate the extraordinary economic packages that the government has introduced for extraordinary times.
When it comes to the Islamic banking and finance industry in Bahrain, we believe the following measures can be introduced by the industry to play its part in the development of the economy in Bahrain:
Islamic banks in the county can jointly set up a waqf fund to support the families affected by the
coronavirus as part of their CSR activities. This may include:
- Families of the deceased, who have died due to this virus. The fund may support the education, healthcare and other living expenses indefinitely or until other means are available.
- Support the families of the sick by paying salaries until they have recovered completely.
- A large number of expats have been affected, these are the people who are from developing countries and send funds to their families on a regular basis. The waqf fund can provide sustenance to these people as well as their monthly salaries, if not covered by the employer.
- At a time when public health has become of utmost priority due to the outbreak, the waqf fund can also be utilized to boost healthcare services, by way of increasing hospital capacity such as hospital beds, ventilators, and medical staff (doctors, nurses), in order to cushion the detrimental impacts of further pandemic.
In addition, providing temporary credit relief to both expats and locals could lead to fewer lay-offs of people affected by the pandemic.
• Small and medium-sized enterprises must also be supported with relaxed working capital and financing terms to ensure continuity of their businesses in these difficult times.
• Lastly, it is expected that default rates of the underlying companies will go up; hence it is important for Islamic banks and financial institutions to work with their clients both on the assets side and the liability side to ensure an optimum solution is reached to ensure NPFs and investors’ expectations are managed well.
The full e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" is available as a pdf download from HERE. The e-book is published by Indonesia's Islamic Finance and Economy Committee (KNEKS) in partnership with DinarStandard and Salaam Gateway. It was launched on May 27, 2020. The 12 countries covered are: Bahrain, Bangladesh, Brunei, Indonesia, Iran, Malaysia, Nigeria, Oman, Pakistan, Saudi Arabia, Turkey, and UAE.