OXFORD NSRTUTE =FOR m ENERGY STUDIES

Oil and the Internationalization of Arab

Naiem A. Sherbiny

Oxford Institute for Energy Studies

F6 1985 The contents of this paper are for the purposes of study and discussion and do not represent the views of the Oxford Institute for Energy Studies or any of its members.

Copyright 0 1985 Oxford Institute for Energy Studies

ISBN 0 948061 11 1 ACKNOW LED GEMEBTS

The author is a senior economist in the Energy Department of the World . He wrote the present paper while visiting the Oxford Institute for Energy Studies in Summer 1985. The paper is based partly on the author's research in the Institute, and partly OR his recent paper entitled "Arab Financial Institutions and Developing Countries" prepared for the 1985 World Development Report, which will shortly appear in the Wor Id Sank's Staff Working Papers Series. Without implication, the author wishes to acknowledge the support and comments of Robert Mabro, Director of the Oxford Institute for Energy Studies; David J Reid, Advisor, Bank of England; and Hikmat Nashashibi, Chief Executive, AI-Mal Group, London. Errors and interpretations are the author's sole responsibility.

, t 1. INTRODUCTION

2. EARLY DEVELOPMENTS OF ARAB BANKS

3. THE 1970s AND EARLY 1980s: OPPORTUNITIES AND CHALLENGES 14

4. CENTRES OF ARAB BANKING 28

5. ISLAMIC BANKS 41

6. FUTURE PROSPECTS 48 TABLE 1 INDEX NUMBERS OF AVERAGE ANNUAL OIL 16 REVENUES OF ARABlOPEC MEMBERS

2 AVERAGE ANNUAL IMPORTS OF ABAB/OPEC 17 COUNTRIES

3 CUMULATIVE NET FOREIGN ASSETS OF 19 THE LOW ABSORBERS

4 INTERNATIONAL ACTIVITIES OF ARAB BANKS 25

5 ASSETS OF SELECTED ISLAMIC BANKS 44

6 SOME PERFORMANCE INDICATORS OF 46 SELECTED ISLAMIC BANKS

A-l LARGEST ARAB BANKS 55

A-2 LEADING ARAB BANKS IH EUROCURRENCY 56 SYNDICATED LENDING 1. IHTRODUCTIOH

The major increases in oil prices during the 1970s caused many changes in the socio-economic map of the , including substantial ly increased financial flows to and from the oil economies. In a short time, the oil exporters became also capital exporters. Some of the financial institutions managing these flows had to establish a presence in international financial centres in a rather short period. In many ways, the

1970s will be seen in banking and finance circles as the decade of internationalization of Arab banks, just as the 1960s was the decade of international ization of American banks.

The internationalization of Arab banks, however, was a process which started unevenly well before the 19708, and not always because of increased oil revenues at home or capital exports abroad. During the 1940s the Jerusalem-based Arab Bank was already operating outside Palestine and into the Arab region

(, , ). The Lebanese banks began to establish branches outside early in the 1950s. The Kuwaiti banks started the internationalization process in the early 1960s.

However, it was during the 1970s that many Arab banks - especially from oil countries - became quite actively engaged in establishing branches, joint ventures, or consortia overseas thus

1 increasing their visibility in international markets.

The focus in this paper will be mostly on banks from the

Arab oil producing countries in the Gulf, because some of those banks have been at the forefront of financial innovation in recent years, and all have had ready access to petrodollar

sources from their start.

The second section thus out 1ines the earl ier developments of

Arab banking which had an explicit international orientation: the

establishment of modern banks in the Arab oil-exporting

countries; the rise of Beirut as a regional financial centre; and

the internationalization of Kuwaiti banks. The stage will then

be set for the third section to examine the specific factors during the 1970s which have prompted Arab banks to establish a

presence in international financial centres on a large scale.

Here, the special relation of oil exports and the inter- nationalization of Arab banks is examined, and the activities of

those banks exp I ored.

The demise of Beirut in the mid-1970s as a regional

financial centre necessitated the search for other alternatives.

Kuwait and have emerged as such centres in the Gulf, and

they appear to be having their share of difficulties. Elsewhere

in the Arab region, Cairo could become an important centre of

Arab banks only if monetary and exchange reforms are adopted.

Outside the Arab region, although London and Paris traditional ly

host the largest numbers of Arab banks, other locations are

increasingly becoming important international financial centres

of Arab banking: Mew York, Singapore, Hong Kong, and Switzerland.

These developments are detailed in Section Four.

2 The rise and expansion of Arab banks in international financial markets began to be associated with another phenomenon

- that of Islamic banks. The increased wealth and monetization of the Moslem countries in OPEC' necessitated the establishment of modern financial institutions. The notion of charging and paying interest which is central to modern banking is un- acceptable on religious grounds to most devout Moslems. An alternative was thus needed to attract the large masses of population into the increasingly monetized economies of the

Moslem countries. What have Islamic banks done so far, and what is their likely role in the future are some of the questions to be taken up in Section Five of this paper.

Finally, Section Six addresses the future implications of the recent major drop in oil revenues for the international activities of Arab banks. A central concern is whether such fall would signal the decline of Arab banks. The paper argues that the relationship between the volume of oil revenues and the international activities of Arab banks is asymmetrical: increased oil revenues have expanded international activities of Arab banks, but the fall in those revenues will not necessarily diminish the internationalization of Arab banks.

1. The population of Ecuador, Gabon, and Venezuela together represent 7 per cent of the combined population of OPEC. The remaining 93 per cent are mostly Moslem, as calculated from The World Development Report 1985.

3 2. EARLY DEVEUIPMEBTS OF ARAB WS

The geneses of the internationalization of Arab banks go

back to the establishment of modern banking in Arab countries by

foreign banks, the emergence of Beirut as a regional finance and

business centre, and the orientation of Kuwaiti financial

institutions towards international business and investment

opportunities during the 1960s.

Foreign banks established in Arab countries f el1 general ly

in two categories: those set up semi-independently by foreigners

to serve the business and commercial interests of resident

colonizing communities; and those established as branches of

foreign banks to participate in the local boom associated with

successful oil finds. Although those banks were established too

early to have a direct relationship with the internationalization

of Arab banks in the 1970s, their presence nonetheless created a

new awareness of and an orientation towards overseas banking.

More importantly, they served in varying degrees as sources of

and training grounds for domestic banking skills which were later

to lead the processes of modernization then international ization I of Arab financial institutions.

The first type of foreign banks in Arab countries was

established long before oil was discovered in commercial

4 quantities. Thus, in 1851 the French established Banque d'Algerie; in 1898 the British established the National Bank of

Egypt; in 1910 the Italians established Banco di Roma in Libya; in 1926 the Dutch established Nederlandsche Handel Maatschappij in ; and in 1920 the British established the Eastern

Bank in Bahrain. Most of these banks were actively engaged in external trading. To the few domestic educated elites, the pro- sperity and sophistication of banking employees appeared to be closely related to the international character of the banks.

However, the great majority of the indigenous communities had their own long traditions and practices in trading, business, and money exchange which had little or no need for modern commercial banking. Financial dual ism was embedded in the socio-economic structures of Arab countries, where ancient institutions co- existed with modern institutions, each serving the distinct financial and commercial interests and needs of vastly different communities.

The other type of foreign banks in Arab countries was established fundamentally in response to discoveries of oil in commercially viable quantities in order to participate in the ensuing boom. Activities of the British Bank of the Middle East

(BBME) in the Gulf characterise this type of banking. Thus, the

BBME established branches in in 1942, Bahrain in 1944,

Dubai in 1946, Oman in 1948, in 1953, Qatar in 1954, and

Abu Dhabi in 1959. In these cases too, financial dualism came into existence with modern banks, and deepened over time with their growth and expansion.

In most cases, the oil revenues which the governments

5 received, though initial ly modest, began to finance the most essential parts of infrastructure. These rather 1imited, but continuing, flows of government expenditures had an unmistakable multiplier effect on the domestic economy: contracting with local merchants for goods and services, employing nationals, buying or

leasing land, renting off ice space, etc. Especial ly noticeable was the boom in land values which contributed to local prosperity. As incomes of the private sector increased, so did expenditures, especial ly on imported consumer goods and durables.

The profits of foreign-owned banks began to increase markedly.

The Gulf countries became a major source of deposits for BBME.

For example, in 1959 deposits in the Kuwait branch plus Kuwaiti- owned deposits with BBME in London represented 47 per cent of

total public deposits in BBME. Furthermore, some of these deposits were interest-free: 50 per cent of deposits in the Kuwait branch of BBME throughout the 1950s carried no interest. 2

The ability of the domestic Gulf economies to absorb government and private expenditures, though expanding quite rapidly, became increasingly limited relative to the sub-

stantially greater expansion in oil revenues. By the early

195Os, most Gulf branches of BEME lacked sufficient local opportunities to absorb all the local deposits. The bank tran-

sf erred a major portion of the deposits in the Kuwait branch to

London: 30 per cent in 1955, and 50 per cent in the mid-1960s.

The same was true, even to a greater extent in Bahrain and

2. Geoffrey Jones “3anking in the Gulf before 1960”, London School of Economics, 1985 (Mimeographed).

6 (60 per cent of deposits invested abroad in 19591, and in Oman

(80 per cent in the 1960~1.~

Impressed by the success, prof its, and international orientation of foreign-owned banks, local merchants in a number of oil countries initial ly pooled resources together and established modern banks, basically to get a share in the growing pie. These banks started operations under favourable conditions because the major merchant shareholders transferred their business transactions to the newly-established banks. Even though such moves implied competition with the foreign-owned banks, growth of business for both types reduced potentials for conflict. In most cases local ly-owned modern banks recruited experienced staff, especial ly national, in management and other positions from the foreign-owned banks. Skills of those staff and their knowledge of international suppliers, banking procedures abroad, and foreign languages - in addition to their

local know ledge and connections - were essential requisites to the success of modern local banks.

The establishment of modern banks by local interests was an integral part of the modernization process sweeping the oil countries. Such event occurred in 1938 in Saudi Arabia with the family-owned National in ; in 1941 in Iraq with the government-owned Raf idain Bank in Baghdad; in 1952 in

Kuwait with the privately-owned National Bank of Kuwait; in 1955 in Libya with Tripoli's National Bank of Libya; in 1957 in

Bahrain with the ; in 1963 in Dubai with

3. Geoffrey Jones, ibid. the National Bank of Dubai; in 1968 in with the government-owned National Bank of Abu Dhabi; and in 1973 in Oman with Muscat's National Bank of Oman.

The activities of both Arab and foreign banks typically concentrated on short-term commercial loans, related for the most part to external and internal trading. Both the exposure and orientation of Arab banks to international banking norms and practices evolved over time to become ordinary daily affairs.

The coexistence of Arab and foreign banks (fully Owned, or branch offices) continued in some countries until the present, such as in Bahrain, Dubai, Abu Dhabi, Qatar, and Oman. In other countries, commercial banks were nationalized following 's example in 1961. Thus, nationalization of the entire banking system was accomplished in 1964 in Iraq, 1965 in Algeria, 1970 in

Libya, and 1971 in Kuwait. Saudi Arabia followed a middle course, where by 1981 all non-Saudi banks had to accept 60 per cent Saudi ownership.

Another contributing factor to the internationalization of

Arab banks was the development of the banking system in Lebanon which followed a distinctly liberal orientation since independence in 1943. In addition, several aspects helped make

Beirut the finance and business centre of the Arab region: the network of contacts through migrant Lebanese businessmen worldwide; a strategic location at the cross roads of three continents; and a good communication system. These aspects, among others, helped expand the number of banks in Beirut from 11 in 1945 to 90 in 1965. The scope of banking services expanded equally substantially: from financing external commerce to the

8 wide range of financial, investment, and intermediation functions normal ly obtained in major international business centres.

Furthermore, the wave of bank nationalizations in neighbouring

Arab countries especially during the 1960s created an influx of f 1 ight capital into Lebanese banks. The apparent stabil ity and prosperity of Lebanon until its tragic civil war has given further inducement to two-related developments. First, the

Lebanese pound gained strength vis-a-vis major international

currencies; during 1955-75 the Lebanese pound improved by 29 per cent against the dollar, and by 44 per cent against the Sterling.

Second, rich individuals and financial institutions in the Gulf transferred to Beirut substantial flows of investment funds.

The wide-ranging scope of Lebanese banking activities, and

the enterprising approaches of Lebanese managers, made inter- nationalization a natural corollary in the development of Arab banking. For example, the Banque Libanaise pour le Commerce which was established in 1950 by a prominent Lebanese family opened subsidiaries in Damascus in 1953 and in Paris in 1956.

The Intra Bank, established in 1951 by a Palestinian businessman, participated in the financing of industrial, tourism, and real

estate projects in the Middle East, Europe, and North America.

Capital investments from the Gulf were instrumental in setting up a number of Beirut-based banks of regionallinternational

character, such as the Eeirut-Riyad Bank (19591, the Credit

Libanais (19611, the Audi Bank (1962), and the Byblos Bank

(1962).4

4. Traute Wohlers-Scharf, Arab and Islamic Banks, OECD, Paris 1983, p.17 and its footnotes, pp 62-63.

9 Through the mid-1960s Lebanese banks were exempted from serious government controls and were allowed to maintain a system of confidential numbered accounts which turned Lebanon into a haven for anonymous capital. The crash of the Intra Bank in 1966 sent shock waves into the relatively small but highly visible financial community which led to government controls, stream-

lining the banking system, and a complete ban on setting up new banks. In the process, the number of banks declined to 74 by

1968 and remained unchanged through 1976. The severity of the civil war had by then forced more Lebanese banks to move the base of their operations from Beirut and set up branches or affiliates in Cyprus as well as in major financial centres such as London,

Paris, and Switzerland.

Parallel to the development of the Lebanese banking system, and at the other extreme, was the development of the Kuwaiti

Banking System. At first, the Kuwaiti system was limited by the monopoly advantages the British Bank of the Middle East had enjoyed since its establishment. The National Bank of Kuwait was established in 1952 for the most part as a result of pressures from Kuwaiti merchants when the country was still a British protectorate. Until 1960 only these two commercial banks were a1 lowed to operate in Kuwait and through them investments were placed overseas, mostly in London, on behalf of the country and its rich families.

In 1960 two additional commercial banks were established: the Commercial Bank of Kuwait and the Gulf Bank. In 1967 another commercial bank was added (A1 Ahli Bank). The activities of the

10 new banks followed in the footsteps of their predecessors: mostly

short-term financing of import trade and, to a lesser extent, guarantees of construction contracts. The deposits which were not possible to deploy productively in Kuwait were generally placed by the banks overseas, mostly in London.

It is the limited absorptive capacity of the Kuwait economy which exp 1 ains why the go v ernment encouraged the es tab1ishment of

specialized institutions to help place investments abroad in a

systematic fashion. Thus, the government participated in the establishment of the Kuwait Investment Company (KIC) in 1961 with

50 per cent of the shares, and also in the Kuwait Foreign Trade,

Contracting, and Investment Company (KFTCIC) in 1964 with 80 per

cent of the shares. The expressed policy of KIC was to diversify

investments to assure a reasonable degree of safety, but at the

same time maximize income. Its activities during 1965-70 were

concentrated in international financial instruments (92 per cent) with variant term structure, all of which were in OECD countries.

The remaining 8 per cent were in direct investments, mostly in

real estate and banking, with a wide geographic spread of

developed and developing ~ountries.~By contrast, the activities

of KFTCIC were relatively more concentrated in direct invest- ments, with 85 per cent of its resources in OECD ventures during

the 1960~~These two investment houses, together with Kuwaiti

commercial banks, formed in 1966 the United Bank of Kuwait in

London to strengthen the position of Kuwaiti banks in

5. KIC Annual Reports.

6. KFTCIC Annual Reports.

11 international operations. This was the first time a Gulf bank was established in a major international financial centre. Its expressed objective was to assist in the management of capital exports. Three years later the same group of banks, together with Socigte' G&&ale, formed in Paris the Banque Franco-Arabe d'Investissements Internationaux, known as FRAB Bank, as the first Arab-Occidental Consortium bank. By 1970 this cluster of institutions helped place substantial Kuwaiti funds in major international markets, estimated for the government at $4.0 billion and for the private sector at $1.2 billion. 7

Apart from those institutions, the Kuwaiti Ministry of

Finance in 1964 took the initiative with the Central Bank of

Egypt to establish in Cairo one of the foreruners of inter-Arab banks, the Arab African Bank, where each held 42.4 per cent of the shares; the remaining 15 per cent were subscribed by the governments of Algeria, Iraq, , and Qatar. A1 though the bank was established as a joint-stock company under Egyptian law, it had a special status similar to off-shore facilities in that it was exempt from exchange-control regulations and from banking and credit legis lation covering joint-stock companies. By 1970, the Bank had a portfolio of 14 direct investment projects, six of which were in Africa, seven in Arab countries, and one in Paris.

During the 1970s the Bank significant 1y expanded its activ it ies in African and Arab countries and substantially increased its capital, to become one of the leading development finance

7. N.A. Sherbiny "Arab Financial Institutions and Developing Countries" World Bank, Staff Working Paper (Forthcoming).

12 institutions in the Middle East. 8

On the official aid front, the government established in

1961 - the year of Kuwait's independence - the Kuwait Fund for

Arab Economic Development (KFAED), as the main institution for the provision of project assistance. Until 1974, the Fund's mandate was limited to the provision of loans to Arab League members; thereafter it extended to all developing countries. The

Kuwait Fund assisted the governments of several oil countries to

set up their national funds: Abu Dhabi in 1971, and Iraq and

Saudi Arabia in 1974. During a 12-year period (1962-731, the

Kuwait Fund processed 45 projects to 12 Arab countries, €or a

total commitment of $370 million, and gross disbursements of $230 million.' Symptomatic of the Fund's dynamism, even in those early

years, was the rapid expansion in its capital. From an initial

capital of KD 50 million ($140 million), the government doubled

the Fund's capital once in 1963, and once more in 1966 to KD 200 million ($560 million).10 Later on during the 1970s, the Fund

expanded its capital stil I further: to KDlOOO mil lion ($3400 million) in 1974, and to KD2000 million ($6900 million) in 1979.

8. Arab African Bank, Annual Reports.

9. Kuwait Fund Annual Reports; and OECD, Aid from OPEC Countries, Paris, 1983, p.46.

10. OECD, ibid, p.45.

13 3. TEJl 1970s dBD EAEtLY 1980s: OPPCHLTUHITIBS Bw) CHdLLEBlGES

The thrust of the foregoing discussion was to show that prior to the major increases in oil prices, modern banking was already established throughout Arab countries; both Arab and foreign banks participated in the monetization of Arab economies;

some countries nationalized their banking system; and Lebanon and

Kuwait stood at the forefront of the internationalization of Arab banks, though in varying degrees and for different reasons. While

the push towards international markets took place in Lebanon as a result of banking skills and financial connections to serve local and regional clients, it occurred in Kuwait as a result of oil- related capital exports.

If the internationalization of Kuwaiti financial institu-

tions occurred during the 1960s when the country's oil revenues were relatively small, there was all the more reason for banks from the small economies of the Gulf and Libya - the so-called

low absorbers'' - to seek international investment opportunities during the 1970s when oil revenues multiplied. There were also

equally good reasons for Kuwaiti banks to expand their

11. Defined in the ArablOPEC context to include Kuwait, Libya, Qatar, Saudi Arabia, and (UAE). Those economies could transform only a minor portion of their annuaL savings into productive investments especially during the 1970s.

14 internationa 1 act i v it ies during the 1970s. Banks from high absorbers like Algeria or Iraq were engaged in the international markets for the most part to finance import trade.

Index numbers of average annual oil revenues into the low-

absorbing countries (1963-69 = 100) were computed according to

the following five time intervals; Table 1.

1963-69 - oil price stability

1970-73 - minor increases in oil prices

1974-78 - following the first major oil price increase

1979-81 - following the second major oil price increase

1982-83 - falling oil prices.

The table shows substantially changed orders of magnitude between the 1960s and 1970s. The multiples began to show even in the

early 19709, but the discontinuities occurred in the mid-1970s.

The decline in 1982-83 of both oil export volume and oil prices

severely affected the index numbers for oil revenues, but they still continued above their 1974-78 averages.

This enormous expansion in oil revenues enabled the

Arab/OPEC countries to expand their imports significantly; see

Table 2. The index numbers in Table 2 facilitate direct

comparisons with the index numbers of Table 1. The comparison

shows generally similar shifts between time periods in the levels

of oil revenues and imports for each country listed, except for

the early 1980s. During 1982-83 the significant decline in

annual average oil revenues from the peak averages of 1979-81

appeared to be accompanied by import expansion, which was

substantial in some countries. This apparent inconsistency is

15 resolved by noting that import demand peaked two years akter the peak in oil revenues in 1980; it declined in 1983.

Table 1

Index Numbers of Average Annual Oil Revenues

of Arab/OPEC Members

Country 1963-69 1970-73 1974-78 1979-81 1982-83

Algeria 100 366 2547 6825 3230

Iraq 100 242 2130 493 9 2315

Kuwait 100 192 1094 2530 1266

Libya 100 298 1258 3105 2175

Qatar 100 289 2178 4800 3467

Saudi Arabia 100 345 3993 12295 8351

UAE 100(a) 379 51 07 12157 9714

(a> for 1966-69

Source ; Calculated from International Financial Statistics, on the basis that average annual oil revenues during 1963- 69 was as follows: $150 million for Algeria, $390 million for Iraq, $640 million for Kuwait, $570 million for Libya, $90 million for Qatar, $740 million for Saudi Arabia, and $140 million for UAE

Table 2 also shows the average annual magnitude of import trade: by country, for the Arab group in OPEC, and for the low absorbers as a group. While Arab banks are unlikely to have financed a1 1 imports of Arab countries, they may have financed the major portion. The volume of import trade itself has expanded geometrically: from an annual average of about $3 billion during the 1960s, to about $6 billion in the early 1970s, to $31 billion in the mid-19708, to $77 billion in the late

16 Table 2

Average Annual Imports of Arab/OPEC Countries

(Millions of US dollars)

1963-69 1970-73 1974-78 1979-81 19 82-83

Algeria 7 40 1550 6240 10170 10550

Iraq 420 700 3630 14070 16880

Kuwait 480 7 80 3340 6230 8640

Libya 440 1030 3580 6700 7 840

Qatar 60 130 7 80 1460 1700

Saudi Arabia 53 0 1160 10150 29900 40070

UAE 180(*) 470 3620 8450 9180

Total Arab 2850 5820 31340 76980 94860

Low Absorbers 1690 3570 21470 52740 6743 0

( Index Numbers )

Algeria 100 210 843 1374 1426

Iraq 100 167 864 3350 4019

Kuwait 100 163 696 1298 1800

Libya 100 234 814 1523 1782

Qatar 100 217 1300 2433 2833

Saudi Arabia 100 21 9 1915 5642 7 560

UAE 100 260 201 1 4694 5100

Source: Calculated from International Financial Statistics, 1984 Yearbook.

(*)denotes author’s estimates, based on partial information.

17 1970s. Arab imports reached their peak in 1982 at $104 billion, after which they retreated to $90 billion in 1983 - a decline of some 13 per cent. The share of the low absorbers in those flows has grown over time: from about 60 per cent in the late 1960s to about 70 per cent in the early 1980s. This partly explains why

Gulf banks were at the forefront of the internationalization of

Arab banks during the 1970s, and also why they have had more difficulties than other banks since 1983.

Imports of individual countries show substantial growth differences: highest in Saudi Arabia, UAE, and Iraq, and lowest in Algeria. As a result, the volume of imports for the individual countries changed dramatically during the 1970s, and with it the amount of trade financing provided by banks from those countries. During the 1960s Algeria was by far the largest importer in the Arab/OPEC countries, fol lowed at considerable distance by the roughly equal imports of Iraq, Kuwait, Libya, and

Saudi Arabia. By the mid-1970s this picture has changed significantly, and by the ealry 1980s it changed still further.

Saudi imports have become about three times Iraq's, the second largest importer, and about equal to the imports of Algeria,

Iraq, Kuwait, and Libya combined. The imp1 ications of these developments for trade financing by Arab banks - especially Saudi banks - are self evident. The implications for the size of Arab banks by nationality show in the volume of assets of those banks in the early 1980s; see Annex Table A-1.

Notwithstanding the major expansion in Arab imports, part of the increased oil revenues in the low absorbers was transmitted abroad for investments. The volume of the invested surplus by

18 country is not precisely known, but estimates of the cumulative current account surplus may serve as a proxy. Such estimates were in fact made by an independent researcher and are reported in Table 3 below. As would be expected, the figures show sub- stantial increases in the capital surplus invested abroad following the two major oil price increases. Combined, the low absorbers have accumulated a total surplus through the end of

1982 in excess of $320 billion, distributed as follows: 26 per cent for Kuwait, 8 per cent for Libya, 4 per cent for Qatar, 51 per cent for Saudi Arabia, and 11 per cent for UAE. It appears

Table 3

Cumulative Net Foreign Assets of the Low Absorbers

(billions of US dollars)

Country At End 1973 1974-78 1979-82 At End 1982

Kuwait 3.7 31.8 48.8 84.3

Libya 3.2 10.2 12.0 25.4

Qatar 0.9 4.6 8.1 13.6

Saudi Arabia 4.2 61.6 98.6 164.4

UAE 0.5 11.7 23.9 36.1

Total 12.5 119.9 191.4 323.8

Sources : For figures at end 1973 from Richard P. Mattione "OPEC's Investments and the International Financial System", Srookings Discussion Papers in Internat iona 1 Economics, No. 6, July 1983, Table 1.3. For 1974-78 and 1979-82, from R.P. Mattione, OPEC's Investments and the International Financial System, the Brookings Institution, 1985, Table 2-4, p.11.

19 that the 1982 figures reported in the table represented a peak, because starting in 1983 practically all the low absorbers have resorted to their accumulated surplus to finance budgetary deficits, a1beit in varying degrees. Saudi Arabia in particular appears to have withdrawn substantial sums, estimated at $35-45 billion during 1983-85, according to the country's annual budgets . The deployment of rapidly increasing investment funds outside the Arab region throughout the 1970s was carried out through a1ternative channel s, most notably bank deposits and other liquid placements in the US and UK. In addition, a new banking formula especially suited for the 1970s began to emerge - that of consortium banks. Because of their role in the process of internationalization of Arab banks during the 1970s, they deserve some detailed analysis. The first consortium bank was the FRAB Bank, established in 1969 by a group of Kuwaiti banks with Socigte' G&&ale. The formula must have proven sufficient-

ly attractive because FRAB was shortly followed by other Arab-

Occidental consortium banks such as the Union des Banques Arabes et Francaises (UBAF) in 1970, the European Arab Bank (EAE) in

1972, and Banque Arabe et Internationale d'hvestissements (BAII) in 1973. This form of international cooperation invol ved net gains to the principal participants: access of European banks to petrocapital in return for access of Arab banks to modern banking techniques, international experience and connections, and developing the capacity to build new financial mechanisms and service products. In addition, this new banking form which

20 enabled both sides to reap the benefits of the rapidly growing commerce between Europe and Arab countries also facilitated the institutional sharing in the costs and risks of the new operations.

What is significant about these major Arab-Occidental consortium banks is that they were all formed before 1974; they a1 1 involved Kuwaiti participation, sometimes substantial; and they all had European banks as major partners. On all three counts, the question is: why? Formation of these consortium banks before 1974 was for the most part in anticipation of future expansion in business, even before the first major oil price increase. Table 2 shows that Arab imports in the early 1970s were already twice the level of the late 1960s. The Kuwaiti participation in a1 1 was due to pioneering years of experience with international financial ventures, be it on the government side (KIC, KFTCIC, and the Arab African Bank), or on the private business side (UBK and BAII).12 That the major overseas partners were European banks was mainly due to their long-standing interest in and familiarity with commerce and finance of Arab economies in general and of the then rapidly growing economies of the Gulf in particular.

Since 1974, however, some Arab banks joined the hitherto

Kuwait dominated consortium banks, thereby changing the structure of their ownership and management. Other Arab banks preferred to establish new consortium banks, evidently because the formula's

12. The role of Abdel Latif A1 Hamad was significant. He was the Director-General of Kuwait Fund, the Managing Director of KIC, and the Chairman of UBK and RAII. appeal was still too strong to ignore. Development of consortium banks during the 1970s went beyond the initial universal mandate of this pioneer group into two additional directions as will be detailed below, namely to semi-industrial countries of Southern

Europe, Asia and Latin America, and within the Arab region itself.

As the size and country composition of Arab financial flows changed, the functions and structures of consortium banks evol ved beyond their initial objectives. For example, FRAB Bank evol ved quickly to include other Arab banks from Saudi Arabia, UAE,

Libya, Tunisia, Algeria and Morocco and OECD banks from Belgium,

HoZ land, Switzerland, Spain, Greece and Japan. Eventually, the

Western partners were bought out by Arab banks, and FRAB became in effect an inter-Arab bank. UBAF became a consortium of many

Arab and OECD institutions. On UBAF's Arab side alone, there were eleven commercial banks, five central banks, nine government banks, and a ministry of finance. The pattern was about the same with BA11 and EAB.

Although most consortium banks were initially set up to promote Arab-European business relations, their mandate expanded quickly to cover a range of activities including commercial banking, trade financing, foreign exchange, money market, and loan syndication. Some, however, still added special features to their services. BAII, for example, in order to attract the rich individual Arab investors, initiated real estate management, insurance, and stock market programs. As such, BA11 was acting as a financial advisor to Arab investors. In addition, the bank became quite active in Eurobond market, managing large issues in

22 both OECD and Arab currencies (including UAE dirham, Kuwaiti dinar, and Bahraini dinar).

The participation of an increas ing number of non-Kuwa i t i

Arab banks in existing consortium banks pushed further their growth momentum and enabled them to enter into joint ventures with leading banks in the major financial centres of London, New

York, Rome, Luxembourg, Frankfurt and Hong Kong. In addition, consortium banks established Asian branches and/or joint ventures in Seoul, Tokyo, India, Pakistan, Sri Lanka, the Philippines, and

Singapore to facilitate trade and investment transactions with that vital part of the ~0rld.l~The waves of business and financial opportunities invol ving the newly created oil-related wea 1th induced the estab 1ishment of specialized international banks to promote bilateral cooperation between individual OECD countries and Arab countries. Thus, the Banco Arab-Espanol

(Aresbank) was established in Madrid in 1975 with a capital of

$19 mil lion; the Banco Saudi-Espanol (Saudesbank) was established also in Madrid in 1979 with a capital of $53 million; the Arab-

Hellenic Bank was established in Athens in 1979 with a capital of

$15 million; and the Arab-Turkish Bank was established in

Istanbul in 1977 with a capital of $20 million. Some of the activities of these bilateral banks were typically short-term oriented, others were investment oriented, financing projects in host countries. Typical of short-term activities, for example,

13. Barun Roy, "Arab-Asian Banking Ties Grow", Arab Banking. and Finance Handbook, Fa1 con Pub1 ishing, , Bahrain, 1983, pp. 29-35.

23 the Arab-Turkish Bank is actively invol ved in financing the rapidly growing Arab-Turkish trade, repatriating the expanding

flows of Turkish workers remittances especially from Saudi

Arabia, and issuing international guarantees for Turkish

contractors working in Arab countries, notably Libya and Saudi

Arabia.

The presence of Arab banks extended beyond international financial centres and Mediterranean capitals to Latin America.

The Arab-Latin American Bank (Arlabank) was set up in Lima in

1977 as a consortium bank to promote financial cooperation and

industrial and commercial relations between Arab and Latin

American countries. The activities of the Arlabank include trade financing between the two regions; merchant and commercial banking; and joint ventures in mining, agriculture, and

pe tr ochem icals .

By the late 1970s Arab financial institutions appear to have responded to the new international business cha 1 I enges by

establishing a global network engaged in a variety of activities.

In addition to the already discussed trade financing, Arab banks

have undertaken a number of commercial and investment activities, as shown in Table 4. The table shows that syndicated Euro-

currency lending is the largest activity of Arab banks (aside from trade financing) cumulatively adding to about $41 billion in

1984, even though it started much later than the others. The

second largest activity is direct investment, cumulatively adding

to about $24 bi 11 ion in 1984 - which is most 1ikely an under-

estimate. Eurobonds is the smallest of Arab bank activities,

cumulatively adding to some $10 billion. Significantly,

24 Table 4

International Activities of Arab Banks

(Millions of US dollars)

Year Syndicated Bonds Direct Eurocurrency Investments Credits

Before 1974 450 1290 1974 68 1560 1975 164 1200 1976 - 316 1400 1977 9 51 53 1 1740 1978 2321 770 2480 1979 2491 7 41 2360 1980 3 583 857 27 60 1981 9102 1676 4890 1982 9798 1619 1760 1983 69 85 n.a. 1100 1984 5716 n.a. 1200

Sources :

1. Syndicated Eurocurrency Credits: from Middle East Economic Survey, several issues, especially 28:14, 14th January, 1985, pp. 81-86.

2. Bonds: from N.A. Sherbiny "Arab Financial Institutions and Developing Countries" World Bank, Staff Working Paper (Forth- coming).

3. Direct Investments: from N.A. Sherbiny, ibid, for direct investments in developing countries; and Bank of England, Quarterly Bul letin, March 1985, for direct investments in developed countries. Mote, however, that differentiating direct investments from investments in securities in developed countries is rather difficult, given the nature of data reporting. It is suspected that reporting direct investments in developed countries is somewhat downward biased, and that the figures presented in the table are therefore conservative estimates.

activities of Arab banks during 1980-84 constituted 86 per cent of cumulative syndicated Eurocurrency loans, 70 per cent of

25 Eurobonds, and 49 per cent of direct investments.

A special focus on Eurocurrency loans syndicated by Arab banks shows that 20 leading banks accounted for about 88 per cent of the total during 1979-83, while the remaining 12 per cent were handled by some 30 other smaller banks; see Annex Table A-2.

Some banks which appeared on the leading 20 loan syndicators in

1983 were not included in some earlier years. For example, neither the Arab ,Banking Corporation nor the Saudi International

Bank appeared on the list in 1979 because they started operation only in 1980. However, other banks established long before did not appear on the list either in 1979 or 1980 because of their previously limited invol vement in Eurocurrency loans. Included in this group are Alahli Bank of Kuwait, Commercial Bank of

Kuwait, National Bank of Bahrain, Riyad Bank, and Bank of Bahrain and Kuwait.

Within the Arab countries themselves, new directions for consortium banks began to shape in Saudi Arabia and Egypt, practically for diametrical iy opposed reasons. The Saudization policy of 1977-81 , aimed at establishing national control of the banking system, turned a number of foreign banks into Saudi-

European consortium banks. Thus, the Banque de 1'Indochine became Al-Bank Al-Saudi Al-Faransi; the Algemene Bank Nederland became Al-Bank Al-Saudi Al-Hollandi; the British Bank of the

Middle East became Al-Bank Al-Saudi Al-Britanni; and Citibank was turned into Al-Bank Al-Saudi Al-Ameriki. l4 In Egypt, €or

~~ ~~~

14. T. Wohlers-Scharf, Op.cit., p.27.

26 opposite reasons, consortium banks were established as a result of the go v ernment's "open door" po 1 icy, which aimed to attract foreign investments in joint ventures with Egyptian institution.

During the second half of the 1970s several Egyptian-Western

Consortium banks were established, the largest of which was Chase

National Bank (Chase Manhattan and ) and

Societe Arabe Internationale de Banque (Banque de Paris et des

Pays-Bas, the Arab International Bank, and the National Bank of

EgY Pt

27 4. CHaTBES OF ARAB MUKIBG

With markedly increased oil revenues in the early 1970s the focal point of Arab banking began to shift from Lebanon to the

Gulf. However, it was the start of Lebanese civil war in 1975 which spel led out the demise of Beirut as a regional financial centre. Within the Gulf, the new centres were Kuwait and

Bahrain. In the wider Arab context, Cairo was struggling to become a regional Arab banking centre. International ly, Arab banks no longer confined their growing presence to London and

Paris, but went to establish anchors in New York, Geneva,

Frankfurt, Singapore and Hong Kong. For a while, the network of

Arab banks appeared to encircle the globe. By the early 1980s, with such international network of banks and financial institutions in place and oil revenue flows into the Arab countries at a historical peak, Arab financial power appeared as a rising force in international financial circles. This new state of affairs, however, turned out to be a transitory phenomenon. Furthermore, practically every centre of Arab banking has drawbacks of its own.

The internationalization of Kuwaiti banks during the 1960s became more consolidated during the 1970s. Kuwaiti institutions established a greater presence abroad and participated in an

28 increasing range of international financial and investment

activities: issuing bonds in both Kuwaiti dinars and US dollars

on behalf of customers in developed and developing countries;

joining Eurodol lar syndicated loans as lead managers, co-

managers, or managers; establishing direct investment joint

ventures in several developed and developing host countries,

especially in the Arab region; assuming a lead role in official

concessional flows to developing countries; promoting complemen-

tary activities to official aid flows such as cofinancing

development projects with other Arab or international aid

institutions; and contributing to schemes of investment

guarantees to improve the investment and business climate in

recipient developing countries,

Alongside these impressive developments, the seeds of

financial crisis were sown in the late 1970s with the

establishment of an informal stock exchange (Sus a1 Manakh) in which the shares of offshore Gulf companies were traded. The

narrowness of the official stock market relative to expanding

domestic 1 iquidity prompted the search for new investment

opportunities, which Suq a1 Manakh helped to satisfy. Feverish

speculation in this unorganized market, and a1 lowing the claims

to be settled by post-dated checks, pushed share prices to

unrealistically high levels, which came tumbling in August 1982,

sending shock waves through the smal 1 investment community. 15

Three years after the Manakh collapse, during wbich the

15. Hazern Beblawi, The Arab Gulf Economy in a Turbulent ARe, St. Martin's Press, New York 1984, pp.230-234.

29 government has spent more than $8 billion in various support and compensation programs, the debt tangle remains with no immediate solution in sight. 16

The Hanakh col lapse was fol lowed by a banking crisis in

1984, during which the profits of commercial banks as a group fell €or the first time in a decade, by about 15 per cent. Many borrowers were not performing not because they were delinquent but because of poor conditions. In view of this banking crisis, the central bank has been seeking to establish greater degree of commercial and monetary discipline, and as a result some reputable financial institutions have taken steps which may ultimately lead to their merger: Burgan Bank and Bank of Kuwait and the Middle East; and KIC and KFTC1C.l-I These successive crises may have raised questions about Kuwait's international financial reputation, However, the response to such crisis, uneven as it may have been, demonstrates government seriousness about corrective actions. Nevertheless, more decisive measures are still needed to induce institutions to respond creatively to adverse situations and thus become more tuned to fickle market conditions. Af teral 1, financial downturns in the past did not necessarily end Kuwait's standing as a financial centre.

Kuwait's modern financial and banking system has a track record of three decades of experience and growth - more than can be claimed by any other Gulf country.

16. Rami Khouri "A Bitter Pill to Swallow" Euromoney, Aug. 1985, pp.119-128.

17. Charles Babington "Still Paying for the Manakh" Euromoney, March 1985, pp.133-136.

30 Bahrain's emergence as an Arab centre of finance is the result of several factors including the government's need to diversify the domestic economic base, the adoption of flexible policies to achieve the diversification strategy and the country's special locational advantages. In the early 1970s,

Bahrain's oil exports begain to decline because of dwindling oil resources. In response, the government opted for giving a prominent role to prepare Bahrain for the post-oil era. The interest in financial services derives from

Bahrain's special locational advantage which lies close to the shore of Saudi Arabia in the middle of the Gulf. That very location enables Bahrain to complete a global circle of financial centres running from London to New York, San Francisco, Tokyo, and Singapore. Bahrain's time zone gives it the distinct ad vantage of operating in currency deal ings and foreign exchange business after Singapore closes, but before the European centres open.

Foreign banks unable to establish operations in Kuwait or

Saudi Arabia due to legal barriers found Bahrain a most convenient alternative. With the 1975 legislation of OBUs

(offshore banking units) model led along the lines of Singapore and Cayman Islands, Bahrain became a highly attractive banking centre. Most major banks over a short period established branch offices, so that by 1983 there were 21 commercial banks, 63 representative offices (from 35 in 19801, 16 investment companies, 6 foreign exchange brokers, 77 OBUs (from 51 in 19801,

31 and another 2 05Us licensed to start.18 In institutional range,

Bahrain began to rival such international banking centres as

Singapore, Hong Kong, Luxembourg, and Nassau and its banking community was getting to be widely diverse.

Capital flows into Bahrain originate for the most part in the Arab countries and Western Europe. The share of Arab countries as sources of funds steadily expanded from 50 per cent in 1978 to 66 per cent in 1983; that of Western Europe steadily declined from 30 per cent in 1978 to 21 per cent in 1983; and that of combined other sources such as the US or Asia also declined from 20 per cent in 1978 to 14 per cent in 1983.

Capital from Bahrain flows to borrowers practically everywhere.

However, Bahrain is a net exporter of funds to the Far East (How

Kong, Singapore, Tokyo), Asia, Latin America, and lately Western

E~r0pe.l~Significantly, about 50 per cent of the assets are lent to Arab clients, thus partly counterbalancing the argument that Bahrain is merely a centre for recycling oil revenues to the outside world.

Assets of OBUs increased rapidly over a short time span: from $23.4 billion in 1978 to $62.7 bi 11ion at the end of 1983.

The pace of growth, however, was rather uneven, because after initial acceleration through 1981, it decelerated significantly during 1982 and 1983. Although the picture for 1984 is still incomplete, there are indications of a decline €or the first time

18. Bahrain Monetary Agency, Annual Report, 1983-

19. Alan E. Moore, "Bahrain's Offshore Banking Units," Arab Bankinn and Finance Handbook, Falcon Pub1 ishing, Manama, Bahrain, 1983, pp. 89-94.

32 in the volume of OBU assets. 20

This reversal of growth momentum was the result of several factors: the serious decline of oil revenue flows into the oil exporting states, the continuing war between neighbouring Iraq and Iran, the accumulation of bad debts, and the related regional banking crisis in recent years. Overt signs of trouble for OBUs, began to appear during 1984 with the departure of some banks, such as Security Pacific, or early in 1985 with the distress sale of the Arab Asian Bank to a minority shareholder and the major reorganization of the United Gulf Rank. Unhappily, before the crisis is over, more OBUs will have departed reducing the demand for qual if ied Bahrainis, off ice space, and family accomodations.

The small economic base of the Bahrain economy together with the high dependence of OBUs on business conditions and oil revenue flows into neighbouring Gulf countries render the island vulnerable to external shocks. It is these factors which explain the heightened state of uncertainty during 1984-85.

A significant part of Bahrain's strength derives from banking 1imitations in neighbouring countries, particularly where banks are nationalized: 60 per cent in Saudi Arabia and 100 per cent in Kuwait. International banking operations not possible to establish in either country found in Bahrain a perfectly satisfactory alternative through the OBUs. Changes in either country to modify banking policies or regulations may thus diminish Bahrain's position. For example, excess short-term liquidity in Saudi banks was previously absorbed easily in

20. The Financial The, July 22, 1985.

33 Bahrain's OBUs, which in turn was transformed readily into short term dollar liabilities. In effect, the process amounted to a de facto internationalization of the Saudi riyal, not a welcome outcome to Saudi authorities. As SAMA began to develop short term instruments, Saudi banks with excess liquidity could turn instead to these instruments rather than direct that liquidity to

Bahrain. The impact of this development on Bahrain's OBUs could be detrimental.

Despite these recent adversities, Bahrain continues to be an important regional centre for Arab banks and a significant link in the network of their global operations. Bahrain's locational advantage, conducive social environment, and the ability of its people to interact easily with international bankers are a11 basic features unlikely to change with business downturns. The tough-minded commercial discipline applied by Bahrain Monetary

Agency on member banks and OBIIS, in addition, continues to be confidence inspiring. What is especially unsettling, none- theless, is the depth and duration of the present downturn.

Elsewhere in the Arab region, Cairo is making a quest to become a centre of Arab banking, though not without serious

limitations. Egypt has always had special relations with Arab countries: culturally, intellectually, politically, socially, or economical ly. With the post-#asser shift in its socio-pol itical orientation, and the adoption of Sadat's inf itah (open-door) policy, Egypt began to undergo some changes of major implications for Arab banking and finance. On the one hand, Egypt opened the gates for hundreds of thousands of its abundant labour to migrate to the labour-short Gulf countries and Libya. On the other, Egypt

34 instituted economic policy reforms to attract foreign investors, including foreign banks.

As the largest demographic base in the Arab region (close to

50 mil1 ion), Egypt has become the major source of -speaking expatriate workers in the Arab oil-exporting countries, including

Iraq, itself a labour exporter until the late 1970s. Over a short period, Egyptian workers remittances to Egypt became a significant source of the country's foreign exchange. From a modest $85 million in 1973, Egyptian workers remittances increased to about $1.8 billion in 1978 and about $2.7 billion in

1980.21 During 1983 and 1984, it is estimated that those remittances have been at a minimum of about $3.0 billion annually .

Such major financial inflows were to a large extent encouraged by the reform of Egyptian banking. They also contributed to raising the national savings rate to about 15 per cent of GDP, and thus to the creation of an environment conducive to the growth of internationa 1 banking, including par exce 1 1 ence

Gulf banks. Furthermore, the large and growing absorptive capacity of the Egyptian economy, the advantages and facilities extended to foreign investors in the banking sector, and the increased market orientation of economic policymaking have a1 1 given signals to Arab banks to establish some presence in Cairo.

By 1983, Cairo was the host to about 30 Arab banks, of which 14

21. N.A. Sherbiny, Capital and Labour Flows in the Arab World - A Critical View, Industrial flank of Kuwait, IBK Paper No. 16, Feb. 1985, p.55.

35 were commercial banks, 9 investment banks, and 7 representative off ices.

Egypt’s drive to improve its banking system and to create a properly functioning capital market to respond to increasing development demands for medium-term and long-term financing has by no means been progressing we1 1. Political difficulties have occasionally adversely affected the capital market, as was evident with the 1978 Arab boycott of Egypt because of the Camp

David accords with Israel, or indeed with the assassination of

President Sadat in 1981. However the effects of these events have been mostly transitory. By contrast, Egypt’s crippling bureaucracy and its brainchild of mu1 tiple exchange system seem to have inflicted more lasting damage to the development of the capital market. Little wonder that the multiple exchange system appears to have eluded even the governor of the Central Bank. 22

The ready convertibility of currencies of the other Arab finance centres - Lebanon, Kuwait, and Bahrain - contrasts sharply with the baffling Egyptian pound. While the formal exchange rate of the pound has moved ever so slowly, if at all, the informal rate has tended generally to reflect market conditions. It is a sad commentary that the barometer of the

Egyptian pound during the last three decades was not the country‘s banking system, but Cairo‘s bazars and back a1 leys.

Other drawbacks to Cairo’s quest are the restrictions on currency transfers, the inconsistent macro management of the economy, and the mixed signals from top government officials regarding the

22. Euromoney, February 1985, p.111.

36 orientation of the economy.

Ultimately, however, Cairo's quest to become a centre of

Arab banking is not altogether hopeless. By comparison with the turbulent Middle East, Egypt has enjoyed both relative stability and GDP growth of 5-6 per cent since Sadat's assassination. Arab aid agencies which boycotted Egypt since

1978 resumed their lending programs in 1984. Egypt was re- admitted to the Islamic Conference, also in 1984. Private Arab investors have generally been active throughout the official boycott, contributing in 1983 some $2 billion, about one fourth of Egypt's total in~estment.~~Five of the largest 30 Arab banks are Egyptian; see Annex Table A-1. Combined, the assets of those five banks are significantly larger than the assets of the

Baf idain Bank, one of Iraq's two commercial banks, and the only one authorized to handle government deposits. The Egyptian stock exchange is one of the few which a1 lows listed companies to be capitalised in dollars and dividends to be made also in dollars.

A new joint venture has been established as a securities dealer and stock exchange promoter, with equity participation from se vera1 Egyptian banks, the International Finance Corporation, and Manufacturers Hanover. Even the country's communication system is improving especially with the outside world. Given these hopeful signs, Cairo's position as a regional centre of finance will ultimately depend on government policy: in minimiz ing rest 1: ict ions on currency transfer 6, estab 1is hing consistent macro management with clear orientation, keeping

23. Ibid, p.112.

37 bureaucracy at bay, and freeing the Egyptian pound from the

confused multiple exchange system.

The contrast of Arab centres of finance with international

centres such as London, Paris, or New York must appear striking

indeed. London's relations with the Arab world are quite complex

'as they encompass history, politics and culture in addition to

trade, finance, and investment. For these reasons London enjoyed

the lion's share of OPEC's surplus placements through 1974.

Furthermore, London has been the world capital of Eurodollar

transactions since the 1960s and it was only natural that it

became the largest centre for Arab banks. In less than ten years

since the first major oil price increase, London has become the

host of at least 60 Arab banks. Only 3 were established before

1970, 12 during 1970-75, 22 during 1976-80, 16 after 1980, and

the remaining 7 did not have a known date of establishment. 24

Close historical and cultural connections made Paris an

obvious and important centre for the establishment of Arab

financial institutions. During the 1950s and 1960s, Paris was

the international financial centre for Lebanese banks, themselves

the most international ly oriented Arab banks during that period.

Subsequently, Paris became the host to the first group of Arab-

Western consortium banks. To make sure that French banking rules

and regulations were carefully followed by the new Arab banks

during the late 1960s and early 1970s, the Banque de France

24. The Financial Times, October 3, 1983, Curiously, a 1984 list compiled by the Banker (November 1984) showed Arab banks in London to have been only 32. Seemingly, the discrepency between the two sources was due to variance in definition of what separates a bank from other financial institutions.

38 insisted on a local connection of sound financial reputation. So most Arab banks have (or had) a French partner in their Paris operations (FBAB, UBAF, or UII).

Much as politics was the impetus for the establishment of

Arab-French consortium banks during the 1970s, so it is behind the decline in the interest of Arab banks to expand their Paris presence and activities during the 1980s. The French Government during the later days of de Gaulle and under Georges Pompidou was the most pro-Arab Western power. The Hitterand Government has instituted a program of bank nationalizations, including share- holdings in Arab consortia. The Arab banks were shaken by the way in which Banque de Paris et des Pays-Bas (Paribas) was nationalized. The socialist regime has instituted tighter exchange controls and less 1 iberal attitude towards the establishment of foreign banks in the country.25 Among other factors, these measures must have weakened the French franc in recent years. Nevertheless, at the end of 1983 Paris was the centre for 39 Arab financial institutions, 3 of which were established before 1970, 7 during 1970-75, 26 during 1976-80, and

3 after 1980. Significantly, 16 of those banks were Lebanese - forming a distinct group established mostly after the civil war has broken out.

Besides London and Paris, there are several other centres which emerged in the early 1980s as international bases of Arab financial institutions fundamentally because of their position in

25. Euromoney, May 1983, pp. 126-130; and The Financial Times, October 3, 1983.

39 the expanding trade, finance, and investment relations with the oil exporting countries. New York is the centre of dollar

transactions worldwide and the base of most US giant banks with which Arab governments and individuals have deposited the largest

sums; it hosts 19 Arab banks, only 3 of which were established before 1980, Several factors explain the increased presence of

Arab banks in New York and their possible growth in the future.

The OS is the largest trading partner for a number of oil exporters in the Arab region, and the need for trade financing will undoubtedly continue. The US is the largest host of surplus placements by governments of the low absorbers. Although the comulative surplus has recently declined, the placements of most

low absorbers will most likely stay fairly stable for the fore- seeable future. Finally, the US provides not only safety for private Arab investors, but the most numerous and diversified investment opportunities world-wide.

Singapore and Hong Kong are key centres of commerce, finance, and investments in the Far East; Singapore hosts 19 Arab banks, while Hong Kong hosts 15. The latter, however, appears to have lost its attraction with the recent announcement of its ultimate return to China. Switzerland is a centre outside the

Gulf of traditional banking and financial conservatism with which the Arabs have had relations for a long time; it hosts 15 Arab banks. Other centres are mostly Mediterranean bases with which the Arab countries traditional ly share culture, history and commerce, such as Cyprus, Rome, Athens, and Madrid.

40 Discussion of the internationalization of Arab banks will be lacking if it fails to include Islamic banks. The underlying rationale is that major capital inflows to OPEC countries, many of whom are Moslem, created challenges to establish Islamic financial institutions, first within their own borders then internationally. This is to be seen as part of a broader phenomenon, that of the revival of Islam and its values. To the world's Moslems, an Islamic economic order represents an alter- native to capitalist and socialist systems: while protecting the rights of property it opposes "excessive" accumulation of wealth, and provides teachings and guide 1ines whereby the deprived have an "acknowledged right" to the wealth of the rich. Principles of

Islamic economics derive from Shari'a, the legal system fundamen- tally based on Quran (the Holy Book of Islam) and Sunna (the traditions of the Prophet Muhammad). Instead of a lender- borrower relationship, Islamic finance relies on the notion of distributive justice, that of equitable risk sharing between the sources of capital (banks) and the users of capital

(entrepreneurs).

Although the first Islamic bank was privately established in

Egypt in 1962, the concept of Islamic financial institutions

43 received a major boost from the establishment in 1975 of the

Jeddah-based Islamic Development Bank (IDB). Capitalized at 2 billion SDRs, and comprised of more than 40 Moslem country governments, about two-thirds of the capital came from four Arab oil countries: Saudi Arabia (25 per cent), Libya (16 per cent), the U.A.E. (14 per cent) and Kuwait (13 per cent). The mandate of the IDB is to foster economic development and social progress in the member countries according to Islamic law.

Most Islamic banks were established in the late 1970s and early 1980s. At present, some 30 financial institutions operate in Arab, Moslem, and other countries. In the Arab countries,

Islamic banks operate in Egypt, Sudan, Jordan, and the Gulf. In other Moslem countries, they are in Pakistan, Iran, Bangladesh, and Ma 1 ay s ia. Other non-Mos 1em countries in which Is 1amic banks operate include the Philippines, South Africa, Nassau,

Luxembourg, Cyprus and Australia; and some financial centres such as London and Gene va. Is1 amic banks, for the most part, depend on private, not governmental, initiative. The outstanding exception is , established in 1978 with 49 per cent government share holding which was recently increased to

60 per cent.

The distinction between commercial and investment banks is not easily applicable to Islamic banks, because they are uniquely characterized by operations of their own, the most common of which are: Morabaha, Mosharaka, and Modaraba. Morabaha is the resale of goods with the addition of a fixed surcharge on the original cost, on a deferred payment basis. Under the Mosharaka principle, an Islamic bank and a client establish a partnership,

42 sharing profits and losses until the time, normally fixed, when the client will buy out the bank’s holding. The Modaraba contract is formally a silent partnership which clearly distin- guishes the capital source (bank) and the entrepreneur (Modareb) who manages the project. Remuneration is based on a predeter- mined percentage of profits, while losses are to be borne by capital providers alone; the Modareb foregoes remuneration for his work. 25

Table 5 summarizes the asset position of some leading

Islamic banks. The table is not exhaustive, but illustrative.

Growth of assets in this group has been fast, averaging about 38 per cent per year in 1982 and 1983. However, the size of these banks measured in absolute and relative terms is still quite small. The collective assets of the sample of banks shown in the table was $2.8 billion in 1981, $3.9 bil lion in 1982, and $5.3 billion in 1983. Significantly, the Kuwait Finance House alone accounted for about 50 per cent of the assets of this group.

Those banks are dwarfed by comparison with some of the leading

Arab banks. For example, the collective assets of the identified sample were less than 114 of the assets of the Raf idain Bank of

Baghdad which, as the largest Arab bank in 1983, ranked 83rd on the Banker‘s 500 list. Assets of the same group combined were at about the same level as assets of Credit Populaire d’Algerie, whose rank was 291 on the Banker‘s 500 list. 27

26. “The First Licensed Islamic Bank in Saudi Arabia” Euromoney, November 1984, pp. 113-121; and Traute Wohlers-Scharf, op.cit. pp. 74-95.

27. The Banker, June 1984.

43 Table 5

Assets of Selected Islamic Banks

(Millions of Indicated Currencies)

Bank Location Year Asset 1982 1983 Est. Donomination

Faisal Islamic Bank Cairo 1977 US dollar 997 1504

Islamic International Bank Cairo 1980 US dollar 89 412

Dar Alma1 A1 Islami Geneva 1981 US dollar 310 286

Kuwait Finance House Kuwait 1978 Kuwaiti dinar 569 800

Faisal Islamic Bank Khartoum 1977 Sudanese 278 n.a. pound

Dubai Islamic Bank Duba i 1975 UAE dirham 509 805

Jordan Islamic Bank Amman 1978 Jordanian 45 72 dinar

Bahrain Islamic Bank Manama 1978 Arab dinar* 29 n.a. --

Total in US dollar equivalent 3872 5320

Sources: Annual Reports by Banks shown, and Middle East Economic Survey, several 1984 issues.

Notes: 1.The Islamic Development Bank was excluded from the table because its functions and objectives differ significantly from the rest of the banks shown. Properly classified, the IDB belongs to development organizations, for the most part outside the scope of the present paper.

2.n.a. denotes not available;

* one Arab dinar equals one SDB.

44 Considering the relative size of Islamic banks, and

though recognizing that Table 5 is by no means exhaustive, it

cannot be said that they have so far offered an alternative

banking formula, However, such comparison is not fair because

Islamic banks have been in existence for no more than a decade while conventional banks as we know them have evolved over more

than two centuries. What is clear, however, is that the

institutional framework of Islamic banks is already in place, and their connections with centres of international finance and Moslem

countries are already firmly established. Furthermore, it appears

that there is a specialized role which Islamic banks can carve out for themselves to service Moslem communities worldwide. In particular, Islamic banks are ideal ly suited to mobilize resources

from the masses of Muslim communities which in principle refuse

the notion of "Riba" (interest charging and receiving), in their

view the principal tenet of modern banking. In Saudi Arabia alone

Islamic banks have a major potential with households which do not have bank accounts, estimated to be 35-60 per cent of total

households. How will Islamic banks perform this specific task remains to be seen.

The rising popularity of Islamic banks could not have been due to especially favourable returns on deposits and equity or to

unusual ly high dividends on paid-up capital, by comparison with

commercial banks. Using such performance indicators for the

period 1980-82 shows that returns on deposits and equity in

Islamic banks have ranged from a high of 16 per cent for Faisal

Islamic Bank of Khartoum to a low of 2 per cent for Jordan

Islamic Bank; see Table 6. By comparison, the same indicator for

45 the 9 conventional commercial banks in Saudi Arabia during the

same period showed much better performance, ranging from 47 per

cent for the Arab National Bank to 27 per cent for the National

Commercial Bank.28 Table 6 also shows that although there was

some correspondence between returns on equity and dividends on

paid-up capital, there was no correlation between these measures

and growth of assets; i.e. the best performing Islamic banks did not necessarily grow fastest. For example, Jordan Islamic Bank which was the poorest performer in the group experienced faster

growth in assets than did Faisal Islamic Bank of Khartoum, one of

the better performers. The only logical explanation of the speed

Table 6

Some Performance Indicators of Selected Islamic Banks (Average 1980-82)

Bank Return on Dividends on Annual Growth Deposits & Paid-up of Assets Equity Capital

Faisal Islamic Bk - 7% 14% 125% Cairo Kuwait Finance House 9% 25% 77% Faisal Islamic Bk - 16% 23% 51% Khartoum Dubai Islamic Bk 6% 8% 35% Jordan Islamic Bk 2% 4% 5 8% Bahrain Islamic Bk 6X 8% 5 9%

Source: Calculated from A.M. Abdeen and D.N. Shook, The Saudi Financial System, Wiley 1984, pp.209-237.

28. As calculated from A.M. Abdeen and D.N. Shook, The Saudi Financial System,

46 of growth is the special appeal of Islamic banks to devout

Moslems in a particular country. Using this yardstick, and judging by the meteoric growth of assets in Faisal Islamic Bank of Cairo, it appears that Egypt must have a large reservoir of

Moslem clients who are especially interested in Islamic banks.

The adverse Middle East economic and other developments of

1983-85 did not spare Islamic banks, especially in the Gulf region. The decline in oil revenues, the fall in precious metals prices, the end of the real estate boom in the Gulf, the post-

Manakh reverberations in Kuwait and the rest of the Gulf, and the

Iran-Iraq war have all combined to create an environment which reversed the fortunes of many banks, including Islamic banks, and caught them in a difficult liquidity squeeze.29 Relatively

little information is yet available on the performance of Islamic banks outside the Gulf region during 1983-85.

29. Euromoney, August 1984, pp. 170-172; and March 1985, pp. 133- 136.

47 6. FUTURE PBOSPECTS

Contrary to popular misconceptions, the present paper has shown that the internationalization of Arab banks did not occur overnight. Earlier efforts during the 1940s, 1950s, and 1960s have paved the way for the major transformation of Arab banks during the 1970s. Although the earlier efforts were not all tied to capital exports, the internationalization of Arab banks during the 1970s was solely caused by the sudden and large expansion in capital exports made possible by the major increases in oil revenues.

This pattern contrasts sharply with that of European banks

(English, French, Dutch and German) during the late 19th century and early 20th century, and with the pattern of American banks during the 20th century. European banks established overseas branches and affiliates "to serve their domestic customers in

their colonial and foreign ventures, to provide them with the

services they required, to finance their imports and exports, and

to help finance their overseas in~estrnents".~~It is striking

that the same sort of motivation resulted in the expansion of

30. J.P. Koszul "American Banks in Europe", in C.P. Kindleberger (ed) The International Corporation, MIT Press, Cambridge 1970, pp. 273-289.

48 American banks abroad, especially during the 1920s in association with expansion of international trade and investment following

WWI, and during the 1960s following the recovery of Western

Europe and Japan from the devastation of WWII. It is equally indicative that American banks abroad declined during the 1930s with the Great Depression and ceased operation during the 1940s with the breakout of WWII.~~

With the substantial decline in oil revenues after peaking in 1980, the main question concerns the future of Arab banks outside their home base. Here it is instructive to note that just as the decline in oil revenues has focussed public interest on the weaknesses developed in the economies of the low absorbers over the last 10-15 years3’, so it has uncovered several weaknesses in the operation of Arab banks both at their home base and abroad. To be sure, the weaknesses of Arab banks are not all their own making; some have resulted from the environments in which they operate, particularly in regard to inappropriate government policies. This is equally true in Arab countries as well as in some host foreign countries.

At their home base, Arab banks tended to take the prolonged prosperity of the oil countries for granted. The volume of domestic business not only was expanding, but the rate of expansion was itself increasing over time. Investments in real estate were being recovered in extremely short periods - 2 to 3

31. Ibid, p. 276.

32. Robert Mabro “The Economic Consequences of the Fall in Future Energy Demand in the Arab World” Middle East Economic Survey 28:31, 13 May 1985, pp. Dl-Dl4.

49 years. Many banks realized enormous profits by turning short-

term deposits into long-term assets. So long as the rate of growth of deposits was accelerating over time, banks were

comfortably awash in liquidity. When oil revenues dropped, business conditions contracted, and the real estate boom came to

an end, growth in deposits began to decelerate seriously and

eventual ly fell. Many commercial banks were caught in a mismatch between their long-term illiquid assets and short-term deposits

and 1iabi 1 it ies.

Other discouraging factors occurred at the same time. The

Manakh crisis in Kuwait, in which banks were heavily involved, has had serious repurcussions beyond Kuwait. Precious metal

prices crashed, reducing the holdings value of several financial

institutions. The re-export trade from Kuwait and Bahrain was practically wiped out as a result of the Iraq-Iran war. Bank collateral until recently was not as important as the borrower’s

personal reputation or his connections within the power structure.

What the crisis did was to uncover many of the weaknesses at once. Some banks in Kuwait, Bahrain, and UAE have suffered more

than others, and it appears that the future may bring more revelations. There is no doubt that more shakeouts will occur before the crisis is finally over. Bankruptcies, takeovers, and mergers will be part of the banking scene in the Gulf for some time to come. The process, painful as it will be, is unfortunately necessary to improve the lax banking practices which have developed over the last decade.

The crisis has also attracted attention of policymakers to

50 the lack of sufficient authority €or central banks, especially in

Kuwait, Qatar and UAE. More methodical procedures are being developed to assure greater commercial discipline than hitherto.

The more rigorous discipline of Saudi Arabia and Bahrain is likely to become the standard for central banks in the Gulf.

A1 though weaknesses of the international ized Arab banks are of a different type, they seem also to have been related to the rapid pace of capital exports. With the decline in oil revenues, the weaknesses have been exposed, and in some cases magnified.

During a period of rapid growth, most internationalized Arab banks were preoccupied with showing results. They concentrated on their comparative advantage in the international financial markets, namely their connections with sources of petrocapital.

Most of those banks thus became heavily engaged in Eurodollar

loan syndication with other more established banks, which provided the necessary expertise and skills. The share of Arab banks in syndicated Eurodollar loan market increased rapidly from

2.5 per cent in 1977 to about 10 per cent in the early 1980s.

The international debt crisis seriously affected the volume of operations in this market, and with it the dollar volume of Arab banks participation, but the share of those banks remained generally unaffected. In the future, a1though furodol lar syndication will be unlikely to grow as before, Arab banks will continue to participate actively, but their share will most

likely be less.

The debt crisis prompted Arab banks to exp 1 or e other banking activities, notably trade finance and investment banking. Other

51 possibilities include floating rate notes, and floating rate

certificates of deposits. The nagging question is how can Arab banks participate in all such activities after oil revenues have

declined so seriously. The answer resides in their high

capitalization by international standards. The ratio of equity

plus reserves to assets in most Arab banks exceeds 15 per cent, whereas it is only 3-7 per cent for most international banks. 33

It is this factor which will give Arab banks room for further

growth of their international operations despite the decline in

oil revenues. In this sense, it appears that the internationali-

zation of Arab banks was asymmetrically related to oil revenues.

Arab banks overseas appear to be going through a transition phase before they become international banks in the fully conven-

tional sense. They have accomplished the most difficult step in

the internationalization process, i.e. established presence in

international financial markets, and what that entails in terms

of clientele, scope of activities, profile, and momentum. Now is

the time for them to attend to the weaknesses in their

operations. The most urgent need is to diversify their

activities, basically to derive an increasing portion of their

income from fees, i.e., investment banking. This reorientation

requires a change in their present skill mix. Skills and

experiences of staff are the most valuable assets of financial

institutions. In the rush to establish themselves international-

ly, Arab banks have not sufficiently attended to the development

33. Address by Sheikh Ali Rhalifa AL Sabah in September 1984 to the Arab Bankers Association in London, as reported in Middle East Economic Survey, 24 September 1984.

52 of their own staff. The existing staff, especially Arab staff, tend to be more narrowly trained in few activities. The present conditions offer some breathing space for Arab banks to develop managerial and staff capabilities to carry out the projected reorientation.

Such reorientation towards investment banking is necessary if Arab banks are to survive in the changed conditions of the

1980s. Until 1982, governments were the source of most Arab investments overseas. Thereafter, as governments started to drawdown on their accumulated assets, it was the private sources which became dominant in Arab investment flows. This private capital comes from the cumulative profits of the 1970s, leaving the Gulf region for the reasons outlined earlier. Such private capital movements offer good opportunities and challenges for

Arab banks to diversify their activities. Most of these movements have been limited to wealthy individuals who either have empires of their own (Khashoggi, A1 Sabah, Pharaon, Oloyan, etc.) or who have set up elite investment clubs comprising a few families each.34 Large untapped potential still exists with less wealthy but more numerous individuals throughout the Gulf and the rest of the Arab region.

The potential volume of business from government agencies in

Arab oil and non-oil countries is quite large, despite the decline in oil revenues. In the non-oil Arab countries most government agencies go to the international market to borrow for their development projects in the tune of $15 billion per year.

34. Financial Times, October 3, 1983.

53 Several government agencies in oil countries such as Iraq,

Algeria, and Oman have already been borrowing in the inter- national market, Together with other government agencies from oil countries, the potential demand of development projects for new resources will be in the tune of $150 billion per year, at

least one-third of which will be secured through borrowing. By

stepping in to intermediate between sources and uses of funds in .

this sizeable market, Arab banks not only would create a hitch

for themselves based on comparative advantage, but also could become the catalyst for financially integrated markets in the Arab region. 35

The demand for trade financing in Arab countries is equally

enormous: imports by the Arab countries are about $90 billion per year; and by the non-oil countries about $35 bil lion per

year. As growth of both oil and non-oil Arab economies continues,

though in varying degrees, the associated investments and imports will expand as well. The process will call for continuously expanding demand for credit , short-term for import financing and

longer term for investment financing. Nothing can be more assuring for Arab banks.

35. A long-time advocate of this view is Hikmat Nashashibi, who elaborated the theme in numerous occasions; see his monograph, Studies in the Development and Integration of Arab Financial Markets (Arabic), Dolphine Publishers, Milano 1982.

54 Annex

Table A-1 - Largest Arab Banks

Bank Head- Year Assets 1983 quarters Est. ( $ b ill ion) Bank 1980 1983

1. Rafidain Bank Baghdad 1941 8.8 22.4 83 2. National Com'l Bk Jeddah 1983 14.9 14.7 119 3. Bank of Credit & Luxembourg 1972 5.3 12.3 136 Commerce Int'l 4. B. Nationale Algiers 1966 6.3 11.4 146 d'Algerie 5. Union de Banques Par is 1970 4.8 11.2 148 Arabes et Francaises 6. Arab Bank Amman 1930 7.1 10.4 157 7. Nat'l Bk of Kuwait Kuwait 1952 5 .O 9.0 171 8. Arab Banking Corp. Bahrain 1980 1.9 8.8 175 9. Commercial Bank of Damascus 1967 3.3 8.6 178 l0.Riyad Bank Jeddah 1957 4.2 7.8 199 11.Nat'l Bk of Egypt Cairo 1898 4.4 7.5 208 12.Gulf Int'l Bank Bahrain 1975 2.9 7.4 211 13. Banque Ext erieur e Algiers 1967 5.9 7.4 214 d'Algerie 14.Gulf Bank Kuwait 1960 4.2 7.1 2 22 15.Com'l Bk of Kuwait Kuwait 1961 5.1 6.6 23 8 16.National Bank of Abu Dhabi 1968 4.7 6.1 252 Abu Dhabi 17. Cairo 1920 3.7 6.1 2 54 18.Alahl i Bk of Kuwait Kuwait 1967 4.7 5.8 26 9 19.Credit Populaire Algiers 1966 3.0 5.2 291 d'Algerie 20.Banque du Caire Cairo 1952 2.4 4.6 329 21.Arab African Int'l Cairo 1964 2.7 4.4 333 Bank 22.Saudi Int'l Bank London 1975 2.7 4.0 358 23.Bank of Kuwait & Kuwait 1971 2.0 3.6 398 Middle East 24.Saudi American Bk Riyadh 1980 2.1 3.5 399 25.Nat'l Commercial Bk Tripoli 1970 2.1 3.4 41 8 26 .Compagnie Arabe et Luxembourg 1973 2.4 3.3 427 Int'l d'Investissement 27.A1 Bank A1 Saudi Jeddah 1977 3.2 3.2 437 A1 Faransi 28. Bank of Alexandria Cairo 1957 1.8 3.2 443 29 .Wahda Bank Benghaz i 1970 2.5 3.0 45 9 30. Jamahyria Bank Tripol i 1969 1.3 2.5 489 31 .Libyan Arab F. Bank Tripoli 1972 3.7 2.5 491 32.8urgan Bank Kuwait 1975 1.5 2.3 500

Sources: The Banker, June 1984; and Alexander E. Fleming, "Survey of Origin and Development of Arab Banks" IMF Survey, February 8, 1982.

55 dfla cdd 6 G ou OEl

Ha -4 0 a unru

56 OXFORD INSTITUTE FUR ENERGY STUDIES 57 WOODSTOCK ROAD, OXFORD OX2 6FA ENGLAND TELEPHONE (0f865) 3?1377 FAX (01865) 310527 E-mail: [email protected] http :Ilwww.oxfordenergy.org