OXFORD NSRTUTE =FOR m ENERGY STUDIES Oil and the Internationalization of Arab Banks 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 Bank. 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 Middle East, 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 (Amman, Cairo, Damascus). The Lebanese banks began to establish branches outside Lebanon 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 Bahrain 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 Saudi Arabia; 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 Kuwait in 1942, Bahrain in 1944, Dubai in 1946, Oman in 1948, Sharjah 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.