Gulf of Woes: Banks decline and fall

When the OPEC oil cartel was at the height of its power in the 1970s and early 1980s, Persian Gulf banks flourished like palm trees in a desert oasis. Arab governments, rich on oil revenues, were financing projects ranging from airports to universities, and the influx of money caused bank assets to grow 20% a year. Newly prosperous gulf families built banks as status symbols to impress their neighbors. The United Arab Emirates, which has a population of 1.3 million, had 53 banks in operation last year. Said an American economist who has studied the financial development of the Middle East: “Nowhere else in the world has a rush of sudden wealth almost instantly produced such a number of family banks as happened in the United Arab Emirates.”

Now oil prices are falling, and the inflow of bank deposits is drying up. A decrease in new construction projects has hit financial institutions particularly hard. The Kuwait Asia Bank was started to help Asian construction companies gain a market in the gulf. But after old jobs were completed and few new ones started, Kuwait Asia’s customers left.

Moreover, many firms that received bank loans in flush times have turned out to be bad credit risks whose problems have been compounded by plunging property and stock values. In Kuwait an estimated one-third of some bank portfolios are made up of loans on which borrowers are no longer making interest payments. In Saudi Arabia, only two of ten banks last year reported an increase in earnings.

Even Bahrain, once the shining jewel of gulf finance, has been having troubles. The island country off the coast of Saudi Arabia emerged in the 1970s as a haven for Westerners and a banking center for the entire region. At one time local officials dreamed that it would become a world financial capital in a class with Singapore. No one talks that way today. The decline in construction financing and restrictions by Saudi Arabia on dealings in the riyal, the Saudi currency, have hurt business. Many banks, including Citibank and Chase Manhattan, have slashed staffs and slimmed operations.

Some problems that were ignored in the boom days are now coming back in the form of nightmares. In the good times, no one paid much attention to the fact that the gulf countries lack the legal structures for modern finance. Only Bahrain and Kuwait have well-developed commercial laws, but neither has a banking code. The United Arab Emirates is only now introducing a bankruptcy law.

Saudi Arabia and Abu Dhabi conduct all litigation, including financial cases, through Islamic courts. That presents banks with a particular problem because Muslim law forbids riba, the earning or payment of interest, on the ground that it is usury. For years the Muslim world quietly allowed the ban on riba to be circumvented by letting the banks call interest payments service charges or commissions. But these days, when Saudi borrowers are handed a bill for interest charges or commissions, they may take refuge in Islamic law and refuse to pay. Banks are left with little means of getting their money.

Some once robust financial institutions have also been hit by questionable dealings involving bank insiders. Dubai’s Abdul Wahad Galadari, former chairman of the Union Bank of the Middle East, borrowed heavily from his bank to speculate in gold and silver. When the Dubai government rushed in to rescue the failing UBME in November 1983, officials found that Galadari owed $8.7 million.

In July, Kuwait’s Hussain Makki Al Juma, managing director of 15 financial organizations around the world, was found by a London court to have defaulted on a personal loan of nearly $74 million. Yet Al Juma was re-elected in August to the board of the Bahrain-Kuwait Investment Group, which he has headed since 1982.

Despite its difficulties, the Persian Gulf financial community is not about to crash. It has holdings of an estimated $70 billion, and 34 of the world’s 500 largest banks are located there. But prospects for future growth are dim. The Iran-Iraq war has made raising funds more difficult. The $94 billion collapse of Kuwait’s unofficial stock market in 1982 badly undermined confidence, and repercussions continue to be felt. Finally, Western bankers will be leery about doing business there until legal uncertainties are clarified. A British lawyer working in Bahrain points out that it took the West nearly 300 years to develop a legal framework for banking. Arab bankers are making great progress, but more must be done before they will have a modern financial structure. –By Gordon M. Henry. Reported by Aileen Keating/Bahrain