On Sunday Oct. 26, Kuwait’s central bank suspended trading in shares of one of the country’s largest lenders, Gulf Bank (GB), after learning that the bank had suffered serious losses in derivatives trading. By one estimate, it had lost as much as 200 million Kuwaiti dinars ($741 million) when the euro fell against the dollar.
According to Gulf Bank statements, clients who made the losses refused to pay the bank, leaving it to meet the debt to foreign banks and undermining its financial strength. The central bank then announced it would guarantee all deposits to prevent a run on GB.
But the central bank’s move stirred fears rather than calming them. Hundreds of anxious depositors formed lengthy queues that night at GB branches around the country, worried that they would lose their savings. Despite those fears, the bank remained opened for business.
Two days later, the lender announced that the board chairman Bassam al-Ghanim had resigned along with another board member, Abdulkareem al-Saeed. Al-Ghanim’s brother, billionaire Kuwaiti businessman Qutaiba al-Ghanim filled the chairman’s seat.
He immediately met with the press to reassure shareholders and depositors of Gulf Bank’s soundness. “The board of directors wishes to confirm to all bank shareholders and customers the bank’s financial status is good, and that all deposits and customer accounts are safe and guaranteed,” he said.
To bolster confidence, al-Ghanim also announced that the bank had halted all trading in derivatives and options and was open to merger talks from other Kuwaiti banks, including Kuwait’s largest lender, NBK. Unconfirmed reports suggested that the National Bank of Kuwait would submit an official offer and even possibly transform the bank into an Islamic bank. Other reports suggested that the entire board and senior leadership of the bank would resign and that it would be bought out by major merchants in Kuwait.
Aftershocks. However the crisis shakes out, the impact is already reverberating. In a report released just days after the Gulf Bank crisis, Moody’s lowered the rating of Kuwait’s entire banking sector, ranking it stable to negative. The rating agency noted that the operating environment for Kuwait’s banks remains “strong” thanks to high oil prices and the economic boom.
Moody’s also sees problems with non-performing loans if the global economic crisis continues. “Bank lending is over-collateralized but this is not in itself sufficient to provide adequate comfort in the event of protracted market weakness. In addition, foreclosure procedures remain largely untested,” said report author Stathis Kyriakides, a Moody’s assistant vice-president and analyst.
The report will only add fuel to the fire. Although the central bank has an-nounced plans to also back investment houses, local and foreign investors are wary. The Gulf Bank debacle exposes an issue that investors – both local and foreign – will find it hard to ignore. Jittery investors are already worried about falling oil prices and the global economic downturn. Now they will also be forced to re-evaluate Kuwait based on issues such as lacking transparency and weak regulation.
Thanks to several years of sky-high oil prices, Kuwait has billions of dollars in surplus. But unlike neighbors Bahrain, Qatar and the United Arab Emirates, it has failed to attract significant amounts of foreign direct investment (FDI). Without it, Kuwait will struggle to diversify its energy-based economy and will find it increasingly difficult to compete economically with its Gulf Cooperation Council neighbors.
While Dubai and Doha diversified their economies and built lasting business ties with some of the world’s leading multinationals, Kuwait dithered over tax rates and investment laws. Its parliament and government have squabbled for years over plans to develop northern oil fields by allowing foreign investors. It has botched repeated efforts to reform simple procedures for starting a business or hiring staff. It has, in short, not lived up to its own aspirations to become a leading regional economic and business hub.
The National Bank of Kuwait notes that Kuwait came last in the region in terms of FDI, pulling in a paltry $110 million in 2006 compared with $8.3 billion invested in the UAE and $2.9 billion parked in Bahrain.
During the recent boom time, when oil prices hit ceilings of nearly $150 per barrel, Kuwait had little incentive to reform its investment laws, or to intensify its efforts to attract FDI. During the 2007-2008 fiscal year, for instance, the government’s budget surplus reached $32.7 billion.
Less-good times. Bust almost always follows boom. Kuwait isn’t facing a recession, but it could see a slowdown in growth due to lower oil prices. International investment bank EFG Hermes issued a report in mid-October warning that Kuwait’s GDP will slow as oil prices drop. The bank forecasts that government spending will continue, especially in infrastructure development and expansion of the oil sector and new energy projects.
In other words, Kuwait has the cash to expand its airport and road networks and will also work to bring online new refineries and raise its oil output.
The government has said that it would not reduce its budget despite sliding oil prices. “We will not cut spending. We are not going to stop spending on development projects. It will not affect our in-vestments,” Finance Minister Mustafa al-Shamali told reporters on Oct. 29.
It has even taken a few key steps towards courting global FDI. For instance, after years of discussion and debate, the parliament finally passed a tax-law amendment in December 2007. It changes the tax on foreign companies from a scalable 5 percent to 55 percent on earnings, to a flat tax of 15 percent. The new tax structure became law in February after being published in the official Gazette. Foreign investors trading in shares will not be taxed and earnings for Kuwaiti agents trading in foreign goods are also tax-free.
But is it enough?
“That 15 percent is still an obstacle,” argues Luis Suarez, chairman of the Am-erican Business Council Kuwait. “From the US perspective, it is an obstacle so long as the tax rate is where it is. I know it’s gone down from 55 percent to 15 percent. But I think that it is still an impediment to companies making foreign direct investments because you have to bear in mind that [in addition to] the 15 percent in taxes that they pay in Kuwait, they are also going to have to pay taxes back home,” Suarez says. “The more competitive you are, the more FDI you attract.”
A clear problem. More important is the lack of strong oversight and transparency. Several years of budget surpluses and an active stock exchange have encouraged investors from across the spectrum – local, regional and global. But the Gulf Bank crisis exposed a very real difficulty for foreign investors. A lack of transparency at nearly every level makes it impossible to know the true standing of financial institutions, companies and investment firms alike.
Banks and other publicly listed companies publish quarterly or annual reports on an irregular basis and often with significant information missing. Efforts to put in place a capital markets authority to oversee activity on the Kuwaiti bourse have stalled over a battle between the Commerce Ministry and the KSE leadership. Who will be in control of the authority once it’s in place and what system – American or British – the authority will emulate are both questions that remain unanswered.
The government targets January 2009 as the new date for the creation of the CMA but parliament must also weigh in, and since 2006 the executive and legislative have found it almost impossible to pass any significant legislation. Repeated cabinet reshuffles and two parliament dissolutions have strained relations between the two branches, and cooperation on significant legislation – especially economic reform bills – is almost nonexistent.
“Kuwait is not reaching its full potential as a result of not being been able to implement its reform and investment program,” explained EFG Hermes economist for the region Monica Malik in a recent report.
The result is a country that is well off, but stagnant, fiscally dependent on oil and unable to diversify or to attract the kind of capital needed to flesh out other sectors. Kuwait pulls in nearly 95 per-cent of total export earnings from oil. It accounts for two-fifths of its gross domestic product. Major foreign investment tends to focus on the energy sector.
Outside the energy sector, however, Kuwait has little to offer and lacks the many reasons that investors choose other Gulf nations like the UAE.

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