Fuelling the recovery: More liquidity or more regulation?

The worst might be over regarding the economic crisis, globally and in the GCC.

Oil prices are stabilising at around $70 per barrel, and real estate prices seem to also be nearing their bottom.

Firms are also beginning, albeit on a low level, to recruit staff again.

New issuance of Sukuk (bonds compliant with Islamic law) topped $9.3bn in the first seven months of 2009, down 16.2% on a year-on-year basis, 'but Sukuk announced or being talked about in the market are estimated at about $50bn', says Dr Mohammed Damak, credit analyst with rating agency Standard and Poor's.

'Bettering Western economies are expected to bring about a surge in oil demand and consequently a surge in volumes demanded altogether with prices', says Faisal Hasan, Head of Research at Global Investment House in Kuwait.

The 'green shoots of recovery' raise questions over whether the worst might be over for the finance sector as well. 'GCC governments and central banks need to continue to support the economy and the finance sector, in particular', Adnan Ahmad Yousif, President of Bahrain's Al Baraka Banking Group and head of the Union of Arab Banks told AME Info.

Inflation fears

S&P's Damak, on the other hand, considers measures that have been taken as sufficient. 'In the UAE the central bank has deposited Dhs70bn in the banking sector and Dhs50bn was injected into the economy. Liquidity at banks has reached a good level. As of now, we do not see an urgent need for more support packages.'

Feisal Hasan of Global also warns of a combination of economic growth and additional liquidity packages. 'Excessive liquidity is a problem in itself, leading to liquidity management issues and inflation', he says. Former Fed-Chief Alan Greenspan warned on Monday in Mumbai that inflation in the US could climb to double-digit levels in the coming years, if the monetary expansion is not reversed soon.

Nevertheless in the Middle East the last legal word might not have been spoken yet. 'Further liquidity measures depend on the regulators' actions and whether they want to see increased capital reserves', Damak points out.

In fact, a look at other regions demonstrates that the struggle has not reached its peak. EU governments are discussing higher reserve requirements in order to prepare banks for the next crisis. In Switzerland, the central bank's president, Philipp Hildebrand, is considering limiting the size of banks, indirectly finger pointing the country's battered giant UBS, which had to be saved from bankruptcy with six billion Swiss Francs of taxpayer's money.

Focus on information exchange

As far as the Gulf region is concerned, 'GCC central banks and governments have traditionally reacted quickly and injected liquidity in times of crisis', says the Union of Arab Bank's Adnan Yousif, who has over 40 years experience in banking.

Regarding the Saad/Algsosaibi cases in Bahrain in early summer, in which GCC banks have allegedly invested $9bn, Yousif identifies a lack of cooperation between central banks as being the issue: 'GCC central banks should improve their exchange of information in relation to lenders and borrowers'.

Bahrain has indeed been hit hard: capital fled the country, dragging the Bahrain Stock Exchange (BSE) down to a new-year low in July while neighbouring exchanges recovered.

However: 'Besides regulatory measures, capital market actions can certainly cushion the effect of dwindling liquidity', Damak explains. The Ahli Bank of Kuwait (ABK), for example, obtained an approval from the Central Bank of Kuwait to increase its capital by 25% on August 10.

Consolidation is another countermeasure. In Dubai, the state-owned Dubai Banking Group became the largest shareholder of investment bank Shuaa Capital.

Islamic banking

Finally, the financial crisis did cast a light on Islamic Banking as an alternative to the conventional system. Islamic Banking is still growing at approximately 15% per annum and is expected to hit $1 trillion in 2010. 'Islamic banks were immune from the crisis since they do not deal with derivatives, hedge funds or short-selling strategies', Yousif claims.

However, a declining credibility among clients can jeopardize any Shariah-compliant financial institution. The model of profit-and-loss-sharing puts Islamic banks at risk of defaulting if their customers fail. 'Islamic Finance's immunity is a myth which is brought up persistently', says Fares Mourad, Managing Director and Head of Islamic Finance at Swiss private bank Sarasin.

The current cacophony of opinions among bankers and analysts shows that although the signs of recovery are visible, the pieces in the banking jigsaw are yet to be set.