Thursday, November 5, 2009

Central Bank of Bahrain Real Estate Exposure Limits Lifted

Reuters reports that the CBB had lifted its previously issued restriction on Bahraini financial institutions" exposure to the real estate sector.

If you read the story carefully, you'll note that the "lifting" occurred 3 or so months ago.

What makes the story worthy of comment now?

From this blog's perspective, there are two takeaways:
  1. The quality of the CBB as a regulator.
  2. The fundamental problem a regulator faces.

On the first , as indicated by this speech by the Governor of the CBB, H.E. Rashid al Maraj,  the CBB was aware of the risks of over exposure to this sector and  has been following this issue actively since 2005.  I can confirm  from direct knowledge that this is case.

As a general rule, the CBB is one of the better central banks in the Gulf in terms of its prudential supervision, including the identification of risks and trends.  It has a highly organized and disciplined regulatory regime comprised of regular review and quarterly updating of its regulations as well as a robust consultancy process

As an example of its ability to look forward, the CBB issued a regulation in 2005 (if I'm not mistaken) on consumer lending designed to prevent consumers from getting over their heads in debt. The updated regulation is included in Section CM-8.1 of the larger Credit Risk Management Module.

The CBB also took a leading role in the creation of the first central credit reporting bureau in the country (again in 2005) enabling banks to determine an individual customers' outstanding credit facilities and obligations with other financial institutions.

The second point is that regulations have to be implemented in the real world.  Often what is a  sound idea would, if implemented, lead to greater problems than not implementing it.

A glance at the financial statements of major Islamic banks in Bahrain (both conventional banks like Kuwait Finance House Bahrain and Bahrain Islamic Bank or investment banks like Gulf Finance House and others) shows the magnitude of the "facts'" that the CBB faces with implementing this regulation.   Causing banks to reduce exposures within the limit would lead to the forced sale of assets in an already distressed market.  Forcing prices down and thus directly impacting collateral values on other loans. 

The extent of the "problem" is not only a matter of credit exposure to the property and construction sector but as well equity investments in real estate or in firms with a direct exposure to that sector, e.g., construction materials, property management, etc. 

In short the CBB faces the classic regulator's dilemma:  how does one safely let the air out of an asset bubble?  One which one has been trying to contain for several years.

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