The face of banking and financial markets is changing rapidly. Twenty years ago, Bahrain shrewdly established itself as the regional financial centre for the Gulf. As its neighbours have become more sophisticated, however, it must adapt its role in order to survive. David Cowan examines Bahrain's

ONCE A PREMIER site for offshore banking in the Middle East, a situation inherited from Beirut, Bahrain is fighting hard to maintain its role as a valuable banking and investment centre in the region. Arab investors are turning to their own indigenous banks or foreign institutions to invest, leaving Bahrain without its traditional client base. With severe declines in the asset base of banks, many banks are seeking new ways to reposition their services.

Bahrain's bankers ascended to dizzy heights in the boom days of the 1970s, rapidly becoming a recycling plant for all those petrodollars, allowing some 75 offshore banks to feather their nests on the island. Today, life is very different and half of those banks have evaporated, with the Kuwait war and declining oil prices forcing over 40 banks to withdraw from the fray.

The country survived the war without serious damage to the structure of banking and financial services. But the warning signs were all too apparent, illustrated by a 16% fall in deposits between the end of July and the end of September 1990, as depositors sought safer havens for their funds after Iraq's invasion of Kuwait.

However, the war was only part of the problem. Improved technology and the emergence of 24-hour trading systems have meant that the attraction of Bahrain as a strategic time-zone location has diminished. Travellers flying from Europe to the Far East no longer need to stop off in the Middle East, which previously brought a lot of transient business to Bahrain and Dubai as stopover centres.

The greatest pressure is coming from competitive forces within the region, with other offshore financial centres becoming more attractive and aggressively marketing themselves, and Saudi banks recapitalising themselves and taking a greater share of the kingdom's financial requirements. One Bahraini banker comments: "The Saudi market just is not there for us anymore, and what business there is does not exist in the same way as before."

The Saudi investor was always a good customer for the offshore banker in Bahrain, but the Saudi banks have since come a long way in meeting their needs, underpinned by a growing domestic capital market and a government actively raising deficit finance tagged with investment incentives. The smaller Saudi investor will now use an indigenous bank and be rewarded, whilst those with greater wealth will shop further afield with the London, New York and Swiss banks being the main recipients, thus by-passing Bahrain altogether.

Amongst the other offshore centres in the region, the biggest competitive threat comes from Dubai, which has aspirations of becoming an important offshore banking and investment centre, offering trade incentives to attract investment and a tax-free investment zone at Jebel Ali. Dubai has been catching up fast in the banking stakes, and now has a successful and competitive banking system.

Some Bahraini bankers, however, feel there are other market opportunities for them to pursue, preferring to leave international private banking to the large foreign banks. The foreign banks are better positioned to offer geographical diversification, hold a larger base of assets spread internationally, and are able to service investors on a global scale, all major pre-requisites for private investors in today's globally diversified financial supermarket.

Not that all private banking business has gone, just the top flight institutions. Competition is still strong between the foreign banks on the island and a handful of domestic banks, vying for a second tier of high net worth individuals and institutions. This level of private banking business has become attractive and created an influx of providers in one form or another. Of particular interest to such investors in the past has been fixed income funds aimed at risk averse investment, but that is changing now as lower interest rates forces investors to look for alternatives, including fixed income funds with higher returns and some equity funds.

Portfolio management is being offered to institutions with large portfolios of more than a million dollars, and individuals valued at high net worth in the BD100,000-plus league. In addition to the home market, business is being sought by Bahraini bankers actively marketing themselves in Saudi Arabia, UAE, Kuwait, Oman and Qatar. Long gone are the days when a banker opened his doors and waited for custom. The new-style Bahraini banker has to work aggressively for his business.

However, according to some bankers on the island, there is still a lot of lucrative business about. One foreign banker speaks gleefully about his private client base. "In the first place our clients are rich, and in the second place extremely rich. Often we deal with companies representing rich families, and so we are talking about billionaires. But there is no standard profile for our clients. They are all different with different investment goals."

This resident foreign banker also refuted the notion that Arab investors are particularly risk-averse. "This notion is completely inaccurate. They have a proportion of their investments they like to play with, and some they use in fixed income and other safer investments. But they all like a bit of a gamble, although they may not choose to admit it because they are Muslims and gambling is against the rules."

Among the foreign banks the most active in Bahrain are Banque Indosuez, Chase Manhattan, Citibank, ABN Amro, and brokerage houses like Merrill Lynch. These foreign banks still see the Arab investor as one to serve at close quarters, rather than sitting in plush offices in London's West End and waiting for them to arrive on shopping trips to Harrods.

What makes Bahrain particularly attractive is the regulatory environment (one of the best in the region) which includes well-defined banking licences, a corporate vehicle for exempt companies, no direct taxation, no restrictions on foreign exchange, and a strong central bank in the form of the Bahrain Monetary Agency (BMA).

The BMA, whilst strictly supervising financial institutions, does not create artificial credit ceilings or restrictive interest rate policies, having scrapped the maximum interest rates for customer Bahraini dinar deposits back in 1990.

An Offshore Banking Unit (OBU) has to be more than a brass plate in Bahrain, with the BMA demanding financial accounting, active operations and staffing, and that the OBU is a branch of an overseas parent bank.

A further development was the opening of the Bahrain stock exchange in June 1989, aiming to become the premier equity market in the Gulf region. Around 30 company stocks are currently traded, comprising a capitalisation of BD914m, but liquidity levels remain low. A number of Bahraini companies are still intending to go public, either on the Bahraini exchange or elsewhere.

A strong stock market would certainly add to the attractions of Bahrain as a banking centre, but the 20% drop in value following the Kuwaiti invasion (some bank stocks lost half their value) suggests a fragile nature and may deter growth for some time yet.

The problem for all financial markets lies in establishing a market niche, often arising from natural factors such as time zones or fabricated attractions like tax breaks. Bahrain's attraction hitherto has been the result of an historical accident due to the fall of Beirut and is natural position in a strategic time zone. Neither of these are great advantages today, and this leaves Bahrain still in search of an identity.

The key lies in the strategies determined by domestic banks, the strong regulatory framework already in place, and the attraction of firms and investors onto the floor of the stock exchange. Bankers had the wit to take advantage of their good fortune in the 1970s and 1980s, but do they have the will to create a mature market for the remainder of the 1990s and beyond?