New corporate governance rules announced by the Central Bank of Kuwait (CBK) in June should continue to strengthen the banking sector and address issues that have been attributed to a weak corporate governance framework. Despite a "mixed environment" in 2011, the banking sector’s financial soundness indicators remain strong, the International Monetary Fund (IMF) concluded as part of its 2012 Article IV staff report for Kuwait. Positive factors included a substantial improvement in liquidity, a decline in non-performing loan (NPL) ratios, and robust capital adequacy and leverage ratios.

The fall in the NPL ratio was attributed to an increase in writeoffs associated with loans to Kuwait’s investment companies (ICs), but some vulnerabilities remained on the asset side of the balance sheet, the IMF said. Notably, a decline in the domestic stock market, a lack of improvement in the real estate sector and continued financial difficulties faced by the ICs have forced banks to set aside higher provisions. Indeed, bank profitability remained flat in 2011, largely as a result of this buildup in provisions.

Some of the challenges experienced by Kuwait’s ICs – and therefore the larger financial sector – have been attributed to the country’s weak corporate governance framework, particularly when it comes to factors such as the efficacy of boards of directors, the strength of auditing and financial reporting standards, and the protection of minority shareholders’ rights. While some of these issues have already been addressed by the executive bylaws published in 2011 by the Capital Markets Authority, the country’s stock market regulator, the CBK has more recently taken the extra step of issuing a new set of corporate governance regulations just for banks.

The new rules will bring bank governance regulations in line with international best practices and replace rules issued in 2004. According to a statement by Mohammed Al-Hashel, the governor of the CBK, published by the state news agency KUNA, the newly released regulations incorporate findings from a variety of international sources, including a 2010 paper from the Basel Committee on Banking Supervision, the Financial Stability Board’s principles on allowances and a 2010 World Bank report on governance criteria for Kuwait’s banks that was commissioned by the CBK.

The new regulations centre on the role of the board of directors, stressing that the board must define strategic goals, improve governance standards, take an active part in management, protect shareholder interests, focus on risk management and improve systems for internal and external auditing. Independence of the board is emphasised to ensure that decisions are made objectively and without compromising the interests of minority shareholders. The new rules also stress that profitability is not the sole raison d’Ítre of bank management, but that interests of depositors and monetary stability must also be taken into consideration.

According to Al-Hashel, the CBK conducted two surveys of local banks to give them a chance to review the new rules, with the feedback indicating that the proposed regulations were workable. The new guidelines will be effective as of June 1, 2013, but as of September 2012 banks will be required to present the CBK with quarterly reports on policies, measures and adjustments that are being taken to comply with the new criteria.

The revised corporate governance framework was revealed just one month after the CBK announced it was changing the rules that govern loan limits in an attempt to boost lending and the overall economy, according to a report from KUNA. Under the new rules, banks will be able to expand their loans against funding that includes deposits and bonds, replacing a regulation that capped the loan-to-deposit ratio at 85 percent. More specifically, banks will be able to lend up to 90 percent of funds maturing within one year, with this limit going up to 100 percent for liabilities whose maturity exceeds one year.

The new policy is “aimed at expanding the lending capability of banks in a manner that enhances the role required of them in financing economic development projects,” Al-Hashel told KUNA. However, some market observers remain sceptical as to whether the new rules will have the desired effect. “The changes are unlikely to spur lending growth, as banks are already fairly liquid,” Naveed Ahmed, a banking analyst at Kuwait-based Global Investment House, told Bloomberg. “This would have been effective if lending caps were the impediment in loans disbursement, which is certainly not the case in Kuwait,” he added.

Indeed, as the IMF pointed out in its Article IV staff report, liquidity conditions in Kuwait are “favourable”, thanks to a rise in retail deposits and “still-moderate” lending growth in 2011.

But should the government hasten the implementation of its $ 108bn National Development Plan, the four-year economic programme approved in 2010, Kuwait’s banks may be now better positioned to boost their lending, thanks to the more lenient loan-to-deposit regulations. However, at the same time, the new corporate governance rules should help ensure that any increase in lending is not carried out in a way that harms either shareholders or the country’s monetary stability.