Annual Report and Accounts 2004 - National Bank of Kuwait

Annual Report and Accounts 2004

His Highness Sheikh JaberAl-Ahmad Al-Jaber Al-SabahEmir of the State of KuwaitHis Highness Sheikh SaadAl-Abdullah Al-Salem Al-SabahCrown Prince of theState of KuwaitHis Excellency Sheikh SabahAl-Ahmad Al-Jaber Al-SabahPrime Minister of theState of KuwaitContents2 Board of Directors4 Chairman’s Message8 Review of Activities26 Economic Developments in Kuwait31 Financial Statements and Auditors’ Report56 Group Directory

OUR VISIONTO BE THE PREMIER ARAB BANKTO ACHIEVE CONSISTENTLY SUPERIOR RETURNS FOR OUR SHAREHOLDERSTO DELIVER WORLD CLASS PRODUCTS AND SERVICES TO OUR CUSTOMERSTO INVEST IN PEOPLETO BENEFIT THE COMMUNITIES IN WHICH WE OPERATEDURING 2004, NBK HAD AN OUTSTANDING PERFORMANCE AT ALL LEVELS, AS WESTEPPED UP OUR EFFORTS TO BE RESPONSIVE AND AGILE IN MEETING CUSTOMERNEEDS WITH APPROPRIATE SOLUTIONS. WE ALSO MADE IMPORTANT STRIDESTOWARDS IMPLEMENTING OUR REGIONAL EXPANSION STRATEGY BY EXTENDINGOUR INTERNATIONAL NETWORK TO QATAR AND JORDAN AND SHORTLY TO SAUDIARABIA AND IRAQ.1

Board of Directors2

11 Mohammed Abdul Rahman Al-BaharChairman2 345 67 82 Nasser Musaed Abdullah Al-SayerDeputy Chairman3 Yacoub Yousef Al-HamadMember4 Hamad Abdul Aziz Al-SagerMember5 Nasser Mohammed Abdul Mohsin Al-KharafiMember6 Mohammed Sulaiman Al-Sayed Ali Al-RifaiMember7 Ghassan Ahmed Saoud Al-KhalidMember8 Yacoub Yousef Al-FulaijMember3

NBK MAINTAINED ITS RECORD OF CONSISTENT GROWTH IN PROFITS WITH ANOTHER OUTSTANDINGPERFORMANCE IN 2004, AS WE PURSUED GROWTH OPPORTUNITIES LOCALLY AND REGIONALLY,BACKED BY A FOCUSED STRATEGY AND STRONG FINANCIAL PROFILE.Chairman’s MessageMOHAMMED ABDUL RAHMAN AL-BAHARCHAIRMAN4

Our standing in the region is well recognised in the financial world. Thereputable financial magazine The Banker named NBK the ‘Bank of the Year2004’ in Kuwait as well as in the Middle East. We have also received suchrecognition from Global Finance, Euromoney and numerous others, markingmore than a decade of praise that truly goes first and foremost to ourpeople, from the management team to staff throughout the organisationwho are dedicated to the Bank’s values and realising its vision.Sound corporate governanceNBK had another outstanding year in 2004, as afavourable economic environment enhanced thepositive results of a carefully executed strategyaimed at deepening our market leadership andexpanding our regional presence. Our marketleadership remained uncontested, not only in size,but also in the value we deliver to shareholdersand customers. We achieved record profit androbust growth in all business areas. Our financialperformance, already among the best on aninternational level, was further enhanced. Ourdiscipline in managing risk and cost was evidentin the quality and diversification of our earnings,as well as in our credit ratings that are thehighest among all emerging market banks.Our vision and valuesNBK’s strategies and initiatives are guided by ourvision to be the premier Arab bank. We strivetowards this goal from a position of strength:from financial and market leadership to valuesand ethics. Equally important is our unrelentingfocus on growth, performance and continuousimprovement that continued to shape our efforts,initiatives and achievements this past year.Together, these endeavours have gained us thetrust of our customers and shareholders, a trustthat has long defined our relationship with themand with the communities in which we operate.NBK has a long history that attests to its standing as a good corporate citizenin Kuwait and beyond. We are committed to upholding this standing throughthe highest standards of corporate governance set by a well-balanced andactive Board that exercises strong oversight on an independent managementteam. Our standards are defined by transparency and accountability at alllevels of the organisation, and by moral and ethical conduct fostered by aculture that holds trust and integrity above all.Sound corporate governance at NBK is based on a set of fundamentalprinciples including protecting shareholders’ rights; respecting, protectingand treating equitably the interests of all stakeholders; clearly definedresponsibilities of the Board of Directors and Executive Management; applyinga policy of disclosure, transparency and sound practice; and reasserting thefunctions of internal and external audit committees. The Board also ensuresthat factors that could prevent the Group from achieving its objectives areidentified, and that processes are in place to address those factors.Performance-drivenDelivering value and superior returns to shareholders is a key aspect ofNBK’s performance-driven culture. Our record of consistent growth inprofitability since the Bank’s inception in 1952 attests to our commitmentand ability to deliver and maintain NBK’s standing, not only among the topperformingbanks in the region, but also among leading international banksand financial institutions.Our results in 2004 also provide strong evidence of our capacity to grow andoutperform our peers and ourselves. The Group’s net profit for the year roseby 24% to KD 150 million (US$ 515 million), a new record for NBK. Earningsper share rose to 98 fils compared with 78 fils in 2003, while return on equityincreased to 29.9% from 27.7%, and return on average assets jumped to2.7% from 2.3%.I am pleased to announce that the Board of Directors has proposed to theGeneral Assembly payment of a cash dividend of 60% of the nominal valueof shares outstanding, up to the date of the General Assembly meeting, inaddition to raising the Bank’s paid-up capital by 5% through the issuance ofbonus shares.5

NBK’s performance demonstrates why ourfinancial strength ratings stand highest among allemerging market banks. During 2004, CapitalIntelligence raised our long-term credit rating to‘A+’, based on our strong financial profile,prudent risk management practices and healthyprofitability. Other leading international ratingagencies, including Moody’s, Standard & Poor’s andFitchRatings, confirmed their top ratings for NBK.Growth with disciplineOur outstanding performance in 2004 is not anexceptional occurrence, but rather a continuationof a consistent record of profit growth throughbooms, busts, expansions and recessions. While apositive business environment provided us withmany opportunities to exploit our fundamentalstrengths, our discipline in diversifying incomesources and managing risks prudently kept ourcourse steady, and our strategy of focusing on thecustomer made us well positioned to pursuegrowth locally and regionally.An improving economy on the back of recordhigh oil revenues and a favourable turn in theinterest rate cycle had a positive impact onbusiness volume and margins. At the same time,the change in the region’s geopolitical environmentcontinued to be a positive factor for Kuwait’seconomy, notwithstanding security issues inneighbouring Iraq. Demand for credit and otherbanking services was strong by retail and corporatecustomers. Investment activity continued toadvance at a fast pace. Money inflows werebuoyed by rising confidence and improvingbusiness opportunities, adding to the deposit base.While other banks were constrained by new Central Bank of Kuwait regulationsaimed at smoothing the credit cycle, NBK’s strong liquidity and financialprofile allowed us to avail ourselves of growth opportunities while maintainingour discipline of balancing risks against rewards. Alongside the growth inbusiness volume, our margins improved, helped by the rise in interest ratesin the second half of the year that allowed us to leverage our traditionallylow-cost deposit base.This past year, NBK completed a number of prominent deals includingarranging the US$ 600 million bridge loan for Equate Petrochemicals Companyand advising and lead-managing the US$ 325 million IPO for Al-QurainPetrochemical Industries Company, Kuwait’s largest ever public subscription.We were successful at broadening our service offering with innovativesolutions, deepening our relationship with valuable customers andpenetration of profitable segments, and raising our investments intechnology and channel development. These initiatives were guided by ourfocus on anticipating and meeting customer needs, and offeringcomprehensive financial solutions that match the world’s best practices.Regional expansionNBK made important strides towards implementing its regional expansionstrategy. As with our focused presence in the major international centres,our goal is to support our Kuwaiti customers and meet all their financialneeds inside and outside Kuwait, as well as to exploit growth opportunitiesin markets where we can leverage our competitive strengths.During 2004, NBK acquired a 20% stake in the International Bank of Qatar(formerly Grindlays Qatar Bank), together with full management control ofthe bank under the terms of a management contract. This deal provides uswith a strategic entry into the promising Qatari market with its hugepotential for growth and development.Earlier in the year, we opened a new NBK branch in Amman, Jordan thatalso enjoys strategic importance in the region, given the country’s success inenhancing its competitiveness, liberalising its economy and moving aheadwith bold reforms.NBK (Lebanon) opened its tenth branch there to cater to a growing numberof visitors, both Kuwaiti and Lebanese residing in Kuwait. We also movedahead with preparations for opening our first branch in Jeddah, Saudi Arabia,and for establishing operations in Iraq and China.Chairman’s Message6

Open and agileIn last year’s report we talked about taking acritical look inside the Bank – at our variousbusinesses, technologies, processes and people –to identify opportunities for improvement, furtherstrengthen our competitive advantage andmaintain NBK’s edge. As a result, we launched aseries of initiatives that will drive NBK’s growthover the long-term, with positive results alreadyevident in various key performance indicators.These results include higher revenue peremployee, higher cross-sell ratio, higher return onassets, lower cost-to-income ratio and, mostimportant, higher customer satisfaction.NBK’s evolution has been and will remain acontinuous process. To better reflect our brandpromise to customers, we examined how itsessence is projected through the NBK logo,branch network and other channels, media andstaff. In the process, we updated our logo toreflect more clearly our openness to understandingour customers and agility in meeting theirevolving needs, while maintaining our strongfoundation and connectedness to our local market.Social responsibilityNBK supports the welfare and development of the community it serves throughcommitting time, effort and money to various charitable, cultural, social andathletic activities and organisations. Education and health also receivespecial attention for their role in promoting prosperity in our communities.Among our regular activities is NBK’s annual charitable campaign heldduring the Holy Month of Ramadan, whose proceeds this year were donatedto cancer patients. We continued to support the specialised Children’sHospital built at the Bank’s own expense and donated to the Ministry ofHealth three years ago. We also held our tenth annual Walkathon thatattracted more than 6,000 participants.With appreciationIn conclusion, and on behalf of the Board of Directors, I would like toexpress our sincere gratitude and appreciation to His Highness the EmirSheikh Jaber Al-Ahmad Al-Jaber Al-Sabah, His Highness the Crown PrinceSheikh Saad Al-Abdullah Al-Salem Al-Sabah, His Excellency the PrimeMinister Sheikh Sabah Al-Ahmad Al-Jaber Al-Sabah, and to members of theCouncil of Ministers and National Assembly, for their wise management ofthe nation’s economic policies.We also thank the Central Bank of Kuwait for its prudent management ofmonetary policy and oversight of the financial sector, and to the Ministry ofFinance, the Ministry of Commerce and Industry, the Chamber of Commerceand Industry, and all government departments and agencies, for theircooperation with the banking and financial sector of Kuwait.Our appreciation also goes to our shareholders for their confidence andcontinued support for NBK’s growth and development. We thank ourcustomers for entrusting more of their business to NBK, and we assure themof our unfailing commitment to uphold the NBK promise of high quality andconvenient services that meet, or exceed, their needs.In closing, we thank and acknowledge all our employees for their energy,caring, professionalism, passion for customer service and unwaveringcommitment to NBK and its mission. Their tireless efforts, integrity,innovation, teamwork and commitment to delivering value to customers andshareholders stand behind our successes and outstanding results. We havetremendous confidence in our management members’ and team’s ability tosustain our record and meet the growth challenges ahead.Mohammed Abdul Rahman Al-BaharChairman7

NBK HAS ALWAYS BEEN A STRONG, RESPECTED AND TRUSTED BRAND NAME INKUWAIT, SYNONYMOUS WITH QUALITY, CONVENIENCE, RICH PRODUCT ARRAY ANDINNOVATIVE TECHNOLOGY.Review of Activities 20048

services offered through a complete spectrum of delivery channels.Customer loyalty, a cornerstone of the Bank’s success, is highly prized by theBank and our employees. Our efforts and initiatives are all geared towardssafeguarding this loyalty and meeting customer expectations.Responding to customer needs requires us to focus on serving them throughthe different stages in their lives. Main events such as graduation, car andhome purchase, marriage, planning for children’s education and retirementrequire products designed to meet a specific goal. Our personalised servicesand customised product offerings cater to all segments of the population,from the most established high networth customers to young children whoconstitute our future customer base.NBK has consistently been the market leader inKuwait in terms of size, market share andprofitability. This is a result of the Bank’sunwavering efforts since its inception to delivervalue to shareholders, customers and thecommunity at large. In 2004 we successfullyleveraged our varied expertise, technology,financial strength and strong relationships withcustomers to strengthen our leading positionand growth potential. We achievedimprovements across our activities, driven by astrategy focused on continuously enhancing ourability to understand and meet customer needs,following best practices and offering world-classproducts and services. We also made progressagainst our strategic goal of expanding ouroperation within the region to realise our visionof being the premier Arab bank.Consumer BankingCustomer focused…NBK has always been a strong, respected andtrusted brand name among consumers in Kuwait,synonymous with quality, convenience, richproduct array and innovative technology. NBK isvirtually a ‘one-stop shop’, revolving aroundcustomer needs and wants with personalisedThe Bank offers young customers specialised services through Zeina for childrenand Azraq for teens, allowing them to open their first bank account andobtain benefits such as reward points, discounts at key stores in Kuwait, andInternet access. Mustaqbal offers young university graduates starting theirfirst job a package of services geared to their needs, such as an ATM card,special loans and discount credit cards.In 2004, NBK launched a new Thahabi package for affluent customers thatoffers access to a personal relationship officer, trained to advise them onwealth management strategies and provide them with the attention theyrequire to manage their finances. Customers also receive priority access tothe call centre in addition to exclusive discounts and offers, as well as otherbenefits.Customer loyalty at NBK is built on superior quality of service, and the Bankmaintains a dedicated approach to measuring and managing service levelsacross sales channels, ensuring that our customers experience the highestlevels of service at all times. NBK’s service quality programme has helpedthe Bank remain a leader in customer service in the local market throughthe systematic benchmarking of service quality. Relationship staff in branchesand in the call centre are highly trained and motivated to serve customersaccording to the highest standards, and are evaluated by internal and externalauditors to ensure they meet these standards.NBK offers the widest range of products and services in the country, fromtraditional deposit accounts and loan packages to credit cards and a full rangeof mutual funds and insurance products. We extend loans to Kuwaiti nationalsas well as a large number of working expatriates. NBK’s loan offering providescustomers with quick approval for the financing they need. In 2004, wefurther enhanced the efficiency of our loan services by establishing a presenceat major car dealerships. We also implemented the first credit scoring systemin Kuwait, which helped to streamline the approval process and to increaseNBK’s potential retail lending market without jeopardising asset quality.9

NBK has often been the first to introduce innovative products in the market,such as the first chip-enabled Smart Card in Kuwait; expansion of debit carduse to enable online purchases on NBK’s website; setting up a bill paymentprogramme with the leading mobile telecommunication provider, schools,major newspapers and movie houses. The Bank has also succeeded inbuilding the largest credit card business in the Middle East through, amongother innovations, the successful Watani Gifts rewards programme. Inanother regional first, the Bank launched the new VISA and MasterCard MiniCards during 2004. Our credit card offering also benefited from theintroduction of our free travel insurance package for premium cardholders,ensuring NBK credit cards continue to offer the best value to our customers.Convenient delivery requires a varied and reliable network of channels.NBK has developed superior delivery through the largest network of branchesand ATMs in Kuwait and a variety of other technology-based delivery channelsthat offer customers the convenience of 24 hour banking without the needto visit a branch. Nevertheless, in 2004 the Bank’s branch network was furtherenlarged with the addition of three new branches bringing the total to 47,while investing significantly in staff and systems to develop Hala Watani,one of the leading full service call centres in the region. Watani Online,NBK’s pioneering online banking service, also received a complete upgrade,improving convenience and enhancing online payments. NBK also expandedits direct sales team, which continued to deliver service successfully to aselect segment of customers.Brand recognition and strength are important elements of customer loyalty.NBK understands that brand strength will be even more important in thecoming period of increasing competition in the local market. Consequently,NBK underwent a comprehensive brand revitalisation initiative in 2004.The project included a redesigned logo and an enhanced look forthe Bank’s branches.Review of Activities 200410

OFFERING THE WIDEST RANGE OF PRODUCTS AND SERVICES IN THE COUNTRY, NBK HAS OFTEN BEENTHE FIRST TO INTRODUCE INNOVATIVE PRODUCTS IN THE MARKET, AS WITH OUR 2004 LAUNCH OFNEW VISA AND MASTERCARD MINI CARDS.11

Corporate Banking‘Best Corporate Bank in 2004’…NBK is an undisputed leader in the provision ofintegrated financial solutions to local and foreigncompanies doing business in Kuwait. We havebuilt a strong franchise by offering uniqueexpertise, product scope and the highest standardof service to leading corporate customers, includinglarge oil corporations, government agencies,investment houses and other institutional clients.Our superior standing was confirmed by TheBanker Middle East award for ‘Best CorporateBank in Kuwait’ for 2004.The general business environment during 2004was dynamic and focused on expansion anddiversification by the corporate sector to benefitfrom the prosperity in the economy. Our CorporateBanking Group (CBG) was well positioned toproactively offer appropriate solutions to eachmarket segment and support their growth, whileachieving aggressive growth targets. This helpedenhance our already strong position in thecorporate lending market where we hold thelargest portfolio of corporate debt in Kuwait, withthe highest quality.CBG’s leadership position is supported by long-established and recognisedexpertise in structuring complex transactions, with unrivalled placementpower. Our roster of corporate deals includes designing, arranging,underwriting, financing and advising major business groups on their localand foreign business activities and investments in the region. Suchtransactions included arranging the US$ 600 million facility to EquatePetrochemical Company for their expansion project, of which 50% was aconventional tranche whilst the other 50% was Islamic financing. The syndicationwas lead-managed by NBK and KFH, the country’s only Islamic bank.CBG works in collaboration with other business units at the Bank to meetthe total banking needs of customers, including investment banking andadvisory services. An example is the private and public placement ofAl-Jazeera Airlines Company, the first private air carrier in Kuwait. Anotherexample is the initial public offering (IPO) to raise KD 99 million forAl-Qurain Petrochemical Company.Our trade finance activity expanded strongly during 2004, fuelled by tradeactivity with Iraq and an upsurge in government spending. NBK’s role in theconsortium of banks, selected to manage the new Trade Bank of Iraq,further contributed to the volume of our business. Growth in oil exports alsohelped boost trade finance business. The unrivalled technical expertise ofour Trade Finance team is demonstrated by Global Finance awarding NBKthe title of ‘Best Trade Finance Bank in Kuwait & the Middle East’ for 2004.International companies doing business in Kuwait continue to choose NBKover other banks for their local banking needs, ensuring our overwhelmingdominance in the sector. The Bank’s leadership position can be attributed toour proven ability to provide real value to international corporates, withtailor-made financing packages. Adherence to the highest professionalstandards, our strong corporate relationships and our international presencehelped the foreign corporate unit win the business for almost all publicsector contracts awarded to international companies for yet another year.This also led many international companies involved in reconstruction andother business activity in Iraq to select NBK as their local banker.Our innovative products, including Watani Online Corporate (WOLC), aredesigned to match our corporate customers’ needs, whilst our financialstrength makes us a reliable partner for the markets in which they compete.CBG is well positioned to take advantage of future growth opportunitiesoffered by the large number of planned high-value projects expected in theinfrastructure and hydrocarbon sectors.Review of Activities 200412

NBK IS THE UNDISPUTED LEADER IN THE PROVISION OF INTEGRATED FINANCIAL SOLUTIONS TOLOCAL AND FOREIGN COMPANIES DOING BUSINESS IN KUWAIT. WE HAVE BUILT A FRANCHISE BYOFFERING DISTINCTIVE EXPERTISE, PRODUCT SCOPE AND THE HIGHEST STANDARD OF SERVICE,EXEMPLIFIED BY THE FINANCING DEAL ARRANGED FOR EQUATE PETROCHEMICAL COMPANY.13

OUR UNIQUE APPROACH TO WEALTH MANAGEMENT, COMBINING TRADITION, INNOVATION ANDACTIVE MANAGEMENT, IS ENHANCED BY OUR PROXIMITY TO CLIENTS, WHILE NBK’S INTERNATIONALNETWORK, INCLUDING NATIONAL BANK OF KUWAIT (SUISSE) IN GENEVA, ENABLES US TO OFFERTHE CONFIDENTIALITY AND SECURITY CHARACTERIZING SWISS BANKING AND MORE.Review of Activities 200414

The Bank’s market edge is enhanced by our proximity to clients through anextensive local branch network and the only significant internationalnetwork of branches and subsidiaries. This network includes the whollyowned Geneva-based subsidiary, National Bank of Kuwait (Suisse), which ispositioned to offer our clients the confidentiality and security characterisingSwiss banking and more.Wealth management delivers its services through several business units,each focused and dedicated to offering appropriate solutions for differentinvestor groups. The business units are committed to offer high networth,institutional and retail clients a broad range of investment productsand services, including personalised wealth management services,separately managed accounts, mutual and Islamic funds, offshore trustand real estate services.Wealth ManagementDistinctive investment solutions…NBK maintained its unique and leading positionin wealth management, stemming from ourability to combine tradition, innovation and activemanagement, and to offer our clients a uniqueapproach. Our distinctive offering is confirmed bythe latest award we received from Euromoney,the reputable financial magazine, naming NBK as‘Best Private Bank in Kuwait’.Wealth management includes two major businesslines: Private Banking and Asset Management.Collaborative teams of skilled professionals fromboth areas work together to help individualclients achieve their aspirations. Our highlytrained and experienced officers are dedicated todevising solutions that meet their clients’ shortandlong-term investment targets. Our approachmakes use of state-of-the-art tools to designdistinctive investment strategies and assetallocation based on each client’s individual risktolerance, profile and performance targets.NBK Private Banking extends a comprehensive range of banking andinvestment products and services to a broad customer base of high networthindividuals and families. Our relationships are long-standing and span severalgenerations. Our focus is to understand and satisfy our clients’ varied financialrequirements with superior service and attractive long-term returns. Servicesinclude offshore trusts and real estate services that offer expert advice andassistance across a broad spectrum of requirements – including buying, sellingand renting property throughout Lebanon, France, the UK, and the US.National Bank of Kuwait (Suisse) SA, based in Geneva is NBK’s whollyowned private banking subsidiary that caters to the needs of high networthindividuals and wealthy families. NBK Suisse (NBKS) offers a broad range ofhigh quality portfolio management and advisory services, custodianship,family trusts and foundations. In 2004, NBKS continued its progress towardsbuilding a unique open architecture platform of investment products usingstate-of-the-art infrastructure for portfolio management and client reporting.NBKS also signed advisory agreements with leading financial consultantsand investment houses to ensure a quality and flexible structure ofinnovative investment vehicles. Last year saw NBKS achieve outstandingresults, despite the challenging market environment, and move a step closertowards its goal of becoming the premier Swiss-based family office for theMiddle Eastern market.NBK Investment Management Ltd (NBKIM), based in London, caters toinstitutional investors, based on discretionary investment mandates. Thisjoint venture with Morgan Stanley has produced good results for our clients,as most managed portfolios have outperformed their respective benchmarks.NBK Global Asset Management (NBK GAM) offers a broad spectrum ofinvestment solutions matching various clients’ profiles and objectives. Thesesolutions involve a variety of asset classes including money market funds,bond funds, equity funds, Islamic real estate funds and alternative investments.15

Investment Banking‘Best Investment Bank in the Middle East’…NBK remains the region’s leading investment bank, providing a spectrum ofservices to governments, corporations and institutions, including debt andcapital raising, advising on corporate strategy and structure, valuations,mergers and acquisition, and other advisory services. The Bank’s strongposition in the local market has been enhanced by its growing regionalpresence. Emerging Markets recognised NBK as the ‘Best Investment Bank inKuwait and the Middle East’ in 2004, after being named ‘Best Mergers andAcquisitions House in Kuwait’ in 2003 by Euromoney.NBK’s investment banking activities are being expanded to meet growingdemand and to provide superior expertise across the Middle East. Our teamof highly qualified professionals continuously strives to secure for ourcustomers optimal and cost-effective solutions.In 2004, we expanded offerings in two strategicareas: direct real estate funds and ShariacompliantIslamic funds. We successfully launcheda second US property fund and created theIslamic Asian Real Estate Fund, a unique Shariacompliantreal estate fund that invests in Class Aproperties across Asia. We also launched the thirdof a series of Islamic leasing funds.NBK GAM’s unique Fundselect programme,launched in 2003, continued to attractinvestments from a diverse group of investors.This ‘open architecture platform’ offers investorsunique opportunities to blend professional assetallocation techniques with the employment ofsome of the world’s most successful specialistfunds, within a single investment portfoliotailored to reflect each client’s risk tolerance.NBK International Brokerage was significantlystrengthened by recruiting new skills in clientservicing and security trading, for the US marketsthat complement our already established onlinetrading platform.NBK’s global wealth management business hasgrown steadily, with assets under managementreaching US$ 6.2 billion. Our outlook for 2005 andbeyond is very positive as we plan to introducefurther new and bold initiatives.In 2004, the Bank advised state-owned Petrochemical Industries Companyon the formation of Al-Qurain Petrochemical Industries Company, andsuccessfully lead-managed the initial public offering (IPO) of 90% of thecompany’s capital. The IPO, at US$ 325 million, was the largest in the historyof Kuwait and another step in the government’s effort to privatise parts ofthe oil and gas sector.Investment Banking, in coordination with the Corporate Banking Group, alsosuccessfully led a public and private offering for Al-Jazeera Airlines, thecountry’s first private carrier. The highly successful IPO was over-subscribedmore than 12 times. The company was the first to be established since theKuwaiti government’s decision to open the airline industry to the privatesector. This deal further confirmed our strategic role in supportingliberalisation efforts in key sectors.The Bank successfully managed and closed a bond issue for CommercialBank of Kuwait. Valued at US$ 200 million, this deal was the largest privatebond issue yet in Kuwait. Investment Banking also received a number ofmandates for bond issues that will be ready for launching early next year. Anumber of restructuring and valuation deals are also in the pipeline.The Bank’s dominant market position in Kuwait, coupled with our expertiseand reputation as a proven market leader, made NBK the first choice for ourclients. Our strategy for the future is to continue to expand investmentbanking activities across the region, providing high-quality strategic adviceand creative financing solutions.Review of Activities 200416

THE EXPERTISE AND PLACEMENT POWER THAT EARNED NBK THE TITLE OF ‘BEST INVESTMENT BANK INTHE MIDDLE EAST’ IN 2004 WERE EVIDENT IN THE SUCCESSFUL PUBLIC AND PRIVATE OFFERING OFKUWAIT’S FIRST PRIVATE AIR CARRIER AND IN OUR LEAD ROLE IN THE LOCAL MARKET’S LARGEST IPO.17

NBK’S INTERNET AND MOBILE DELIVERY CHANNELS ARE EXAMPLES OF OUR ONGOING INITIATIVESTO EMPLOY THE LATEST TECHNOLOGIES IN PROVIDING CUSTOMERS WITH CONVENIENT ANDPERSONALIZED SERVICES.Review of Activities 200418

NBK was also a pioneer when it introduced online banking for the first timein Kuwait in 1998. Watani Online offers customers a quick and easy way toview and manage their accounts, pay bills including utility and mobiletelephone bills, and pay school tuition fees. The Bank leveraged its onlinepayment engine with strategic merchants, such as MTC Vodafone, KuwaitNational Cinema, educational institutes, and major newspapers, enablingcustomers to use their NBK debit card for online payments. With MyWOL,customers can also customise and enhance their online banking experience.A sizeable share of our customers use Watani Online to conduct most oftheir transactions, accounting for about 8% of the Bank’s delivery channel mix.We are continuously developing the usage and personalised functions ofWatani Online and have achieved notable improvements in transactionperformance, as measured by the total execution time and success rate forlogging in to an account and checking the account balance.Internet and e.BusinessA pioneer bank…NBK continued to maintain its leading position indelivering remote banking services, with emphasison Internet and mobile technology. The Bank wasamong the first to embrace the Internet, and ouronline banking offering was the first in the region.We were early in anticipating the convenience ofmobile telephone technology as a means ofdelivering products and services to our customers.Above all, our leadership in this arena stems fromour firm commitment to innovation and technologyin delivering value-added services as well asconvenience, confidentiality and security to ourcustomers. In recognition of this, Global Financenamed NBK the ‘Best Internet Bank in Kuwaitand the Middle East’.We have been on the Internet since 1995, whenwe were among the first in Kuwait to launch aninformation portal. Today, our bi-lingual websitewww.nbk.com offers customers access to comprehensiveinformation on NBK’s products and servicesat their convenience. NBK also uses targeted emailsto keep customers informed of new services, promotionsand special events. In 2004, www.nbk.comwas given a complete revamp in line with therefreshed NBK logo and enhanced look.The Bank’s NBK Mobile offering leverages our technological expertise inusing mobile messaging to provide customers with personalised alerts ontheir account activity, as well as promoting products and services to targetedgroups of customers and communicating with them.These initiatives have made NBK a forerunner in the delivery spaceproviding customers with convenient banking options, both in the physicaland online worlds.International BankingRegional expansion…NBK’s international presence is a key asset, allowing us to providecomprehensive financial services to our customers, from corporations andbusiness people to wealthy individuals and those who travel frequently.NBK’s international network of Group offices outside Kuwait consists of thesubsidiaries, National Bank of Kuwait (International) PLC, based in Londonand Paris; National Bank of Kuwait (Lebanon) SAL; and NBK (Suisse)in Geneva; together with the branches in New York, Singapore, Bahrain andJordan; associated representative offices in Bangkok and Ho Chi Minh City;and an associate company in Qatar.The planned expansion of our international network continued during 2004with the opening of a new branch in Amman, Jordan and the acquisition ofa 20% stake in the International Bank of Qatar (formerly Grindlays Qatar Bank),together with full management control of the bank under the terms of amanagement contract. Under NBK’s management it is intended that IBQ willdevelop and grow significantly in the future. The Bank intends to undertakefurther expansions in 2005 with entry into the Iraqi market through amajority stake in Credit Bank of Iraq; opening a new branch in Jeddah, SaudiArabia that will provide a full range of services and support to NBK customers;and the establishment of a representative office in China.19

A full range of corporate, treasury, trade finance,retail and private banking services are providedby the International Banking Group. We payparticular attention to the requirements of theBank’s traditional customer base of exporters andcontracting companies involved in the public andprivate sectors in Kuwait and the Gulf. Within thetreasury and foreign exchange markets, wecontinue to pursue a policy of conservative riskmanagement, with a particular focus on servicingclients in the Middle East.Highlights of our international operations were asfollows:• NBK London, Paris, New York and Singaporemaintain a strong focus on providing support tocustomers involved in contracts and projects bothin Kuwait and the region. These core activities,combined with a well-diversified lendingbusiness, provided stable and growing incomeagainst the backdrop of economic and politicaluncertainty.• NBK Group’s personal customers continue tofind London and Paris, which offer a full range ofcounter services, convenient and secure locationsfor deposits, whether for longer-term investmentsecurity or for their banking needs whentravelling in Europe.• The International Banking Group’s Treasury teamcontinued to thrive within their operating environment,despite increased competition from Westernbanks keen to operate within the Gulf region and the threat of technologyplatforms to the traditional transactional model. The rapid expansion ofeconomic activity throughout our operating region is expected to continueover the coming year. The Group is well placed to benefit from increasedbusiness opportunities and from the additional liquidity generated byregional growth.• Private Banking in the New York, London, Lebanon and Paris officescontinues to provide real estate advisory services and related finance to theBank’s private banking clients who wish to acquire commercial or residentialreal estate.• A revival of the real estate market in Lebanon and the inflow of capital forinvestment in tourist real estate projects have ensured that the Lebanonoffices remain active in this area. The Lebanon operation has been verysuccessful in providing a full range of real estate services to Kuwaiticustomers wishing to buy property in Lebanon. The Bank offers legal andadvisory real estate services ranging from valuation, government registrationand payment of utility bills to financing the property purchased. The branchhad a very active summer season highly appreciated by our Kuwaiti clients.• Our New York office has increased US dollar clearing during 2004 to morethan US$ 2 billion daily for a client base consisting of government agencies,investment companies, financial institutions, oil companies and banksthroughout the Arab world.• Our Bahrain offshore banking unit continues to provide a full range oftreasury and wholesale banking services to a broad customer basethroughout the Middle East and North Africa. During the year the branchselectively participated as lead manager in several syndications, FRNs andbond offerings both in the primary and secondary markets.• The new Bahrain retail branch, in its first full operational year, provides afull range of retail and corporate banking services to domestic clients as wellas Kuwaiti investors; it also provides loans to corporate and high networthclients, and trade finance services. During the year the branch providedselective local and regional corporate clients with facilities through directlending and syndications.• Core activities in the Asia Pacific Region undertaken by the Singaporebranch and the representative offices in Vietnam and Thailand continue tofocus on providing support to a growing number of customers involved inprojects and trade in the Middle East, as well as maintaining ageographically balanced and primarily investment grade wholesale lendingportfolio and an active 24-hour treasury.• NBK’s Jordan branch was opened in April 2004. It now operates as a fullcommercial bank providing services to Kuwaiti and Jordanian companies aswell as individuals.Review of Activities 200420

NBK IS DISTINGUISHED AMONG KUWAITI AND ARAB BANKS BY ITS INTERNATIONAL NETWORKSPREAD ACROSS THE WORLD’S MAJOR FINANCIAL CENTRES FROM NEW YORK, LONDON, PARIS,GENEVA, SINGAPORE AND BAHRAIN TO EMERGING ARAB MARKETS WITH OUR RECENT EXPANSIONINTO JORDAN AND QATAR.21

AS THE LEADING PLAYER IN THE LOCAL MONEY AND FOREIGN EXCHANGE MARKETS, NBK PLAYS THEROLE OF MARKET MAKER FOR THE KUWAITI DINAR, BOTH LOCALLY AND INTERNATIONALLY.Review of Activities 200422

Treasury‘Best Foreign Exchange Bank in the Middle East’…NBK is an important player in the local moneyand foreign exchange markets. The Bank’sTreasury group plays the role of market maker forthe Kuwaiti dinar both domestically andinternationally. In the local interbank moneymarket, NBK is a net lender, providing other localbanks with cash management facilities for theirshort-term and medium-term cash flowrequirements. In 2004, Global Finance presentedNBK with the ‘Best Foreign Exchange Bank inKuwait and the Middle East’ award.The Bank offers a wide range of treasury, assetand liquidity management services to ourcustomers. The Treasury team works closely withother areas in the Bank, including ourinternational branches in the world’s majorfinancial centres, providing timely, innovative andcost-effective solutions to corporate customers.Risk ManagementDiscipline and prudence…Efficient Risk Management is a core NBK discipline to maintain its stabilityand quality of assets. The comprehensive global Risk Managementframework adopted by the Bank has continued to evolve in light of theGroup’s expanding activities, and has once again proven its effectiveness.This framework is designed to produce an accurate and timely evaluation ofthe Bank’s risk exposure in addition to ensuring risk is effectively controlledand mitigated. The system allows NBK to manage the Group’s exposure tocredit, market, liquidity and operational risks. NBK continually modifies andenhances its Risk Management policies and systems to reflect changes inmarkets and products and in best practice.Credit Risk Management at the Bank is based on two tenets: ‘FocusedDiversification’ and ‘Prudent Lending’. Risk is thus managed at both theindividual transaction and portfolio levels. Processes in place aim to ensurethat credit risks are adequately assessed, properly approved, continuallymonitored and actively managed. Domestic and International Credit Controlconstantly monitor the quality of the Bank’s credit portfolio and ensure theBank’s adherence to the credit policies and regulators’ directives. Our practicesare designed to preserve the independence and integrity of the risk assessmentprocess. This has enabled NBK to maintain the highest asset quality.The Bank actively manages Market Risk arising from the mismatch betweenassets and liabilities and their sensitivity to adverse movements in interestrates, exchange rates and equity prices; striving to make the Group’s riskprofile transparent to senior management, the Board of Directors and theregulator. The Bank employs both statistical and non-statistical measuresincluding, but not limited to, value-at-risk (VAR) from any adverse marketmoves in an ordinary market environment, as well as measures of positionsize and sensitivity limits, mainly pertaining to its non-traded book.Liquidity Risk is monitored and evaluated daily. In addition to ensuring thatthe Bank’s balance sheet profile complies with regulatory requirements, theTreasury team is actively involved in cash flow management and in meetingthe Bank’s funding requirements at all times. In doing so, managementconsiders a variety of liquidity risk measures as well as market conditions,prevailing interest rates, liquidity needs and the desired maturity profile ofits liabilities.Management of Operational Risk also receives high priority and is controlledby the Bank’s Operational Risk and Compliance functions. Operational Risk ismeasured across a number of processes based on the probability and impactof risks, together with the potential mitigating effects of controls and insurance.To monitor and control Operational Risk, the Group maintains a system of23

comprehensive policies, procedures and internalcontrols, which are continuously improved andstreamlined to confirm their effectiveness withoutinterfering with the conduct of business. Thisprocess is supported by a strong Internal Auditfunction, through independent review, and anInsurance and Risk Financing function. The keythemes for this function are transparency ofinformation, escalation of key issues, andaccountability for issue resolution.Risk Management also evaluates potentiallyextreme events. The Bank has a sound businessresumption plan built on the foundations of afully equipped disaster recovery centre. The centreis tested periodically to ensure that, in the eventof a disaster totally disabling our main datacentre, the Bank can restore a complete range ofservices on a timely basis.NBK closely monitors the use of its financialsystem to identify, control and prevent potentiallyillicit use of its services pertaining to MoneyLaundering and/or Terrorism Financing. The Bank’sAnti-Money Laundering and Combating TerrorismFinancing initiatives are constantly challengedand reviewed to ensure full compliance with localrequirements and international best practices.NBK and the CommunitySocial responsibility…At NBK we recognise that the support and trust we receive from thecommunity are key to our success. In return, we are committed to givingback to the community, through charitable programmes, sponsorship andparticipation in community activities. The Bank’s employees play animportant role in many volunteer and sponsored activities, in particularthose intended to increase the public’s awareness and participation in social,charitable and athletic activities.Most notable of the Bank’s efforts is its annual charity campaign during theHoly Month of Ramadan, with last year’s proceeds going the Cancer Centrerun by the Ministry of Health. NBK also continues to support the specialisedChildren’s Hospital built at the Bank’s own expense and donated to theMinistry of Public Health in 2000.The Bank also made several charitable contributions to local organisationswith a long history of serving the needy in Kuwait and abroad. At the sametime, we continued to sponsor annual events and campaigns, such as theNBK Walkathon that had a record 6,000 participants of all age groups in 2004.Education and human development receive special attention in our communityefforts. NBK holds several summer internship programmes for students toacquaint them with the banking business. It also sponsors and participatesin conferences and forums held throughout the Arab world, in addition tohosting investment seminars for customers. Most notable last year were twoseminars sponsored by NBK, with prominent international experts addressingpressing economic issues. The first was given by Dr. Bergsten, Director of theInstitute for International Economics, Washington, D.C., who talked about theglobal economic and investment environment. The second was a symposiumabout oil markets, with several renowned speakers addressing the outlookfor the global oil industry, and whether the recent rise in oil prices to historichighs defines the beginning of a new era or is a reflection of temporarymarket imbalances.Our efforts are a reflection of our commitment to NBK’s larger communityand our responsibility to work for its advancement and welfare.Review of Activities 200424

OUR CONTINUED SUPPORT FOR THE SPECIALIZED CHILDREN’S HOSPITAL, BUILT AT THE BANK’S OWNEXPENSE, REFLECTS NBK’S COMMITMENT TO GIVE BACK TO THE COMMUNITY THROUGH CHARITABLEPROGRAMMES, SPONSORSHIPS AND PARTICIPATION IN COMMUNITY ACTIVITIES.25

KUWAIT’S OIL EXPORTS AND BUDGET REVENUES SOARED ON HIGHER OIL PRODUCTION ANDPRICES, ALLOWING FOR EXPANSIONARY GOVERNMENT SPENDING. HIGHER SPENDING, COMBINEDWITH OPTIMISM AND AMPLE LIQUIDITY, FUELLED PRIVATE SECTOR ACTIVITY AND BOOSTEDDEMAND FOR BANKING SERVICES AND THE PROFITABILITY OF LOCAL BANKS.Economic Developments in Kuwait26

Oil sector and public financesKuwait’s economy continued to project indicatorsof robust growth during 2004, following a verystrong performance the previous year. Higher oilprices and increased crude oil production ensureda bonanza for Kuwait’s main export and the statebudget, allowing government spending toaccelerate. Optimism and ample liquidity fuelleddomestic activity, which in turn strengtheneddemand for banking services and boosted localbanks’ profitability. The strength of the economycontinued to be reflected in Kuwait’s solidsovereign rating amongst the highest in theregion (Fitch: AA-, S&P: A+, Moody’s: A2).Iraq-related business activity remained vibrant,with local companies garnering a considerableshare of contracts awarded by coalition forces.Though the traffic of foreign companies usingKuwait as a launching pad for their activities inIraq slowed notably with the deteriorating securitysituation there, the flow remained significantenough to lift demand for local services.We expect faster growth to be reported for boththe oil and non-oil sectors in 2004. Nominal GDPgrowth could easily top 20% compared to 16% in2003, though real growth is likely to be a moremoderate 5%. The oil sector will continue to setthe pace for growth, with prices likely to remainin their new higher range. Private sector activitiesare expected to pick up notably as well, driven byincreased government spending and domesticinvestment, both public and private.Capital spending by the government rose sharplylast year, and the trend is expected to continue.While oil, petrochemicals and power projectsremain the biggest and most visible, thegovernment has put forward plans to develop thecountry’s infrastructure with private sector participation,including ports, roads and the airport, aswell as its two largest islands.Oil prices soared during 2004 on strong global demand, boosting oil revenuesand ensuring a record budget surplus for the state. Kuwait export crude priceaveraged US$ 32.7 for the year, a 22% increase over 2003, while averagedaily production rose by 6.9%. With oil receipts accounting for 92% of budgetrevenues, the budget is expected to log a surplus in fiscal year 2004/05,which closes in March, possibly twice as large as last year’s KD 1.41 billionsurplus that equalled 11% of 2003 GDP.Oil constituted over 91% of Kuwait’s export receipts, whose growth in 2003helped widen the country’s current account surplus to 18% of GDP. Theincrease was slightly tempered by a 17% rise in imports that reflected strongdomestic demand and Iraq-related activity. Investment income dropped by2.5% to KD 1.1 billion (US$ 3.3 billion), or 8% of GDP, following several yearsof more substantial declines. Rising interest rates and a general improvementin global markets and corporate profits should begin to show up in higherinvestment income in 2004.The government has used past surpluses to accumulate foreign investmentassets in the Reserve Fund for Future Generations, estimated at KD 22 billion(US$ 75 billion) and, to a lesser extent, boost spending. Budget expendituresduring the first 10 months of the current fiscal year 2004/05 rose by 13%,in line with last year. Employment-related spending, which makes up morethan half of government expenditures, saw relatively strong growth due tocontinuing pressures to create jobs for a growing number of Kuwaitis. Thispart of the budget is also proving to be a boon to the private sector, throughsupporting growth in consumer spending.Capital spending has been a main focus of fiscal policy over the last threeyears. The bulk of spending on development and maintenance projects relatesto upgrading Kuwait’s infrastructure in power and water as well as publicworks. Capital spending rose by 23% last fiscal year 2003/04, while theapproved budget for 2004/05 was increased by 14%.Capital spending in the oil sector, which falls outside the purview of thegeneral budget, is also on the rise to meet ambitious and urgent plans toincrease production and export capacities, and improve efficiency. Plannedprojects include expanding export facilities and upgrading gathering centresand pipelines. Plans for two major petrochemicals projects are also in anadvanced stage, with at least one likely to start in 2005.Project Kuwait, the scheme to invite international oil majors to participate inthe development and operation of the country’s northern fields, is alsoprogressing. A draft operating services contract and the economic model forthe project have been approved by the Council of Ministers, along with thelegislative framework needed to secure parliamentary approval before tenderscan be launched.27

National incomeSoaring crude oil output and prices resulted insubstantial growth in GDP in 2003, which rose by16% to reach KD 12.4 billion (US$ 43 billion). Oilsector GDP rose by 32%, pushing its share of thetotal to 51%, with some of the gains coming fromhigher refining volume and margins. Meanwhile,the provisional estimate for growth in the non-oilsector was below expectations, standing at 4.5%compared to 6.1% in 2002.Services and trade remained the main drivers ofoverall growth in non-oil activities, havingbenefited from the resumption of trade with Iraqand opportunities available in supportingreconstruction in that country. Financial serviceswas the only sector to show higher growth.Kuwait continues to have one of the highest percapita GDP levels in the region at KD 5,008 (US$16,800) in 2003, behind only Qatar and the UAE.The population grew at a rate of 8.1% in 2004following a 5.2% increase in 2003, on the back ofa rise in the number of expatriates, who made up65% of the 2.75 million residents. Demographicgrowth, rising income and rapid expansion inconsumer lending have made consumers the maindriver of growth in domestic demand.Private consumption increased by a healthy 5.4%in 2003, down from 10.1% the previous year.Government consumption rose by 10%, though ittoo moderated from a post-liberation record of16% in 2002. The private sector also boostedinvestment spending, led by real estate propertydevelopment. Gross capital formation rose by 10%in 2003, though net capital accumulation remainedunder 5% of GDP. Private investment opportunitiesare constrained in the absence of privatisation andmuch needed reforms, notwithstanding preliminaryliberalisation measures such as the recentenactment of implementing regulations governingforeign direct investment.Activity in the real estate market remained vibrant in 2004, as reflected inrising sales and bank loans to that sector. The value of properties sold wasup 10%, with the investment and commercial sectors particularly strong. Incontrast, growth in residential sales slowed down, affected by a drop in loanapprovals and disbursements by the Savings and Credit Bank. The averageprice per unit sold increased by 10% for apartment and commercial propertiesand by 7% for residential properties.Monetary developmentsMoney supply growth accelerated in 2004 to 10.8% to reach KD 11.52 billion(US$ 39.1 billion), compared to a 7.8% increase in the previous year. Rapidcredit expansion was the main factor driving money supply growth, thoughthis slowed significantly towards the end of 2004. Bank lending has beengrowing at a fast clip during the past two years, benefiting from low interestrates and strong demand triggered by vibrant economic activity. Interest ratesstarted to rise in mid-2004, though they remained relatively low. Meanwhile,the drain on domestic liquidity, manifested as a drop in foreign assets at theCentral Bank of Kuwait (CBK) for over two years, began to reverse in the finalquarter of 2004, with the full year showing an overall inflow. Payments forlosses due to the Iraqi invasion by the UN Compensation Commission (UNCC),a significant source of liquidity in recent years, continued to decline to KD140 million from KD 436 million a year earlier.Private sector deposits rose by 11%. Time deposits made the biggestcontribution to growth following two flat years, though their share of thetotal was little changed at 51% at year-end. Sight deposits also saw stronggrowth of 16%, albeit slower than last year’s, while growth in savings depositsaccelerated to 8%. Foreign currency deposits witnessed large monthlyfluctuations throughout the year, with a jump in December causing theirbalances to rise sharply from a year ago.The CBK issued two directives in 2004, which had an impact on bank balancesheets. The first limited the use of back-to-back interbank placements andloans to increase the regulatory ceiling on a bank’s consumer loan portfolio.The second required banks to meet an 80% maximum loan-to-deposit ratioby the spring of 2005. As most banks, with the exception of NBK, were inbreach of this maximum, the second directive led to a slowdown in creditgrowth during the second half of the year as banks sought to meet the target.NBK stood to benefit as it enjoyed a stable and adequate deposit base,allowing it to continue expanding its lending activity selectively. Banks alsosharply reduced their interbank placements and loans to banks as a result ofthe first directive, erasing all the increases seen since they began to use suchagreements to expand their consumer lending. Consequently, consolidatedlocal bank assets rose by a mere 1.5% following double-digit growth duringthe previous two years.Economic Developments in Kuwait28

Credit growth moderated somewhat during 2004to 16% from last year’s 23%, with total outstandingdomestic facilities reaching KD 9.81 billion (US$33.3 billion). Personal facilities continued todominate growth in credit, having risen by 17%,while lending to the trade sector was only slightlybehind in volume, though it was the fastestgrowing at a rate of 31%. Loans to the real estatesector continued to see healthy growth of 12%.Growth in salary-based loans to consumers slowednotably from a fast pace in recent years, followinga CBK directive scaling back maturities for newloans and effectively lowering the amount that aborrower can borrow on a given salary. AnotherCBK directive limiting the use of back-to-backinterbank loans to increase their consumer lendingceiling also contributed to reducing salary-relatedcredit during the second half of the year, as did therecent rise in interest rates. Still, such loansaccounted for 10% of the growth in domestic creditduring the first nine months of the year, andrepresented 25% of total outstanding facilities.The redemption of outstanding Debt PurchaseBonds (DPBs) continued with the balance held bybanks falling by KD 215 million. Banks continuedto hold KD 604 million in DPBs on their books atthe end of 2004, representing 3.2% of totalbank assets.Liquid assets of banks, comprising cash, depositswith the CBK and public debt instruments, fell by9.1%. The decline was largely the result of a continueddrop in time deposits with the CBK. At theend of 2004, liquid assets as defined above represented13.2% of total bank assets, versus 14.8%at the end of 2003 and 21% at the end of 2002.Following a period of declining and low interest rates lasting some four years,the CBK began lifting its benchmark discount rate starting on July 1st. By theend of 2004 the CBK had hiked its discount rate five times, by a total of oneand a half percentage points to 4.75%. The CBK’s actions mostly followedsimilar moves by the US Fed. The rise in the discount rate has been followedby increases in deposit rates. This is reflected in the rise in the semi-annualinterest rate paid by the government to local banks on its outstanding DPBs,where this rate has normally matched the average cost of local currencydeposits. The rate was set at 1.88% for the December payment compared to1.76% in June. Lending rates also moved higher with the discount rate, as mostloans in Kuwait are extended on a variable rate basis.Interest rate policy in Kuwait is dictated by an exchange rate regime thatpegs the dinar to the US dollar within a narrow band. However, theexchange rate remained fixed throughout 2004 at KD 0.2947 per dollar. Thedepreciation in the dollar, and thus in the Kuwaiti dinar, relative to majorcurrencies helped raise inflation in 2004, though it remains relatively low.The November consumer price index was 1.8% higher from a year agoversus an increase of 1.2% in 2003.Banking and financial sectorA strong domestic economy, higher lending volumes and rising interest ratesprovided a solid boost to the profitability of Kuwaiti banks. Consolidated profitsof the country’s nine banks were up 23% during the first nine months of 2004.While earnings growth came largely from net interest income, fees andcommissions also saw healthy growth.Banks have been consistently the most profitable sector among locally listedcompanies, contributing 28% of total reported earnings in 2004. As a whole,listed companies saw earnings growth slow down to 12% during the firstnine months of 2004 compared to a 92% rise in 2003. Still, the rise inearnings, coupled with improved business prospects, kept investors bullishon local stocks.The Kuwait Stock Exchange (KSE), among the best-performing markets in 2003,sustained its rally in 2004 albeit at a more moderate pace. The general marketindex rose by 34% versus 102% in 2003, while the value weighted index roseby a smaller 15%. Market capitalisation rose by 23% to KD 21.5 billion (US$73 billion), or roughly 140% of our GDP forecast for the year. Of the KD 3.7billion increase in market capitalisation, KD 1.4 billion came from the listingof 18 new companies. Trading activity was down slightly from last year, thoughit remained relatively high. The market price-to-earnings (P/E) ratio declinedto 13.5 from 14.7 at end-2003, using 12-month trailing earnings.29

Islamic banksFollowing the issuance of Law No. 30/2003, asection was added to the law of the Central Bankof Kuwait (CBK) in relation to Islamic bankingactivities, giving the CBK full regulatory andsupervisory authorities over such activities and thepower to license new domestic and foreign banksto operate in Kuwait according to Islamic Sharia.Under the amended law, any Kuwaiti bank mayapply for CBK permission to set up a singleindependent Islamic banking subsidiary. However,the CBK decided to adopt a gradual approach inthis respect, whereby two new banks besidesKuwait Finance House (KFH) shall be licensed inthe first stage before reviewing its policy onlicensing other new Islamic banks, or subsidiariesof conventional Kuwaiti banks. Accordingly, the CBKgave its initial approval to the existing KuwaitReal Estate Bank to convert into an Islamic bank.The CBK also licensed a new Islamic bank,Boubiyan Bank, which is expected to start itsoperations in the middle of the year 2005.Licensing of foreign bank branchesThe CBK law was amended in 2004, whereby legalrestrictions on the entry of foreign banks into thelocal market were lifted. Previously, foreign bankscould own no more than 40% in a local bank, withthe other 60% held by the Kuwaiti government orKuwaiti financial institutions. Pursuant to theamended law, the CBK approved the applicationof one European-based bank to establish a branchin Kuwait. Several regional and internationalfinancial institutions are believed to have appliedfor licences as well.Removal of deposit guaranteeIn April 2004, the Kuwaiti government lifted itsguarantee of local bank deposits. Authoritiesbelieve that Kuwaiti banks have attained sufficientfinancial strength in terms of solvency, liquidityand profitability, so that they are well able nowto safeguard their customer deposits on their own.As such, local banks no longer need the blanketguarantee of deposits introduced in 1986 and reaffirmedin 1992. At the time, the measure wasintended to resolve financial and banking system problems arising from the1982 Souk Al-Manakh crisis and the subsequent 1990 Iraqi invasion, whichleft the banking system with substantial non-performing loans. This recentdecision aims at increasing competition and improving the efficiency of thebanking system, ultimately benefiting bank depositors and shareholders.Limits on ownership of local banksPursuant to Law No. 28/2004, Article (57) of the CBK law was amended,whereby Clause (2) of the same stipulates that without the prior authorisationof the CBK, the direct or indirect ownership by a single person, be it a naturalor juridical person, shall not exceed 5% of the capital of any Kuwaiti bank.Government bodies and entities with attached and independent budgetsshall be exempted from such provisions. Where the ownership of a singleperson exceeds the 5% limit, the excess must be disposed of within theduration specified by the CBK. Failure to observe the aforementioned maximumlimit shall result in the shareholder not availing of the excess shares in regardto voting rights in the General Assembly and in directing the bank. Casesexisting prior to the effective date of this law (15/03/2004) shall not besubject to the provisions of this Clause.According to the executive procedures and mechanism set by the CBK forapplying the provisions of Clause (2) of Article (57) referred to above:1. In cases where exceeding the set percentage was not deliberate, such asownership resulting from recovering a debt, or benefiting from a will orinheritance, then such excess shall be disposed of within two years of the dateof ownership. During that period, the owner may request the CBK to approve –according to the set rules – the excess percentage.2. In cases where exceeding the set percentage occurs due to other reasons,such as resulting from purchase or merger operations or otherwise, disposalof the excess shall take place within a year from the date of ownership.3. Investors who own, directly or indirectly, in excess of the maximum limit –whether the ownership was dated prior to 15/3/2004 or after that date,with the approval of the CBK – shall be classified into three categories:a. ownership exceeding 5% and less than 10%;b. ownership from 10% to less than 25%;c. ownership equivalent to or exceeding 25%.In case an investor’s ownership percentage drops, the investor in any of thesecategories shall be allowed to increase the ownership percentage once againwithout reverting to the CBK – if the decline does not exceed 1% of thecapital in the first category, or 2% in the second category, or 3% in the thirdcategory. In the event the decline exceeds the allowable percentage foreach category, then the approval of the CBK shall be required prior toincreasing the percentage once again.Regulatory Developments30