The main purpose of the study is to understand the problems faced by Arcapita bank of Bahrain as a result of the financial crisis. Arcapita is an international investment firm established in 1997. Having its headquarters at Manama, Bahrain; it is operating currently in Singapore, Atlanta, London & Bahrain. The bank has almost 70% of the paid-in-capital apprehended by 300 individuals and institutions that are by and large from the Arabian region & the remaining 30% is apprehended by Arcapita's management. Since inception, the bank has offered many services to its customers focusing especially on 4 key areas namely private equity, real estate, infrastructure and venture capital.
Background of the study:
With a move to satisfy the requirements for quality alternative investments from the Middle East investors, Arcapita was formed built on Shari'ah principles. Over the years the returns from these investments fared relatively well in line with the conventional alternative investments. All these ended up in the bank having an investor base with investors from those who would invest only in Islam-oriented investments, investors preferring Islam-oriented investments and investors with indifference to the Islamic or un-Islamic nature of a given investment.
Arcapita offers services designed in such a way to help strengthen the communication ties and also ensure effective service. The Bank's middle and back office with over 80 individuals from Corporate management, Financial management, IT and investment placement groups help dedicate their roles so as to ensure high standards in services to customers. In 2009, Arcapita launched its online portal for investors so as to enable investors check and review their portfolio investments and thereby analyzing on their investments. The bank also has an integrated banking system operational in line with the online portal which produces portfolio and cash statements thereby informing investors about their investments with Arcapita.
Arcapita has a dedicated Investment Placement team with 20 members who maintain their responsibility of maintaining relationships with their customers, individual investors, including high net worth individual investors, institutional investors and Sovereign wealth funds. This had been helping the bank to a great extent in determining the path of investment flow thereby ensuring that bank services meet the desires of the investors. So far they have been doing well in the 4 countries where they have established office. The Team has helped in getting excess 70 investments worth $6.6 billion.
With all these advancements, the bank has witnessed a transformation in its investor base with more long-term investors investing in high risk investments thereby looking forward to higher returns despite the high risks involved in such investments.
Statement of the problem:
The motto of the study is to understand the impact of global financial crisis on Bahrain banks. This can be understood from the answer to three key questions:
What impact did the bank face due to the crisis?
How is it affected their investor base?
What are the steps taken to ensure stability during such crisis?
Definition of the problem:
Global crisis began in the late 2008 owing to drastic rise in the defaulter numbers to housing loans in US. This shattered economies everywhere as investors in housing and real sector found their land values depreciating due to the depreciation of dollar. In order to clear debts, many companies were granted aid which finally resulted in banks requiring bailout from the crisis. On the contrary very few economies survived the crisis with proper hedging of funds via bonds, shares, debentures, etc.
Hypothesis of the study:
The study will help analyze the steps to be taken in order to withstand and ensure stability in times of crisis in Bahrain banks.
Significance of the study:
The study is essential in the face of global crisis which had doomed many companies and moreover banks too. Arcapita bank of Bahrain too did not miss to be a target of this crisis. By the end of 2009 fiscal, the bank had been exposed to various challenges of crisis like drying up of credit, drastic fall in its corporate earnings and moreover failure to lure investors out of their market owing to price volatility after the dollar depreciation. The bank however worked on its strategies for crisis like focusing on matching its liabilities to maturity profile of assets thereby protecting their balance sheets. The bank moreover started supporting the financing needs of the portfolio owing to banks pulling out from the system.
Major factors that act as an immunity in times of crisis include proper governance, timely action to identify defaulters and effective tactics to identify genuine investors. The strategies used by Arcapita in their core areas to fight crisis gives an idea as to how to tackle the crisis challenges. In case of Arcapita's private equity industry, the bank planned to focus on seeing the stability in the capital and operational structures of the existing portfolio companies thereby checking on their capability to give returns once the upswing occurred. In terms of new investments, Arcapita had decided to set up capital in sectors they knew well and in situations where they offered a differentiated value proportion.
Arcapita's real estate team has professional who ensure offering diverse investment opportunities to their investors by analyzing geographies, transaction structures and return profiles. In the area of infrastructure business, Arcapita has ensured a sizeable physical asset base as a surety to protection from devaluing of the investment, thereby establishing a hurdle to be an entrant in a competitive business. The venture capital wing of Arcapita focuses on investing in companies with proven management teams, defensible positions in large addressable markets and strong existing customer base.
The root for all these success in handling the crisis can be attributed to the carefully cultivated corporate culture that supports teams to work with quality, dedication, innovative thinking and coordinated decision-making. This has helped the bank to develop and maintain a conservative capital thereby helping mitigating risks.
Scope and limitations:
A major part of the study was based on the strategies to be undertaken in the wake of economic crisis. The strategies used by Arcapita are also applicable to other banks. Moreover effective co-ordination among investors and employees help ensure stability in operations. The study also focuses on strategies focused by Arcapita on each of its diverse business areas with the advantage of giving diverse investment options to customers.
Major limitation included considering only Arcapita bank in Bahrain for the impact of global crisis on banks in Bahrain. Another limitation is the timing. The researcher has limited time to fulfill this research and deliver it to the course mentor to pass the requirement of the degree. Hence the researcher will try to get as much related data as possible.
Reference:
Hugh Barker and John Hobday (2012), ARCAPITA files to protect its stakeholders
Annual reports of Arcapita 2008
Annual reports of Arcapita 2009
Annual reports of Arcapita 2010
Annual reports of Arcapita 2011
http://www.arcapita.com/
2
Chapter
Literature Reviews
2.1 Defining the troubling economic conditions
The existing financial crisis faced by the banks is proving a challenge to the macroeconomists. Actually the traditional macroeconomists believed in the perfect market situation and did not recognize the financial frictions as observed in the last decade. Therefore the traditional models are not so helpful in understanding the present day financial crisis which has resulted in the fall of great economies of the world, especially the European countries. The fall of the global banks like Lehman brothers, Franklin Templeton and Barclay, followed by the fall of economies of Greece, Portugal, Cyprus, Spain Slovenia, Italy, Ireland, Slovakia, Malta, Belgium and now France, Austria and Germany joining the show.
2.2 Financial frictions in financial institutes
Bernanke and Gertler (1989), Carlstrom and Fuerat (1997), Kiyotaki and Moor (1997), and Bernanke, Gertler and Gilchrist (1999) introduce financial frictions into business cycle models. Thus, we had the models which helps us understand the financial frictions on just non financial institutions. Later, Albuquerque and Hopenhaya (2004), Alvarez and Jermann (2000), Jerman and Quadrini (2011) and Miao and Wang ( 2011 a,b,c) introduced a model to introduce financial frictions into the banking sector in the form of endogenous borrowing constraints - or Islamic banking and financing.
Therefore in our model household put deposits in a bank and deposits become liabilities of the bank. Now if the bank chooses to default, then the depositors can seize a fraction of bank capital. Instead of liquidating seized bank capital, deposit repayments. The threat value to depositors is the stock market value of the bank with seized bank capital.
2.3 The banking bubbles
As in Kocherlakota (2009), and Miao and Wang (2011a), we construct a third type of equilibrium in which households believe that banking bubbles may burst in the future with some probability. We show that even though there is no shock to the fundamentals of the economy, changes in confidence trigger a financial crisis. We show that immediately following the collapse of the banking bubble, deposit shrink, lending falls and credit spreads rise, causing real investment and output to fall.
Following Gertler and Karadi (2011) and Gertler and Kiyotaki (2010), we model this inefficiency as a deadweight loss of output. We also follow their studies and assume that the size of direct lending responds to credit spreads according to a feedback rule. In our model, credit spreads rise sharply at the onset of a crisis. The central bank then injects credit in response to movements in credit spreads, according to the feedback rule. We show that this credit policy can mitigate economic downturns. The net effect on welfare trades between this benefit and efficiency costs.
2.4 The role of capital requirements
Bank capital requirements ensure that banks are not participating or holding investments that increase the risk of default and that they have enough capital to sustain operating losses while still honoring deposit withdrawals. In our model, there is no uncertainty about fundaments and hence there is no issue of risk-taking behavior. However, it should be kept in mind that the bank is an Islamic bank, and in Islamic financing the real-estates are vital investment instruments which underlay an inherent
Shin (2012) and Bruno and Shin (2012a,b) focus on the role played by large European banks. These banks are not only systemically important. These studies allude to three factors that fueled a lending boom accompanied by greater risk taking. The factors are
easy monetary policy that lowers funding costs for banks,
adoption of a regulatory structure that allows higher leverage, and
an asset price boom and real appreciation of the currency that strengthens the balance sheet position of borrowers.
Evidence for this for funding is provided by Baba, McCauley, and Ramaswamy (2009),who find that by mid-2008,justbefore the collapse of Lehman Brothers, over 40 percent of the assets of U.S. prime money market funds were short-term obligations of foreign banks, with obligations of global European banks representing the largest share. And of course; Arcapita was one of the Banks that used to merge in foreign currencies in Sukuk as s form of Islamic bonds.
2.5 Effects of the lenders financial conditions on loan pricing
Pornrojnangkool (2009), Hellman, Lindsey and Puri (2008), and Uchida, Udell and Yamori (2008)], and the borrower's choice of debt and lenders [e.g. Kwan and Carleton (2009)], there are relatively few studies on the effects of the lenders financial conditions on loan pricing. Berger and Udell (2004) used the same kind of data as in this paper to link portfolio performance to the tightening of bank credit standards and lending volumes, referring to their findings as the institutional memory hypothesis.
Murfin (2009) studied the supply-side effects on loan covenants and found evidence that banks wrote tighter loan contracts than their peers after suffering defaults to their own portfolios, even when defaulting borrowers were in different industries and geographic regions than current borrowers.
For modern crises, the practical problem is that understanding crises by outsiders relies on observed events such as firm failures or government actions, and government statistics. This problem is manifest in defining and dating crises. In the modern era the determination of whether an event is a crisis and when it starts and ends, is based on governments' actions because these are readily observable. Boyd, De Nicolò and Loukoianova (2011) study the four leading classifications and dating of modern crisis events. They show that for many crises the dating of the start and end dates differ quite significantly. There is also some disagreement on which events are crises.
Further, they show that the start dates are late. This is because the government actions follow the crisis which has already begun, often in the form of a quiet run (Gorton (2012). The dating of the start and the end of a crisis is largely based on contemporary accounts of the crisis, and there is ambiguity
2.6 Governance reform at the financial institutes
The central irony of the governance failures of 2007-2008 was that many took place in some of the most sophisticated banks operating in some of the most developed governance environments in the world. A number of countries in different continent faced debt crisis. The examples of failures of major financial institutions in different continents and countries include the followings.
Europe
United Kingdom:
United States:
The major reasons that were concluded as the cause of such failure and crisis are categorized as follows.
Risk Governance.
Incapability of many boards to posess a comprehensive understanding.
Senior management failure to adopt the necessary part in the report.
Risk management is done in a visible manner.
Remuneration and alignment of incentive structures.
A good governance practice requires the alignment of executives and board renumeration with the long term interest of the company. This will decrease skepticism of the companies over incentive system and compensation.
Broad independence, qualifications, and composition.
Ensuring broad terms objectives with goal of preserving a balance of power will certainly help in productive tension among the board of directors. Thus after decreasing in productive tension, the ability to react the rising risk increases.
Shareholder engagement.
The right to appoint directors and to make key corporate decisions inform their decision making and prevent management from taking such decisions.
2.7 Creating Responsible Financial Markets
The steps to control such as situation were taken as follows.
Interventions made by state owned financial institutions.
Disclosure and transparency.
Redefining shareholders rights and responsibilities.
Other suggestions given by the experts to avoid such a situation in future include the followings.
The requirement of accountable capitalism.
Adding vertical regulations.
Considering new approach to regulations.
Formation of IOSCO (Global organization of securities.)
Thus a formal strategy has been planned which includes taking the following steps.
No single strategy.
Identifying business characteristics and performance from time to time.
Looking for cost efficiencies.
Creating suitable business size.
Keeping an eye on the throughput and prices.
Upgrading current business strategies.
Identifying the role of government in normal conditions.
2.8 The ICGN agenda: core issues to address
The crisis has highlighted a number of issues which are relevant to shareholders, particularly institutional shareholders, and these are areas where the ICGN will seek to engage actively in the policy debate. Below is a list of these issues and the ICGN's position on them.
Strengthening shareholder rights
Strengthening boards
Promoting fair and transparent markets
Independent accounting standards
Remuneration setting
Regulating credit rating agencies
The corporate governance also has a vital role in overcoming the financial crisis as seen in the last decade. Restoring confidence for the future and preventing regulations will help overcome the needs of the investors and ascertain economic growth in future.
This also consists of securing and maintain the rights of the shareholders and other kinds of transparency that helps in keeping a record of healthy financial position of the company, its upcoming goals and capacity to achieve them.
Also the shareholders must recognize the share owner's rights and responsibilities in the terms of creating a long term wealth for the shareholders and owners of the company.
Conclusion:
The current financial crisis has differently affected the economies of the various countries. While the capitalist and developed nations faced the financial crisis more severly. While the developing nation under control of the government governance showed lesser affect of the financial crisis.
Thus it's a good idea to allow the government to work as controlling agent like in China, India and other Asian countries wherein the governments were consistently and confidently trying their best to keep their economies on the right track. The final outcome is that all these countries especially the two mentioned were able to show consistent growth in the last decade while the rest of the world was facing financial crisis.
