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The protraction of the global liquidity crisis currently poses challenges for Bahraini banks, as most rely on global banks and capital markets for both treasury management and generating funding.
Another major risk is the possibility of a significant rise in corporate default rates in the US and Europe in the event of a prolonged recession.
Though generally safe from the 'toxic' structured products the kingdom's banks have exposure in US and European high-grade corporate bonds, says Bahrain-headquartered Securities & Investment Company (Sico).
A default rate rise or sharp price decline could lead to a further increase in write downs. Finally, further falls in oil prices pose another risk to the growth Bahrain's economy and consequently the banking sector.
It is in this context Bahrain is planning to set up a safety-net fund to guarantee bank customers' deposits in the event of a collapse, which is a model that other GCC countries can follow.
The idea is simple. Banks will pay into a fund, which will in turn pay out to customers, should any bank collapse.
The plan has been drawn up by the Central Bank of Bahrain (CBB).
The fund would mean depositors would have rapid access to the cash they were owed.
Meanwhile, Standard & Poor's Ratings Services has revised its outlooks on six banks in the Gulf to stable from positive.
At the same time, it affirmed its long- and short-term counterparty credit ratings and various debt ratings on these banks.
The banks S&P's took the rating actions on are Emirates Bank International, National Bank of Dubai, Kuwait Finance House, Burgan Bank, Bank Muscat and BMI Bank.
The outlook revisions mainly reflect the less supportive environment in which these banks operate, says S&P's credit analyst Emmanuel Volland.
The impact of the global market turmoil, plunging oil prices, falling stock markets and the liquidity dry-up is creating fresh challenges for GCC banks in terms of business growth, profitability, asset quality, and liquidity.
These developments, combined with specific factors at each bank, reduce the likelihood of near-term upgrades for these banks.
"We believe the macroeconomic fundamentals of the GCC countries remain sound. But the expected economic slowdown and tighter liquidity in the region's financial markets will dampen GCC banking systems' performances for the rest of this year and throughout next year," says Volland.
However, global rating agency Fitch Ratings says the banking system in the Gulf Co-operation Council (GCC) is among the world's strongest and at par with the typical developed-country systems.
Fitch rates banking systems of the UAE, Saudi, Kuwait, Qatar and Bahrain among the top 10 strongest among the emerging market systems in its "Bank Systemic Risk Report".
The Gulf countries' banking system is at par with the US, UK, Germany, Switzerland, Japan and Singapore.
Fitch says the GCC is one of the few regions in the world where credit growth accelerated this year. Nominal credit growth in the Gulf increased from an average 25 per cent in 2006 to 36 per cent in 2007 and to 44 per cent in the first half of this year.
The fastest acceleration has been in Oman, but credit growth has also accelerated sharply in the UAE, Bahrain and Saudi Arabia. By contrast, credit growth has stabilised in Qatar, though at a high 52 per cent. Kuwait is the only country where credit growth has slowed this year, as regulatory constraints bite.
Liquidity conditions have tightened in the Gulf over the summer.
Fitch believes it was a deliberate policy move as the authorities increased sales of government and central bank paper.
It also reflects the exit of speculative funds, which had built up at the end of 2007 in expectation of a revaluation of GCC exchange rates against a weakening dollar.
Revaluation was one potential policy option to offset the monetary loosening implied by the region's dollar pegs.
The strengthening in the US dollar over the summer, combined with a restatement of the GCC intention to move to a common currency led these speculative funds to leave.
The turmoil in the US and European financial markets has had some impact on external funding, though in general GCC banks have not been reliant on interbank or capital market funding, Fitch says.
The Qatar Investment Authority, meanwhile, has announced it will contribute 10 to 20 per cent of additional capital to its banks.
Fitch continues to regard GCC banking systems as generally strong. The rating agency said strengths include competent supervision, healthy profitability, sound asset quality and capitalisation as well as a largely retail deposit base.
However, there are some signs of asset quality deterioration in the retail books in much of the region. A correction in property markets is a risk factor for the region's banks. But Fitch believes any impact on asset quality as manageable by the regional banks.
Fitch believes credit growth slowdown in the wider Middle East and Africa (MEA) region is expected to be less pronounced.
