## _cr04151

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### Overall assessment: financial stability, regulation, and supervision
- Authorities maintained financial system stability despite large fluctuations in oil prices, regional security threats, large swings in the local equities market, and moral hazard and rent seeking.
- Regulation and supervision safeguarded banking-sector stability, but vigorous regulatory and institutional reform—especially in the securities sector—is desirable to ensure continued stability and greater efficiency.
- Kuwait possesses sufficient wealth to offset even a major financial crisis without affecting present consumption levels, but policies should aim to avoid resource waste and burdens on future generations.
- Prudent fiscal and monetary policies, and an open exchange and trade system, have kept inflation low and domestic incomes stable despite global oil price volatility.
- Structural pressures noted: escalating social welfare burdens, government employment policies amid rapid population growth, and greater international integration require wide-ranging structural reforms.

### Banking sector soundness and supervisory framework
- Soundness indicators and structure:
  - Capitalization, asset quality, earnings, and liquidity described as strong.
  - CBK supervision “conforms in most respects to international standards.”
  - Seven commercial banks; one operates under Islamic law; two specialized (industry and real estate); one branch of a foreign bank.
  - Two largest banks account for about half of local banks’ total assets, loans and deposits.
  - Local banks’ total assets declined from 168 percent to 159 percent of nominal GDP (1998–2002).
  - Net foreign asset position of Kuwaiti banks narrowed from 9.2 percent of GDP in 1998 to 3.8 percent in 2002.
  - Total short position of the Kuwaiti banking system doubled from 0.4 to 0.8 percent of banks’ capital (1998–2002).
- Supervisory gaps and recommended legal changes:
  - Amend the CBK Law to enhance CBK powers and independence as banking regulator and supervisor.
  - Firmly establish CBK’s ability to conduct consolidated supervision.
  - Remove MoFE influence over CBK decisions on licensing, closure, and certain remedial actions.
  - Grant CBK authority to share confidential supervisory information with appropriate domestic and foreign authorities.
  - Give banking supervisors authority to reject applications for banking licenses when owners do not meet the “fit and proper” test.
- Stress tests (selected findings):
  - Banking system could withstand significant shocks; limited sensitivity to market risk due to short-maturity structure of interest-bearing instruments.
  - Liquidity adequate; large foreign reserves allow lender-of-last-resort support in domestic and foreign currency if necessary.
  - Some institutions sensitive to equity and property price declines; supervisors should monitor exposures and require remedial actions.
  - Stress test results (selected exact figures from Table 4):
    - Pre-shock impaired loans 5.5; pre-shock provision 59.1; pre-shock CAR 18.3.
    - Mild shock, no change in collateral: post-shock impaired loans 6.5; provision 57.6; CAR 18.0; Number of Banks CAR<12 = 0.
    - Severe shock, sectoral shock, 50 percent haircut on collateral: post-shock impaired loans 10.1; provision 75.0; CAR 13.8; Number of Banks CAR<12 = 5.
  - Interpretation: system broadly resilient; shocks must be substantial to threaten system-wide soundness; a few banks show particular vulnerability to collateral value changes.

### Securities market: activity, governance gaps, and priority reforms
- Market activity and recent performance:
  - Equities market among the largest and most active in the Arab world; large swings and weak governance historically.
  - KSE index: previous record high 2,790 (October 1997); bottomed 1,318 (January 2001); ended 2002 at 2,375; reached 4,808 (end-December 2003).
  - Annual trade value: KD 3,584.6 million (end-2001); KD 6,680.3 million (end-2002).
  - Turnover ratios: 50.3 percent (2001); 75.0 percent (2002).
- Regulatory and institutional gaps:
  - Regulation and supervision scattered across multiple laws and agencies; principal agency (MC) lacks adequate powers.
  - No explicit prohibition of market manipulation and insider trading.
  - Inspection, investigation, and surveillance powers materially inadequate and lack a clear process.
  - Entry standards, fit and proper assessments, and prudential pre-requisites are weak; individuals not licensed; no proficiency requirements.
  - Accounting and auditing standards not fully enforced across-the-board.
- Priority recommendations (selected):
  - Create by law a single, independent, and accountable capital market regulatory agency with full powers to develop and regulate the securities market and industry.
  - Prohibit insider trading and market manipulation; establish comprehensive inspection, investigation and surveillance systems.
  - Define entry standards for all types of market intermediaries; subject owners and officers to fit and proper assessments.
  - Build regulator capacity to enforce disclosure requirements and examine compliance with internationally acceptable accounting and auditing standards.
  - Short-run market volatility measures: moral suasion, tightening margin requirements, reinforce supervision of personal and trading credit.

### Insurance sector: size, structure, and supervisory needs
- Market size and structure:
  - Total premium revenue in 2002: KD 94.6 million (about $315 million), or about 1 percent of GDP.
  - Seven Kuwaiti insurance companies; two new insurers operating on Islamic principles; ten foreign insurance branches.
  - Non-life insurance ~75 percent of market; life and health ~25 percent.
  - Four largest national companies collected about 75 percent of total premium income in 2002.
  - National insurers ceded 63 percent of non-life premiums to international reinsurers in 2002 (94 percent for property insurance).
- Business model and vulnerabilities:
  - Domestic insurers rely heavily on reinsurance and act mainly as brokers rather than underwriters.
  - Insurance penetration lower than benchmarks: Kuwait ~1 percent of GDP (2002) vs. emerging markets 3.4 percent and advanced economies 9.0 percent.
- Supervisory framework and recommendations:
  - Supervision rests with the insurance department in the MoCI under a 40-year old law lacking key elements of modern supervision.
  - High-priority recommendations:
    - Enact a revised insurance legal framework including creation of an independent supervisory agency.
    - Strengthen capacity of the insurance department of the MoCI in the near term (hire senior advisor; obtain expert advice on underwriting, liability management and reinsurance; add staff with industry experience).

### AML/CFT assessment: progress, key deficiencies, and action items
- Progress and key deficiencies:
  - Law 35/2002 enacted; subsidiary rules implemented by some regulators, but the legislation has yet to be formally extended to cover the broad financial sector.
  - Financing of terrorism has not been criminalized.
  - FIU located within CBK with no distinct organizational structure; limited independence and constrained ability to share information with foreign counterparts.
  - Standard for filing STRs is “reasonable belief” rather than mere suspicion; leads to limited filings and risk of tipping-off.
  - Vulnerabilities in the fast-growing stock market and in the gold market.
- Priority actions (selected exact recommendations):
  - Formally extend Law 35/2002 to cover the broad financial sector.
  - Exercise more control over ownership of financial institutions.
  - Strengthen procedures for international cooperation in AML/CFT.
  - Criminalize the financing of terrorism.
  - Restructure the FIU to give it greater independence of operation, including the capacity to cooperate with foreign counterparts.
  - Lower the level of suspicion required for filing suspicious transactions reports.
  - Introduce AML regulations for investment companies; issue Ministerial Order to extend coverage of Law 35/2002 to all relevant institutions.
  - Enact new legislation to create an independent, adequately resourced FIU and amend Law 35/2002 to include reporting of outbound cross border movements of currency, gold or other precious materials.
- FATF-related recommended actions (selected):
  - Ratify and implement the Palermo Convention and the 1999 Convention on Suppression of the Financing of Terrorism.
  - Enact legislation to provide for identification, freezing, seizure, and confiscation of terrorist assets.
  - Enact legislation to permit FIU to request from, and share information spontaneously with, foreign counterparts through administrative procedures.

### Monetary operations, money market, and payment system
- Monetary policy framework and instruments:
  - CBK determines and implements monetary policy; objective to ensure exchange rate stability under open exchange and trade system.
  - Exchange rate peg redefined in terms of the U.S. dollar in early 2003.
  - Most active instrument: deposit facility (weekly deposit auction and continuous deposits at CBK-set rates).
  - No reserve requirements; liquidity requirement and maturity ladder used to regulate banks’ liquidity.
  - Temporary liquidity requirement imposed in connection with removal of the implicit government guarantee on deposits.
  - CBK maintains unsecured overnight lending facility at penalty rate unchanged at 10 percent; maintains ceilings on bank lending rates tied to the discount rate.
- Policy recommendations:
  - Develop marketable instruments for open market operations (government bills or bonds, CBK bills, mortgage-backed securities).
  - Reduce reliance on banks’ deposits with CBK by using marketable instruments; simplify and streamline multiple liquid asset requirements; in the medium term, reduce or introduce more flexibility in the 20 percent liquid asset requirement.
  - Ease or remove ceiling on lending rates (Article 111 of the Commercial Law) to improve pricing of risk and facilitate SME lending.
  - Consider tying the marginal lending facility penalty more closely to a market rate.
- Money market specifics:
  - Interbank market averaged approximately KD 3.7 billion (2001) and KD 3.9 billion (2002) per month.
  - Bulk of activity in interbank deposits of one month; most lending unsecured.
- Payment system and RTGS:
  - SC system operated by CBK handles about KD 200 million per day among 11 institutions.
  - SC system does not fully observe Core Principles 2 or 3; Core Principle 9 also not fulfilled.
  - Preparations for RTGS well advanced; implementation target date April 2004 (delayed by military activity in Iraq in early 2003).
  - Recommended actions: continue high priority implementation of RTGS; promulgate regulations on finality characteristics and intra-day liquidity procedures; set participation criteria for RTGS.

### Lender of last resort, deposit guarantee, and resolution framework
- Lender of last resort:
  - Article 41 of the Central Bank Law gives CBK power to provide loans and advances in emergency cases for up to six months with adequate collateral.
  - CBK has not recently used emergency lending; provided broad emergency support in past crises.
- Deposit guarantee and intended policy change:
  - Government implicitly guarantees all bank deposits; authorities intend to remove this implicit guarantee in the near future.
  - Preparatory measures: special liquidity requirements effective October 2003 requiring banks to maintain liquidity ratios varying from 25 percent to 35 percent depending on CAMEL rating and other measures.
  - Authorities do not plan to implement deposit insurance when the guarantee is removed; staff recommends development of a funded deposit insurance scheme for small depositors.
    - Rationale: scheme would not be particularly costly and may be desirable on social policy grounds; absence of deposit insurance may increase likelihood of small depositor runs.
- Resolution powers and suggested reforms:
  - Current measures available to CBK: prohibit certain activities, set business limits, appoint temporary controller, take over management.
  - Closure or merger decisions currently require MoFE approval (Article 63 and Article 65 of Central Bank Law).
  - Proposed CBK Law amendments would strengthen CBK powers (remove or change staff, deem directors unqualified, dissolve boards, appoint commissioner), but revocation of banking license and approval/arrangement of mergers would still require MoFE approval.
  - Staff recommends sole CBK authority to revoke banking licenses and approve or arrange bank mergers to enhance independence and effectiveness.

### Macro environment, oil dependence, and recent performance
- Oil dependence and macro exposure:
  - Oil sector represents almost half of total domestic production.
  - Oil generates 91 percent of export earnings and more than two thirds of government revenue.
  - Fiscal and external balances subject to significant fluctuations due to oil price volatility.
- Recent macro figures and developments:
  - Post-1990–91 recovery: fiscal and external current account balances since mid–1990s reached surpluses on the order of 20 percent of GDP.
  - Inflation fell from about 10 percent a year in the early postwar years to about 2 percent a year since the late 1990s.
  - Government sector constituted 71 percent of GDP in 2002 (ministry of planning).
  - 2002 fiscal surplus (including investment income) estimated at 25 percent of GDP.
  - 2002 external current account surplus estimated at 12 percent of GDP.
  - Broad money growth slowed to 5 percent in 2002 from 13 percent in 2001.
  - Credit to private sector picked up strongly financing personal loans, real estate lending, securities trading.
  - Real GDP estimated to have decreased by about 1 percent in 2002; real GDP estimated to have increased by 10 percent in 2003.
- Key exact indicators (selected from Table 1):
  - Nominal GDP (U.S. dollars millions): 1998 25,945; 1999 30,077; 2000 37,017; 2001 34,236; 2002 35,333; 2003 42,372; 2004 41,621.
  - Kuwait crude export price (U.S. dollar per barrel): 1998 10.3; 1999 16.1; 2000 25.0; 2001 21.2; 2002 22.9; 2003 25.6; 2004 23.5.
  - Real GDP percent changes: 1998 3.6; 1999 -1.7; 2000 1.9; 2001 0.6; 2002 -0.4; 2003 9.9; 2004 1.9.
  - Consumer price index percent changes: 1998 0.1; 1999 3.0; 2000 1.8; 2001 1.7; 2002 1.4; 2003 2.0; 2004 2.0.
  - Current account (U.S. dollars millions): 1998 2,215; 1999 5,013; 2000 14,672; 2001 8,328; 2002 4,190; 2003 8,046; 2004 6,482.
  - International reserve assets (U.S. dollars millions): 1998 4,034; 1999 4,928; 2000 7,170; 2001 9,997; 2002 9,256; 2003 7,348; 2004 8,188.

### Non-bank financial institutions and systemic linkages
- Investment companies and funds (March 2003):
  - 38 investment companies (11 Islamic), 37 investment funds (5 Islamic).
  - Total assets of investment companies and funds ≈ 23 percent of total assets of the financial system.
  - Investment companies’ off-balance sheet activity ≈ KD 5.2 billion (about 41 percent of 2003 GDP).
  - Conventional investment companies concentrated in foreign markets; Islamic investment companies core domestic and growing quickly.
  - Capitalization: conventional investment companies ≈ 30 percent of total assets; Islamic ≈ 32 percent.
  - Investment companies listed on KSE: 27.
- Linkages and risks:
  - Investment companies’ reliance on bank credit rose from 7.5 percent of total liabilities (2000) to about 13 percent (2002).
  - Local banks’ lending to investment companies ≈ 9 percent of local banks’ total lending portfolios and 32 percent of bank stockholders’ equity (end-2002).
  - Some investment companies rely on foreign bank credit lines that could be withdrawn in stress.
  - Recommendation: compile more detailed comprehensive data on bank–investment company–market linkages.

### Legal, governance, and structural issues affecting financial stability
- Legal framework and courts:
  - Many laws date from earlier eras and need updating to support private sector growth and market-based practices.
  - Judiciary broadly efficient, independent, and well paid; insolvency and debt recovery procedures broadly adequate though drawn out at times.
- Corporate governance and company law:
  - Entities subject to CBK supervision and listed companies have adequate governance arrangements.
  - Suggested revision of Law on Commercial Companies (No. 15 of 1960) to improve governance, disclosure, liability of the Board of Directors, and auditors’ roles.
  - Examples of outdated procedures: formation of a shareholding company requires an Amiri Decree; MoCI representative required at shareholder meetings.
- Insolvency and bankruptcy:
  - Bankruptcy provisions could be revised to create more efficient exit mechanisms; reorganizations or workouts rarely used.

### Summary of priority recommendations (Box 1 highlights)
- General:
  - Reduce moral hazard and encourage prudent risk-taking, including elimination of the blanket deposit guarantee, bank bailouts, and bailouts of investors in the stock and real estate markets.
- Banking (selected):
  - Enact amendments to the CBK law to enhance CBK independence and powers; establish consolidated supervision and remedial authority.
  - Continue close monitoring of banks’ lending risks associated with the stock market and real estate; further develop stress testing and supervisory capability.
  - Ease or remove the ceiling on lending rates to enable better risk pricing, including SME lending.
- Securities (selected):
  - Enact a new Capital Markets Law creating a single, independent and accountable authority.
  - Prohibit insider trading and market manipulation; establish inspection, investigation and surveillance systems.
  - Define entry standards and develop a unified code of prudential regulations.
- Insurance (selected):
  - Enact a new insurance law including modern supervision framework and independent agency.
  - Strengthen insurance department capacity in the near term.
- AML/CFT (selected):
  - Formally extend Law 35/2002 to cover the broad financial sector.
  - Strengthen procedures for international cooperation; criminalize financing of terrorism.
- Monetary operations (selected):
  - Reduce reliance on banks’ deposits with CBK by using marketable instruments in monetary operations.
  - Simplify multiple liquid asset requirements; reduce or introduce flexibility in the 20 percent liquid asset requirement.
  - Foster secondary market development.
- Payment system:
  - Continue high priority implementation of the RTGS system; ensure regulations comply with Core Principles 3 and 9 and publicly disclose major policies.

*Source: Kuwaiti authorities; and IMF staff report excerpt (content unit _cr04151).*

### 1. Selected Economic Indicators, 1998–2004....................................................................8

### 1. Selected Economic Indicators, 1998–2004....................................................................8

### Overall assessment: financial stability, regulation, and supervision
- The authorities have succeeded in maintaining financial system stability despite large fluctuations in oil prices, regional security threats, large swings in the local equities market, and moral hazard and rent seeking.
- Regulation and supervision have safeguarded banking-sector stability, but vigorous regulatory and institutional reform—especially in the securities sector—is desirable to ensure continued stability and greater efficiency.
- Kuwait possesses sufficient wealth to offset even a major financial crisis without affecting present consumption levels, but policies should aim to avoid resource waste and burdens on future generations.
- Prudent fiscal and monetary policies, and an open exchange and trade system, have kept inflation low and domestic incomes stable despite global oil price volatility.
- The objective of building official assets for future generations is conducive to stability, but escalating social welfare burdens, government employment policies amid rapid population growth, and greater international integration call for wide-ranging structural reforms.

### Banking sector soundness and supervisory framework
- The banking sector appears sound: capitalization, asset quality, earnings, and liquidity are all described as strong.
- The CBK has established a comprehensive system for banking regulation and supervision that "conforms in most respects to international standards."
- Recommended legal/institutional changes:
  - Amend the CBK Law to enhance CBK powers and independence as banking regulator and supervisor.
  - Firmly establish CBK’s ability to conduct consolidated supervision.
- Stress tests findings:
  - Banking system could withstand significant shocks.
  - Limited sensitivity to market risk due to short-maturity structure of interest-bearing instruments.
  - Exchange rate risk contained by strict enforcement of prudential requirements.
  - Liquidity is adequate; Kuwait’s large foreign reserves allow lender-of-last-resort support in domestic and foreign currency if necessary.
  - Most banks can absorb a fairly pronounced deterioration in asset quality.
  - Some institutions show particular sensitivity to price declines in the equity and property markets; supervisors should monitor exposures and require remedial actions.

### Securities market: activity and governance gaps
- The equities market is among the largest and most active in the Arab world but has historically shown large swings and weak governance structures.
- Equity prices increased markedly over the last year and reached new record highs.
- Regulation and supervision have significant gaps and are scattered across multiple laws and agencies.
- High-priority recommendation: create a single, independent, and accountable capital market regulatory agency to address risks from inadequately regulated market activities.
- Specific supervisory/legal gaps identified: insider trading and market manipulation, auditing and disclosure standards enforcement.

### Insurance sector: small size and regulatory needs
- The insurance sector is small; development is constrained by economic and social policies.
- Government’s predominant role limits the non-life insurance market; generous social welfare reduces demand for private life and health insurance.
- Domestic insurers rely heavily on reinsurance and act mainly as brokers rather than underwriters.
- Regulation and supervision are based on an old law missing key elements of modern insurance supervision.
- High-priority recommendations:
  - Enact a revised insurance legal framework including creation of an independent supervisory agency.
  - Upgrade supervisory capacity; strengthen the capacity of the insurance department of the MoCI in the near term.

### AML/CFT, monetary operations, and crisis management
- AML/CFT framework has recently been strengthened, including enactment of new legislation, but significant vulnerabilities remain and early action is needed.
- Monetary operations have been effective but could be more efficient:
  - CBK uses both market-based and administrative instruments; most active instrument is a deposit auction.
  - Liquidity ratios bind government securities and preclude development of repurchase operations.
  - Recommendation: consider developing marketable instruments for open market operations and support secondary market development.
  - CBK imposes a ceiling on lending rates; the ceiling should be eased or removed.
  - Consider streamlining the monetary operations framework; development and implementation are broadly transparent.
- Systemic liquidity and crisis management:
  - CBK has authority for emergency lending based on collateral; not recently used.
  - Plans exist to lift the implicit blanket guarantee on bank deposits, accompanied by steps to avoid liquidity problems.
  - CBK decided against coupling lifting the guarantee with establishing formal deposit insurance due to prevalence of large deposits; this leaves open potential responses to bank runs.
  - Introducing coverage for small deposits remains an option given many small depositors whose aggregate holdings are a small share of total.
  - CBK has various powers to deal with problem banks; it would be desirable for CBK to have sole power to revoke banking licenses and arrange bank mergers (currently require minister of finance approval).

### Box 1. Priority Recommendations
- General:
  - Take steps to reduce moral hazard and encourage prudent risk-taking, including elimination of the blanket deposit guarantee, bank bailouts, and bailouts of investors in the stock and real estate markets.
- Banking:
  - (i) Enact amendments to the CBK law to enhance CBK independence and powers, establish consolidated supervision and remedial authority.
  - (ii) Continue close monitoring of banks’ lending risk associated with the stock market and real estate sectors; further develop stress testing procedures and supervisory capability; be prepared to take quick supervisory action if necessary.
  - (iii) Ease or remove the ceiling on lending rates to enable lenders to better price risks, including SME lending.
  - (iv) Seek authority to share confidential supervisory information with appropriate domestic and foreign authorities.
- Securities:
  - (i) Enact a new Capital Markets Law creating a single, independent and accountable authority with full powers to develop and regulate the securities market and industry.
  - (ii) Prohibit insider trading and market manipulation; enforce prohibitions by establishing comprehensive inspection, investigation and surveillance systems.
  - (iii) Define entry standards for all types of market intermediaries.
  - (iv) Develop a unified code of prudential regulations.
  - (v) Allow the market to diversify product lines and liberalize participation of foreign intermediaries.
- Insurance:
  - (i) Enact a new insurance law including elements of a modern insurance supervision framework and independent status for the supervisory agency.
  - (ii) Strengthen capacity of the insurance department of the MoCI in the near term.
- AML/CFT:
  - (i) Formally extend Law 35/2002 to cover the broad financial sector.
  - (ii) Exercise more control over ownership of financial institutions.
  - (iii) Strengthen procedures for international cooperation in AML/CFT.
  - (iv) Criminalize the financing of terrorism.
- Monetary operations:
  - (i) In liquidity management, reduce reliance on banks’ deposits with CBK by using marketable instruments in monetary operations.
  - (ii) Simplify and streamline multiple liquid asset requirements; in the medium term, reduce or introduce more flexibility in the 20 percent liquid asset requirement (e.g., counting deposits with the CBK and permitting banks to meet the requirement on average over time rather than every day).
  - (iii) Building on the preceding steps, foster secondary market development.
- Payment system:
  - Continue high priority implementation of the RTGS system, ensuring regulations comply with Core Principles 3 and 9 and publicly disclose major policies.

### Macro environment: recovery, oil dependence, and recent performance
- Post-1990–91 war recovery:
  - Oil production and exports restored; fiscal and external current account balances since the mid–1990s reached surpluses on the order of 20 percent of GDP.
  - Stock of foreign assets recovered; infrastructure rebuilt; public debt substantially reduced.
  - Inflation fell from about 10 percent a year in the early postwar years to about 2 percent a year since the late 1990s.
  - Government sector dominated economic activities; ministry of planning reports government sector constituted 71 percent of GDP in 2002.
- 2002–03 developments:
  - Fiscal surplus (including investment income) estimated at 25 percent of GDP in 2002.
  - External current account surplus estimated at 12 percent of GDP in 2002 (Table 1).
  - Net foreign assets of the CBK declined to the equivalent of about eight months of prospective imports of goods and services.
  - Growth of broad money slowed to 5 percent in 2002 from 13 percent in 2001.
  - Credit to the private sector picked up strongly, financing personal loans, real estate lending, securities trading, and loans to nonbank financial institutions, with limited impact on non-oil GDP growth.
  - Real GDP estimated to have decreased by about 1 percent in 2002, mainly from a drop in oil production in line with OPEC mandates; real non-oil GDP growth remained sluggish.
  - 2003: real GDP estimated to have increased by 10 percent; external current account and fiscal surpluses at 19 percent of GDP.

### Table 1: Key selected economic indicators, 1998–2004 (highlights preserved exactly as reported)
- Nominal GDP (market prices, U.S. dollars millions)
  - 1998 25,945
  - 1999 30,077
  - 2000 37,017
  - 2001 34,236
  - 2002 35,333
  - 2003 42,372
  - 2004 41,621
- Crude oil production (millions barrels per day)
  - 1998 1.87
  - 1999 1.98
  - 2000 1.95
  - 2001 1.75
  - 2002 2.03
  - 2003 1.97
- Kuwait crude export price (U.S. dollar per barrel)
  - 1998 10.3
  - 1999 16.1
  - 2000 25.0
  - 2001 21.2
  - 2002 22.9
  - 2003 25.6
  - 2004 23.5
- Percent changes (selected)
  - Nominal GDP: -14.1 (1998), 16.0 (1999), 23.8 (2000), -7.6 (2001), 2.3 (2002), 18.2 (2003), -1.8 (2004)
  - Nominal non-oil GDP: 5.9 (1998), 3.9 (1999), 3.5 (2000), 4.2 (2001), 6.6 (2002), 7.1 (2003), 6.4 (2004)
  - Real GDP: 3.6 (1998), -1.7 (1999), 1.9 (2000), 0.6 (2001), -0.4 (2002), 9.9 (2003), 1.9 (2004)
  - Consumer price index: 0.1 (1998), 3.0 (1999), 1.8 (2000), 1.7 (2001), 1.4 (2002), 2.0 (2003), 2.0 (2004)
- Public finance (In percent of GDP)
  - Total revenue, of which: 46.4 (1998), 68.7 (1999), 77.8 (2000), 66.3 (2001), 68.6 (2002), 61.3 (2003), 57.6 (2004)
  - Oil and gas revenue: 26.4 (1998), 46.7 (1999), 55.3 (2000), 42.9 (2001), 49.0 (2002), 42.3 (2003), 38.2 (2004)
  - Investment income 2/: 16.6 (1998), 19.3 (1999), 18.2 (2000), 16.6 (2001), 14.4 (2002), 14.2 (2003), 14.7 (2004)
  - Total expenditure: 48.7 (1998), 39.5 (1999), 39.2 (2000), 44.8 (2001), 43.2 (2002), 42.6 (2003), 44.1 (2004)
  - Fiscal balance (deficit -): -2.3 (1998), 29.3 (1999), 38.7 (2000), 21.5 (2001), 24.6 (2002), 18.6 (2003), 13.6 (2004)
  - Fiscal balance excluding investment income (deficit -): -18.9 (1998), 10.0 (1999), 20.5 (2000), 4.9 (2001), 10.2 (2002), 4.4 (2003), -1.2 (2004)
- Money and credit (Changes in percent of beginning broad money stock)
  - Foreign assets (net): -1.9 (1998), 1.5 (1999), 11.4 (2000), 6.5 (2001), -4.1 (2002), -3.4 (2003), 3.7 (2004)
  - Domestic assets (net): 1.1 (1998), 0.1 (1999), -5.1 (2000), 6.3 (2001), 8.8 (2002), 16.0 (2003), 3.7 (2004)
  - Claims on government (net): -1.4 (1998), -2.7 (1999), -7.3 (2000), -4.1 (2001), 0.2 (2002), -3.5 (2003), -2.0 (2004)
  - Claims on nongovernment sector: 7.3 (1998), 3.6 (1999), 3.9 (2000), 12.0 (2001), 10.6 (2002), 18.5 (2003), 5.6 (2004)
  - Broad money: -0.8 (1998), 1.6 (1999), 6.3 (2000), 12.8 (2001), 4.8 (2002), 12.5 (2003), 7.3 (2004)
- Interest rates (Percent per year)
  - Kuwaiti dinar three-month deposits: 5.9 (1998), 5.3 (1999), 5.4 (2000), 3.7 (2001), 2.2 (2002), 1.5 (2003), ...
  - U.S. dollar three-month deposits: 5.1 (1998), 4.9 (1999), 6.0 (2000), 3.3 (2001), 1.3 (2002), 0.7 (2003), ...
- External sector (U.S. dollars millions)
  - Exports: 9,616 (1998), 12,225 (1999), 19,476 (2000), 16,246 (2001), 15,365 (2002), 20,992 (2003), 19,045 (2004)
  - Of which: oil and refined products: 8,470 (1998), 11,027 (1999), 18,184 (2000), 14,976 (2001), 14,058 (2002), 18,784 (2003), 16,736 (2004)
  - Imports: -7,715 (1998), -6,708 (1999), -6,451 (2000), -7,049 (2001), -8,118 (2002), -10,241 (2003), -10,896 (2004)
  - Current account: 2,215 (1998), 5,013 (1999), 14,672 (2000), 8,328 (2001), 4,190 (2002), 8,046 (2003), 6,482 (2004)
    - In percent of GDP: 8.5 (1998), 16.6 (1999), 39.6 (2000), 24.3 (2001), 11.9 (2002), 19.0 (2003), 15.6 (2004)
  - Overall balance: 288 (1998), 894 (1999), 2,241 (2000), 2,827 (2001), -741 (2002), -1,907 (2003), 840 (2004)
    - In percent of GDP: 1.1 (1998), 3.0 (1999), 6.1 (2000), 8.3 (2001), -2.1 (2002), -4.5 (2003), 2.0 (2004)
  - International reserve assets: 4,034 (1998), 4,928 (1999), 7,170 (2000), 9,997 (2001), 9,256 (2002), 7,348 (2003), 8,188 (2004)
    - In months of imports of goods and services: 5.0 (1998), 7.4 (1999), 9.7 (2000), 8.3 (2001), 5.6 (2002), 6.0 (2003)
  - Total external debt (incl private sector): 9,938 (1998), 10,057 (1999), 9,955 (2000), 11,095 (2001), 12,939 (2002), 12,480 (2003), 12,847 (2004)
    - In percent of GDP: 38.3 (1998), 33.4 (1999), 26.9 (2000), 32.4 (2001), 36.6 (2002), 29.5 (2003), 30.9 (2004)
- Exchange rates (Percent changes)
  - Exchange rate (U.S. dollars per KD, period average): 3.28 (1998), 3.28 (1999), 3.26 (2000), 3.26 (2001), 3.29 (2002), 3.34 (2003), 3.34 (2004)
  - Nominal effective exchange rate: 5.5 (1998), -0.6 (1999), 4.7 (2000), 5.8 (2001), -0.7 (2002), -6.1 (2003), ...
  - Real effective exchange rate: 3.0 (1998), 0.9 (1999), 4.1 (2000), 5.1 (2001), -1.0 (2002), -6.8 (2003), ...

*Source: Data provided by the authorities; and staff estimates. (Fiscal numbers note: fiscal year changed from July–June to April–March effective 2001/02. Investment income includes profit of public enterprises. Interest rates and exchange rate entries for 2003 are partial series as noted in the table.)*

### 13.      In the years ahead, the Kuwaiti authorities will face difficult decisions. Kuwait’s fiscal

### _cr04151 - 13.      In the years ahead, the Kuwaiti authorities will face difficult decisions. Kuwait’s fiscal

### Overview of the financial system
- The Kuwaiti financial system is sizeable and well developed, including commercial and specialized banks, a growing number of financial companies and investment funds, insurance companies, and an active stock exchange.
- At the end of 2002:
  - Total assets of financial institutions amounted to more than 200 percent of GDP.
  - Stock market capitalization reached about 100 percent of GDP.
- Establishment of new banks domestically is restricted, but there is adequate competition in financial markets, with the exception of the insurance sector.

### Banking system — structure and performance
- Sector composition and ownership:
  - Seven commercial banks: one operates under Islamic law, two are specialized (industry and real estate), and one is a branch of a foreign bank.
  - Government directly or indirectly holds controlling interests in two banks; most banks are privately owned and usually controlled by related shareholder groups; only one bank has diffuse ownership.
  - Cross participation among banks, and between banks and other financial institutions, seems limited.
  - Market concentration: the two largest banks account for about half of local banks’ total assets, loans and deposits.
  - No evidence of oligopolistic practices reported.
- Growth and funding:
  - In 1998–2002, local banks’ total assets grew broadly at the same rate as nominal GDP, mainly driven by loans to customers.
  - Local banks’ total assets slightly declined from 168 percent to 159 percent of nominal GDP over this period.
  - Banking activity is still primarily funded by retail deposits, though foreign funding has increased.
  - Net foreign asset position of Kuwaiti banks narrowed from 9.2 percent of GDP in 1998 to 3.8 percent in 2002.
  - Over the same period, the total short position of the Kuwaiti banking system doubled from 0.4 to 0.8 percent of banks’ capital.
- Profitability and costs:
  - Average rates of return on both banks’ assets and equities showed an upward trend interrupted in 2002.
  - Operating costs have remained broadly under control, although personnel expenses are quite significant in a few banks.
- Supervision and regulatory compliance:
  - The CBK strictly enforces prudential safety and soundness requirements through on-site and off-site supervision and has developed an early warning system.
  - CBK requires banks to institute comprehensive risk management programs addressing credit, liquidity, interest, market, and operational risks.
  - Legislation was recently enacted to bring Islamic financial institutions under CBK supervision (see Box 2).
  - An update of the 2000 assessment of the Basel Core Principles shows Kuwait as compliant or largely compliant with most principles and subprinciples.
  - CBK is not yet compliant with principles related to consolidated supervision, information sharing, share transfers, international cooperation, and operations of foreign banks.
  - Issues identified:
    - Inability to share confidential supervisory information with appropriate governmental authorities and foreign bank supervisors.
    - Foreign investment laws should be amended to provide for the entry of foreign banks, while CBK must assess effects on banking soundness.
    - Involvement of the MoFE in CBK decisions on licensing, closure, and administrative actions could compromise CBK independence; legislative changes to eliminate MoFE involvement should be considered.
  - Legislation currently before the national assembly, if enacted, would correct several issues identified.

### Non-bank financial institutions
- Size and composition as of March 2003:
  - 38 investment companies, 11 operating in accordance with Islamic law.
  - 37 investment funds, 5 of which under Islamic law.
  - Total assets of investment companies and funds amounted to about 23 percent of the total assets of the financial system (without fully considering off-balance sheet activity).
  - Investment companies’ off-balance sheet activity amounted to some KD 5.2 billion (about 41 percent of 2003 GDP), part of which is invested in domestic investment funds.
- Business orientation and capitalization:
  - Conventional investment companies: activity heavily concentrated in foreign markets.
  - Islamic investment companies: core business is domestic and have been growing quickly in recent years.
  - In aggregate, conventional and Islamic investment companies are well-capitalized at about 30 and 32 percent of their respective total assets.
- Supervision and market listing:
  - Investment companies are licensed and supervised by the CBK.
  - 27 investment companies are listed on the KSE and subject to KSE rules and regulations.

Box 2. Regulation and Supervision of Islamic Financial Institutions (summary of key points)
- Under Kuwaiti law, the CBK is responsible for supervision, regulation, and licensing of deposit and non-deposit taking financial institutions, including investment houses operating under Islamic principles.
- Historically, Islamic banks were not subject to CBK registration and supervision; the existing Islamic bank had voluntarily adhered to CBK prudential regulations but was not legally within CBK supervisory jurisdiction and was not subject to on-site inspections.
- Recently enacted legislation (effective December 2003) brings all Islamic banks under CBK supervision and provides for licensing of new Islamic banks by the CBK:
  - The existing Islamic bank has six months from the effective date to file for an Islamic banking license with the CBK.
  - Once a license is issued, the bank becomes subject to CBK supervision.
  - The CBK announced it would initially limit to three the number of Islamic banks it will license to promote competition and allow refinement of supervisory policies.
- CBK actions and supervisory gaps:
  - CBK has developed examination programs and procedures for Islamic banks.
  - Areas needing strengthening: assessment of liquidity, regulatory standards for transparency and disclosure, and the Islamic legal underpinnings of financial transactions.
  - Further review of existing regulations is needed to ensure specific risks in Islamic banking are adequately addressed.
  - CBK states its staff has adequate understanding of Islamic finance principles through outside training and experience supervising Islamic investment houses.

### Securities markets — structure, performance, and regulatory gaps
- Historical and market activity:
  - First official stock exchange (OTC) opened in April 1977; reorganized as the KSE under an Amiri Decree of 1983 after the Suq al Manakh crisis.
  - Reopened in September 1992 after suspension during the Iraqi invasion; a forward market was reintroduced in 1998.
  - Trading on the KSE opened to GCC citizens in May 1988 and to all foreigners in August 2000.
  - Annual trade value:
    - KD 3,584.6 million at end-2001.
    - KD 6,680.3 million at end-2002.
  - Turnover ratios:
    - 50.3 percent (2001).
    - 75.0 percent (2002).
- Market indices and recent performance:
  - KSE Index history:
    - Previous record high 2,790 points in October 1997.
    - Dropped and bottomed at 1,318 points in January 2001.
    - Ended 2002 at 2,375.
    - Reached a new record high of 4,808 at end-December 2003—slightly more than doubling in 12 months.
- Market infrastructure:
  - Complemented by a clearing, settlement and depository company (KCC), stock brokers, and investment companies.
  - KATS fully automates trading (introduced 1995); KCC carries out settlements and safekeeps securities.
  - 13 stockbrokers licensed to intermediate trades; their functions limited to order executions through KATS and administrative operations; prohibited from providing investment advice.
  - Other capital market activities (investment advisory and fund management by investment companies) are either unregulated or outside MC jurisdiction and are supervised by the CBK.
- Regulatory deficiencies relative to IOSCO objectives and principles:
  - Lack of an appropriate legal and institutional framework due to multiplicity of laws and agencies; the principal agency (MC) cannot effectively regulate, develop, ensure efficiency, fairness, and transparency.
  - No explicit prohibition of market manipulation and insider trading.
  - Inspection, investigation, and surveillance powers of the regulating agency are materially inadequate and lack a clear process.
  - Standards for market entry, prudential pre-requisites for licensing, and regulation of the issue market and intermediaries are weak:
    - Individuals are not licensed; no proficiency requirements for service providers.
    - Owners, founders, operators, and managers are not subject to an adequate fit and proper assessment.
  - Internationally accepted accounting and auditing standards are not fully enforced across-the-board; CBK enforces such standards for institutions it supervises.
  - No legal provision requiring auditors of financial service firms to be selected on the basis of eligibility criteria to be developed by the regulating agency.
- Recommended reforms to align with international standards (central measures highlighted):
  - Creation by law of a single, independent, and accountable authority with full powers to regulate, supervise, and develop the securities market.
  - Develop rules, regulations, and systems to deter and detect unlawful and fraudulent practices; prohibit insider trading and market manipulation by law and establish inspection, investigation, and surveillance systems.
  - Define entry standards for all types of market intermediaries; provide prudential regulations governing licensing, supervision, and performance; subject owners and officers to fit and proper conditions to be developed by the regulator.
  - Build regulator capacity to enforce disclosure requirements and examine compliance of auditors and audited companies with internationally acceptable accounting and auditing standards.
  - Arrange continuing training programs for regulator staff.
- Market volatility mitigation:
  - Short-run measures may include moral suasion, tightening margin requirements, and reinforcing supervision of personal and trading credit (CBK issued guidance in the second half of 2003).
  - Direct restrictions on or intervention in the market are deemed unnecessary and not advisable.

### Insurance sector
- Size and penetration:
  - Total premium revenue in 2002: KD 94.6 million (about $315 million), or about 1 percent of GDP.
  - Insurance penetration compared with benchmarks:
    - In line with other Gulf states.
    - Significantly lower than 3.4 percent of GDP for emerging markets and 9.0 percent for advanced economies.
- Market structure:
  - Seven Kuwaiti insurance companies, including two new insurers operating on Islamic principles.
  - Ten foreign insurance branches from Arab and western countries.
  - Non-life insurance products account for about 75 percent of the market; life and health insurance account for the remainder.
  - The four largest national companies collected about 75 percent of total premium income in 2002, benefiting from requirement that only national companies may bid for insurance contracts from government-owned companies.
- Reinsurance and business model:
  - In 2002, national insurance companies ceded 63 percent of their non-life premiums to international reinsurance companies (94 percent for property insurance).
  - National insurance companies function more as insurance brokers than underwriters.
  - The four largest national companies are highly capitalized and profitable, earning most income from investments and reinsurance commissions rather than underwriting for their own account.

*Source: Kuwaiti authorities (content unit _cr04151).*

### 27.      Supervision of the insurance sector rests with the insurance department in the

### _cr04151 - 27.      Supervision of the insurance sector rests with the insurance department in the

### Insurance supervision: assessment and recommendations
- Supervision of the insurance sector rests with the insurance department in the MoCI.
- An informal review of the observance of the IAIS core principles for insurance supervision showed:
  - The scope of regulation and supervision is defined by a 40-year old law that lacks many key elements of a modern insurance supervision regime.
  - The law includes adequate provisions for financial reporting and on-site inspections, as well as a (high) minimum capital requirement and deposit reserve requirements.
  - The focus of the law is on regulation and compliance; the supervisor does not have the mandate, powers, or capacity to undertake a thorough analysis of possible financial and operational risks.
- Recommendations to strengthen supervision and enhance independence:
  - Create an independent agency.
  - Even short of creating an independent agency, enhance DI’s capacity by:
    - hiring a senior advisor with expertise in insurance supervision;
    - obtaining expert advice on developing supervisory guidelines for underwriting, liability management and reinsurance;
    - adding staff with industry experience.

### Anti‑Money Laundering/Combating the Financing of Terrorism (AML/CFT): status and gaps
- Progress and remaining deficiencies:
  - Kuwait’s AML system has been reinforced, but some significant deficiencies remain in the legal and regulatory framework.
  - Major development: enactment of Law 35/2002, combined with implementation of subsidiary rules by some regulators.
  - The legislation has yet to be extended formally to cover the broad financial sector.
  - Distinct variations exist in the level of compliance testing applied to different sectors, with notable weaknesses in the gold and equities markets.
  - The financing of terrorism has not been criminalized, although authorities have taken robust measures to prevent the abuse of charitable organizations.
- Urgent further work required:
  - Restructure the FIU to give it greater independence of operation, including the capacity to cooperate with foreign counterparts.
  - Lower the level of suspicion required for the filing of suspicious transactions reports.
  - Implement adequate “fit and proper” tests for the ownership and management of non-bank financial institutions.
  - Criminalize insider dealing and market manipulation.
  - Create effective gateways and procedures for international co-operation with respect to both mutual legal assistance and regulator-to-regulator exchange of information.
  - Incorporate explicit provisions relating to the financing of terrorism in national law.

### Monetary instruments and operations: framework and practices
- Institutional setting:
  - Monetary policy in Kuwait is determined and implemented by the CBK in accordance with the Central Bank Law.
  - The CBK has considerable operational independence, although by law the CBK board’s decisions on monetary and credit policies can be suspended and sent for referral to the MoFE, which can issue binding instructions to the CBK board.
  - The CBK’s principal monetary policy objective: ensure the stability of the exchange rate under an open and liberalized exchange and trade system.
  - In early 2003, the exchange rate peg was redefined in terms of the U.S. dollar in line with the decision of the GCC.
  - As a short-term objective, the CBK also aims to stabilize interest rates, particularly the 30-day interbank rate.
- Instruments and operational details:
  - The CBK relies on both market-based and administrative instruments.
  - Most actively used instrument: deposit facility.
    - The CBK conducts a weekly deposit auction for banks; and throughout the week permits banks to deposit as much as they wish at rates set by the CBK, generally slightly below the interbank rate.
    - These instruments are used both to absorb liquidity and, within limits, to add liquidity.
  - The CBK does not impose any reserve requirements, but uses a liquidity requirement and a maturity ladder to regulate banks’ liquidity.
  - A temporary liquidity requirement that depends on the risk characteristics of each bank has been imposed in connection with the removal of the implicit government guarantee on deposits.
  - The CBK maintains an unsecured overnight lending facility at a penalty rate, which has for some time been unchanged at 10 percent.
  - The CBK maintains ceilings on bank lending rates that are tied to the discount rate.
  - The CBK is working on bringing the Islamic banks into the monetary framework (the major Islamic bank does not participate in the CBK’s deposit facility, nor does it hold government securities).
- Policy observations and recommendations:
  - Use of marketable instruments in monetary operations could foster financial market development.
    - Securities that could be used include government bills or bonds, CBK bills (which would need to be reintroduced), or mortgage-backed securities (if and when such a market develops).
    - At present the CBK has no government securities in its portfolio for open market operations; most government securities are needed by the banks to meet the liquidity requirement.
    - The aggregate amount of treasury bills and bonds outstanding may be becoming insufficient for banks to meet the liquidity requirements.
    - Development of open market operations would require supporting measures to ensure adequate supplies are available for monetary operations.
  - It would be desirable to ease or remove lending rate ceilings to:
    - facilitate increased lending to SMEs;
    - lead to better pricing of risks;
    - support efficient private sector growth.
  - The CBK has been abolishing the rigid interest rate structure; the ceiling on lending rates remains as a legal requirement (Article 111 of the Commercial Law) and removal will require amendment of the Commercial Law.
  - The CBK might consider reducing the penalty on the marginal lending facility and tie it more closely to a market rate to reduce volatility in the interbank overnight rate.
- Transparency:
  - Monetary policy transparency is relatively high.
  - Roles, responsibilities, and objectives of the CBK are clearly spelled out in the CBK Law and disseminated via the CBK’s website, annual reports, and other means.
  - The process for reporting monetary decisions is well-developed but could be more comprehensive:
    - Meetings of the Board of Directors when it considers monetary policy issues could be announced in advance and reported on more systematically.
  - Governor and other high officials devote considerable time to keeping the public informed, including speeches on the CBK’s website.
  - Accountability and assurances of integrity by the CBK are good, including regular financial reporting and appearance of officials before the national assembly.
  - Areas for improvement include more public disclosure relating to the conduct of personal financial affairs of CBK staff and legal protections for CBK staff in the conduct of their official duties.

### Money market: activity and constraints
- The interbank money market is fairly active but constrained by several factors, including high levels of bank liquidity.
- Market characteristics:
  - A few major corporate customers participate; foreign banks are not allowed to borrow but may lend.
  - Total volume in the interbank market averaged approximately KD 3.7 billion and 3.9 billion per month in 2001 and 2002, respectively.
  - Bulk of activity in interbank deposits of one month; some deposits are for three months, one week, and overnight.
  - Most lending is unsecured; participants set individual limits on counterparties.
  - The CBK frequently auctions treasury bills of three and six months’ maturity in the primary market.

### Payment system: structure, deficiencies, and recommended actions
- Retail and bank-to-bank usage:
  - The Kuwaiti payment system is still strongly oriented to the use of banknotes for retail-level transactions; checks continue to play a role in the settlement procedures of the equity clearing system and loan sharking.
  - Banking community has made significant progress toward electronic transactions.
  - For bank-to-bank transactions, the SC system operated by the CBK for 11 institutions handles about 200 million KD per day among the banks and is systemically significant.
- Compliance with Core Principles and governance:
  - The SC system does not fully observe 2 or 3 of the 10 Core Principles for systemically important payment systems, primarily those relating to the completeness of the system rules and procedures and to governance arrangements.
  - The SC system appears to satisfy the immediate needs of its users.
- Oversight and RTGS development:
  - Oversight and development of the payment system rests with the CBK, as specified in the CBK Law.
  - The CBK has discouraged the use of paper checks and encouraged a national banking community network for shared ATMs and POS terminals.
  - The CBK has managed the construction of the RTGS system to permit large value transfers to clear and settle with immediate finality.
  - Preparations for the RTGS system are well advanced; implementation was delayed by military activity in Iraq in early 2003. The commencement of RTGS operations now has a target date of April 2004.
  - Steps taken have not been accompanied by clearly stated policy objectives and plans for the payment system.
  - The CBK has disclosed its decision to introduce an RTGS system to a wide range of bodies, public and private.
  - The CBK should set out at least a short statement of plans and policies for the payment system, including promulgation of regulations on the finality characteristics of the RTGS transfers and procedures if intra-day liquidity injections are required.
- Additional improvements advised:
  - Core Principle 3 (clearly defined procedures for management of credit risk) has not been fulfilled for the existing SC system; this could give rise to moral hazard.
    - This could be addressed by regulations for the SC (and the RTGS system, when live) including reference to CBK supervision requirements for policies relating to credit risk.
  - Core Principle 9 (objective and publicly disclosed criteria for participation) has not been fulfilled.
    - The desire of newly created Islamic institutions and additional branches of banks from other GCC countries for participation will render this lack of transparency more problematic.
    - CBK recognition of this issue: criteria will be developed for participation in the RTGS system.

### Lender of last resort and deposit insurance
- Lender of last resort:
  - In recent years, the CBK has not needed to provide emergency lending to the banking sector.
  - Contingency procedures exist; Article 41 of the Central Bank Law gives the CBK power to provide loans and advances in emergency cases for a period of up to six months, with collateral considered to be adequate by the CBK.
  - In past crises (Suq al Manakh in 1982, Iraqi invasion in 1990) the CBK provided broad emergency support.
- Deposit guarantee and policy intentions:
  - The government now implicitly guarantees all bank deposits in Kuwait, although the authorities intend to remove this implicit guarantee in the near future.
  - In 1992 the government publicly committed to guarantee all bank deposits to restore confidence; the guarantee was not formalized in law.
  - Market participants operate under the assumption the full guarantee remains in place; banks previously received assistance when they experienced problems.
  - Authorities recognize the current system increases moral hazard, reduces market discipline, and could prove costly to the government; they intend to remove the guarantee and communicate this decision to the public.
- Preparatory measures:
  - Banking supervision department reinforced liquidity requirements on banks in preparation for removal of the guarantee.
  - Special liquidity requirements effective October 2003 require banks to maintain a liquidity ratio that varies from 25 percent to 35 percent, depending on the bank’s CAMEL rating and other measures of financial strength.
- Deposit insurance stance and staff recommendation:
  - Authorities do not plan to implement deposit insurance when the guarantee is removed, reasoning that the bulk of deposits are held by large depositors who, owing to cost considerations, would probably not be covered by any deposit insurance scheme.
  - Small depositors do not account for a very significant proportion of total deposits, are not seen as a threat to systemic stability, and might be compensated in ways other than by deposit insurance.
  - Staff recommends development of a funded deposit insurance scheme for small depositors:
    - Such a scheme would not be particularly costly and may be desirable on social policy grounds.
    - In the absence of deposit insurance, the likelihood of a run by small depositors may be increased.
    - If lender-of-last-resort support to potentially insolvent institutions is to be avoided, authorities may need to be prepared to step in with renewed support for depositors if a run is to be stopped.

### Resolution of troubled institutions: powers and suggested reforms
- Existing powers and practices:
  - The CBK believes it has adequate powers for dealing with problem banks should they develop.
  - Current context: emergence of banking problems is unlikely as banks are well-capitalized and closely supervised.
  - Possible CBK actions to prevent failure include:
    - prohibit the bank from engaging in certain activities;
    - set limits on the bank’s business;
    - appoint a temporary controller to supervise the bank;
    - take over management of the bank for a period and determine viability.
  - If these measures proved insufficient, a decision to close a bank or to merge it with another bank would have to be issued by the MoFE based on a recommendation of the Board of Directors of the CBK (Article 63 of the Central Bank Law).
    - Article 65 specifies that if such a decision is rendered to delete a bank from the Register of Banks, after first giving it an opportunity to express its views, the bank must be liquidated.
- Proposed legal amendments and staff recommendations:
  - The proposed amendment to the CBK Law will strengthen CBK powers considerably:
    - If enacted, the CBK would be empowered to remove or change staff, deem a director as unqualified, or dissolve a board of directors and appoint a commissioner to run the bank pending the appointment of a new board.
    - However, revocation of a banking license would still require approval by the MoFE, as would the approval or arrangement of a bank merger.
  - Staff recommends that revocation of the banking license and approval or arrangement of a bank merger be left to the sole decision-making authority of the CBK board to enhance its independence and effectiveness in dealing with troubled banks.
- Historical practice and policy signaling:
  - To date, no bank in Kuwait has been closed or had its license revoked.
  - During systemic crises the CBK and the government supported the entire banking system.
  - CBK officials indicated they would not bail out a troubled bank in the future, and would instead take control of the bank and write the shareholders’ net worth down to zero.
  - The staff encouraged the authorities to inform the banks and the public of this policy.

### Vulnerabilities and soundness of the financial system
- Section heading provided; detailed analysis of specific vulnerabilities is contained in subsequent text beyond the supplied excerpt.

*Source: IMF staff report excerpt.*

### 47.      The Kuwaiti economy is highly dependent on oil and vulnerable to oil price

### _cr04151 - 47.      The Kuwaiti economy is highly dependent on oil and vulnerable to oil price

### Economic dependence and macro vulnerabilities
- The oil sector represents almost half of total domestic production.
- Oil generates 91 percent of export earnings and more than two thirds of government revenue.
- Fiscal and external balances are subject to significant fluctuations due to oil price volatility.
- The direct exposure of Kuwaiti banks to the oil sector is modest.
- The government seeks to protect the economy from fluctuations in oil prices through its stabilization fund.
- Recent stock market run-up reflects high liquidity, declining interest rates, and limited private sector investment opportunities; the index reached new highs in 2002 and doubled again in 2003.
- A sharp decline in equity prices could cause insolvency of some investors, lower net worth of firms and households, reduce economic activity, increase NPLs, and tighten bank credit.
- Real estate activity: sales of property increased by 56 percent in 2002.
- Real estate lending by commercial banks increased by 25 percent in 2003 (12 months change to June).
- A decline in real estate prices (triggered by an interest rate hike or a drop in stock market prices) would lead to a decline in collateral values and an increase in NPLs.

### Banking sector soundness (summary of indicators and trends)
- Overall assessment: Kuwaiti banks are by and large well capitalized, highly liquid, and asset quality has improved over time, albeit unevenly.
- Average CAR remains well above the statutory minimum of 12 percent despite a downward trend.
- Impaired loans for the banking system almost halved, declining to 5.4 percent of gross loans by the first quarter of this year.
- Specific provisions reached, on average, 60 percent of total impaired loans (note: if general provisions are considered, the coverage ratio jumps to 91 percent).
- Specific provision coverage varies among banks: as of March this year it ranged between 16 percent and 75 percent.
- Despite a recent decline, Kuwaiti banks’ liquidity position is, on average, strong.
- Market and liquidity risks are limited owing to:
  - Very short-term maturity of financial instruments in the market.
  - Tight controls on banks’ foreign exchange exposure.
  - Limited range of movements in interest rates and exchange rates under the highly credible pegged exchange rate regime.
- Indirect exchange rate risk: almost 20 percent of total loans are in foreign currency and directed to nontradable goods sectors.
- Liquidity caveats: in a few cases liquid assets fall short of the total amount of deposits of the ten largest financial sources; in at least one bank the maturity mismatch might be a source of concern.
- Credit risk sensitivity: banks are more sensitive to credit risk; a significant drop in oil prices combined with sharp corrections in real estate and equity prices could adversely affect financial soundness.

### Financial Soundness Indicators (selected exact figures from Table 3, end of period)
- Regulatory capital to risk-weighted assets (*) by year: 1999 23.7; 2000 22.2; 2001 22.0; 2002 19.7; 2003 19.0.
- Regulatory Tier I capital to risk-weighted assets (*) by year: 1999 22.9; 2000 21.8; 2001 20.7; 2002 18.3; 2003 17.6.
- Capital (net worth) to assets by year: 1999 12.6; 2000 12.4; 2001 12.2; 2002 11.1; 2003 11.3.
- Sectoral distribution of loans to total loans (Real estate) by year: 1999 19.9; 2000 16.3; 2001 19.0; 2002 18.6; 2003 18.3.
- Sectoral distribution (Personal facilities) by year: 1999 31.9; 2000 32.1; 2001 33.0; 2002 37.4; 2003 37.8.
- FX loans to total loans 1999 23.5; 2000 21.4; 2001 19.1; 2002 20.4; 2003 19.2.
- Impaired loans to gross loans (*) 1999 9.9; 2000 9.9; 2001 8.0; 2002 5.6; 2003 5.4.
- Provision to gross loans 1999 6.8; 2000 6.4; 2001 5.5; 2002 5.0; 2003 4.8.
- Total provision to impaired loans 1999 71.1; 2000 66.8; 2001 70.7; 2002 91.2; 2003 91.0.
- Impaired loans net of provisions to capital (*) 1999 29.1; 2000 32.1; 2001 25.6; 2002 16.1; 2003 16.4.
- ROA (*) 1999 1.8; 2000 2.0; 2001 2.0; 2002 1.8; 2003 2.0.
- ROE (*) 1999 15.3; 2000 17.6; 2001 18.2; 2002 17.4; 2003 18.2.
- Interest margin to gross income (*) 1999 30.4; 2000 33.0; 2001 37.0; 2002 41.0; 2003 44.3.
- Liquid assets to total assets (*) 1999 17.8; 2000 21.2; 2001 24.3; 2002 21.2; 2003 18.3.
- Customer deposits to total (non-interbank) loans 1999 134.1; 2000 139.3; 2001 147.4; 2002 130.3; 2003 123.6.
- Net open position in FX to capital (*) 1999 0.4; 2000 0.3; 2001 0.9; 2002 0.8; 2003 0.2.
- Stock price index of bank shares by year: 1999 104.7; 2000 124.9; 2001 147.0; 2002 137.7; 2003 119.2.

### Stress testing: scenarios, assumptions, and findings
- Two stress-testing methods were used:
  - Sensitivity analysis of banks’ CAR to changes in amount and distribution of impaired loans, including potential losses in the value of outstanding collateral that would force additional provisions.
  - System resilience scenarios reported in Table 4 with two scenarios: mild shock and severe shock.
- Mild shock assumptions:
  - Spread between domestic and foreign (U.S.) interest rates widens modestly (13 basis points).
  - U.S. dollar depreciates a further 10 percent with respect to main currencies.
  - One-notch downgrade of all loans (domestic and foreign currency).
  - No sectoral shock considered.
- Severe shock assumptions:
  - Interest rate spread widens by 50 basis points.
  - All loans downgraded by two notches.
  - 25 percent of personal facilities to trade in shares and 10 percent of real estate loans turn into bad debt.
  - 50 percent haircut on collateral value is imposed.
- Stress test outcomes (selected exact results from Table 4):
  - Pre-shock impaired loans 5.5; pre-shock provision 59.1; pre-shock CAR 18.3 (percent figures as table entries).
  - Mild shock, no change in collateral: post-shock impaired loans 6.5; provision 57.6; CAR 18.0; Number of Banks CAR<12 = 0.
  - Mild shock, 50 percent haircut on collateral: post-shock impaired loans 6.5; provision 66.2; CAR 17.2; Number of Banks CAR<12 = 0.
  - Mild shock, 70 percent haircut on collateral: post-shock impaired loans 6.5; provision 67.9; CAR 17.1; Number of Banks CAR<12 = 1.
  - Severe shock, no sectoral shock, no change in collateral: post-shock impaired loans 7.4; provision 57.9; CAR 17.4; Number of Banks CAR<12 = 0.
  - Severe shock, no sectoral shock, 50 percent haircut on collateral: post-shock impaired loans 7.4; provision 65.4; CAR 16.7; Number of Banks CAR<12 = 1.
  - Severe shock, sectoral shock, no change in collateral: post-shock impaired loans 10.1; provision 69.5; CAR 14.5; Number of Banks CAR<12 = 3.
  - Severe shock, sectoral shock, 50 percent haircut on collateral: post-shock impaired loans 10.1; provision 75.0; CAR 13.8; Number of Banks CAR<12 = 5.
- Interpretation:
  - Banking system broadly resilient; shocks must be substantial to threaten system-wide financial soundness.
  - A few banks show particular vulnerability to changes in collateral value, especially those with high exposure to real estate and stock market–related lending; one bank with high sensitivity plays a crucial role in the system.
  - Strong supervisory enforcement, complemented by moral suasion if necessary, may be needed; authorities have already taken steps.

### Non-bank financial institutions
- Insurance sector vulnerability seems limited.
- Investment companies have grown in importance and have increasingly relied on bank credit: from 7.5 percent of their total liabilities in 2000 to about 13 percent in 2002.
- Liquidity concerns may arise if maturity mismatch between assets and liabilities continues to worsen.
- Some investment companies may rely on credit lines from foreign banks that could be withdrawn in difficult times.
- At end-2002, local banks’ lending to investment companies amounted to approximately 9 percent of local banks’ total lending portfolios and 32 percent of bank stockholders’ equity.
- Potential for systemic risk from linkages between local banks and investment in the stock market appears contained at present, reflecting CBK regulations limiting investment companies’ leverage and the relatively small exposure of local banks to investment companies.
- Recommendation: compile more detailed and comprehensive data on these linkages.

### Key structural issues affecting financial stability — Legal system
- Laws and institutions underpinning Kuwait’s financial and commercial sectors are mostly satisfactory but some need updating; many legal norms were designed a generation ago and for a business culture based mainly on personal and family relationships.
- Little movement toward adopting laws that create an enabling environment for private sector growth in a regional or global economy.
- Judiciary: broadly efficient, respect for and compliance with the law is high, judges are well paid and independent, cases of corruption are rare, and court infrastructure is good.
- Insolvency and debt recovery:
  - Laws and procedures appear broadly adequate.
  - Attention could be given to revising bankruptcy provisions to create a more efficient exit mechanism for failed companies (use of legislation to promote reorganizations or workouts is almost nonexistent).
  - Debt recovery and enforcement of security procedures are satisfactory though sometimes drawn out.
  - Real estate and commercial registers appear efficient.
  - For unsecured housing loans, attachment of salaries is usually effective; courts’ ability to impose travel bans aids debt repayment.
- Corporate governance:
  - Entities subject to CBK supervision and listed companies have adequate governance arrangements.
  - Revision of the Law on Commercial Companies (No. 15 of 1960) could improve governance, disclosure, liability of the Board of Directors, and the role of auditors across the commercial sector.
- Examples of outdated procedures:
  - Formation of a shareholding company requires the issuance of an Amiri Decree and can take months.
  - A representative of the MoCI is required to be present at all shareholder meetings.

*Source: CBK; and IMF staff estimates, as presented in the provided IMF document.*

### 60.      Changes in the stock market’s operations may help to improve its functioning

### 60.      Changes in the stock market’s operations may help to improve its functioning

### Stock market operations and market intermediation
- Findings and proposed operational changes:
  - Short selling might be introduced as the regulatory and legal framework is strengthened, accompanied by adjustments in the regulation of margin trading.
  - A more balanced use of short selling and margin trading by dealers or speculators would help to smooth out market movements, while maintaining market liquidity.
  - Given the liquidity of the market, the affluence of investors, and the robustness of the trading and settlement systems, a case can also be made for diversifying product lines and liberalizing foreign participation.
  - Though investment companies provide advisory services, stockbrokers are prohibited from offering such services; as a result, information intermediation, which is a core function of a capital market, is largely absent.
  - The role of market intermediaries should be redefined in conjunction with the more general overhaul of the securities regulatory framework.
- Institutional note:
  - To some extent, changes in this direction are already envisaged in the comprehensive four-year work plan developed by the stock exchange (“Kuwait Stock Exchange Development Strategy”).

### Development of corporate and government bond markets
- Rationale for development:
  - The stability and efficiency of the financial system could be enhanced by developing corporate and government bond markets to complement equity and bank finance.
  - A more developed corporate bond market would provide a long-term funding source to the real economy and alleviate stresses on the banking system by allowing banks to obtain some of their funding longer-term.
  - A more developed government bond market could stimulate the provision of long-term finance, enhance the contribution of the financial sector to economic growth (particularly of the non-oil business segment), and be useful for monetary policy (open market operations/repos) and smoother inter-bank market functioning.
  - Availability of government debt instruments across the maturity spectrum can set reference prices for other debt instruments and help institutional and individual investors achieve more efficient portfolios.
  - A well developed government securities market is not necessarily inconsistent with a budget surplus environment.
- Current market characteristics and regulatory drivers:
  - Corporate bonds in Kuwait are small compared to bank loan and equity markets, although they have been growing as a funding source for banks’ consumer loans.
  - A CBK regulation of 2000 prompted banks to issue corporate bonds by allowing banks to make consumer loans up to 30 percent of the proceeds from a bond issue (by contrast, consumer lending funded by deposits is capped at 12 percent of deposits).
  - Corporate bonds in the Kuwaiti market are seldom traded, though they are listed on the KSE; they are either in bearer form or in book-entry form, and settle at KCC.
  - Most corporate bond investors are institutions and high net worth individuals.
- Key statistics:
  - The outstanding balance of KD and U.S. dollar corporate bonds in the Kuwaiti market stood at KD 369 million and $775 million, respectively, at the end of August 2003.
- Policy considerations for government debt issuance:
  - The government may want to assess steps to develop the market for treasury securities, and establish objectives for size, range of maturities, and liquidity created by active market-makers.
  - Although there is a cost associated with the issuance of government debt, the benefits noted may also be substantial.

### Credit information systems
- Recent development:
  - The recent creation of Ci-Net represents a major step forward in the development of credit information systems, and should help to significantly improve the behavior of individual borrowers and reduce credit risks for lenders.
- Operational details:
  - All financial institutions (e.g., banks, investment companies, leasing companies, and others) are members of Ci-Net, which shares information on the credit performance of the borrower and his compliance with CBK regulations regarding limits on personal borrowings.
  - Previously, it was not possible for financial institutions to track borrower performance and compliance effectively.

### Summary assessment of compliance of the Basel Core Principles for Effective Banking Supervision — main findings and recommendations
- Context and mission:
  - A joint mission of the International Monetary Fund and the World Bank visited Kuwait in September 2003 as part of the FSAP and conducted an update of the assessment of compliance with the Basel Core Principles.
  - The update drew on: (i) an assessment completed in March 2000; (ii) laws, supervisory regulations, and directives issued by the CBK; (iii) discussions with CBK supervisors; and (iv) meetings with the senior management of all Kuwaiti banks.
  - The assessment was conducted by Mr. Michael Yuenger (U.S. Office of the Comptroller of the Currency), with the assistance of Mr. Robert Liu (World Bank).
- Banking system structure and soundness:
  - There are six commercial banks, three specialized banks (one operating under Islamic law), and one branch of a foreign bank.
  - The assets of the commercial banking system in Kuwait, including the Islamic bank, totalled KD18.8 billion as of September 30, 2003.
  - The banking sector is concentrated, with the two largest banks accounting for more than half of the local banks’ total assets, loans and deposits.
  - The banking system appears sound, with an average capital adequacy ratio estimated to be 19 percent.
  - Profits in 2003 have increased over 2002, and asset quality has improved, with non-performing assets declining from 9.9 percent of total loans at December 31, 2000 to 5.4 percent at March 31, 2003.
  - Total provisioning has increased and currently represents approximately 91 percent of NPLs.
- Legal, institutional and supervisory strengths and gaps:
  - The Central Bank Law gives the CBK full responsibility for banking supervision and grants it powers to issue directives and instructions to regulate banking activities.
  - The Banking Law dates to 1968 but the Central Bank Law has been amended to take account of changes in international practices; the Central Bank Law was amended to bring the Islamic banks formally under the jurisdiction of CBK, effective December 2003.
  - The CBK lacks a written comprehensive troubled bank resolution framework, including a prompt corrective action program.
  - All accounting and reporting for corporate entities, including banks, is subject to IAS; the Stock Exchange prescribes additional disclosure standards for listed companies; banks are required to have two independent external auditors.
  - The laws governing companies (Law on Commercial Companies, No. 15 of 1960) and bankruptcy (Law of Commerce, No. 68 of 1980) could be improved to align with modern international corporate practice.
  - There is no formal deposit insurance system; the government has provided an implicit guarantee of depositor accounts (except inter-bank deposits) historically, and intends to remove the guarantee in the near future. The authorities do not plan to implement a deposit insurance scheme when the guarantee is removed.
  - The CBK’s supervisory program is staffed with about 140 professional and support staff.
  - A significant deficiency is the legal prohibition on CBK from sharing confidential supervisory information with appropriate governmental and foreign supervisory authorities; pending legislation would permit such sharing.
- Licensing, ownership and consolidated supervision issues:
  - The CBK lacks the authority to determine the suitability of controlling shareholders for proposed new banks or proposed acquisitions of controlling shareholder interests in established banks; Kuwaiti corporate law permits acquisition of controlling interests without prior regulatory approval.
  - Consolidated supervision is limited because the CBK cannot approve ownership control changes, request corporate information, or share information with other governmental authorities and foreign host country supervisory authorities.
- Prudential and supervisory practice highlights:
  - The Central Bank’s prudential regulations and requirements for banks are generally sound; minimum capital requirements are above the Basel Capital Accord minimum.
  - Classification of accounts is based on delinquency status and not on loan quality; a minimum general provisioning of 2 percent is required on all performing credits.
  - The definition of “connected parties” is too narrowly defined and should be broadened to include affiliates and/or parties related to directors and senior management through common ownership.
  - The CBK has revised anti-money laundering guidelines, broadly in line with good international practices, though weaknesses remain in Kuwait’s overall AML framework.
  - Both on-site inspection and off-site supervision are performed; the CBK receives appropriate monthly and quarterly reports from banks and validates supervisory information through on-site work and external auditors.
  - The CBK has legal authority to supervise overseas activities of locally incorporated banks and requires prior approval for overseas branches; only one branch of a foreign bank operates in Kuwait, reflecting restrictions on foreign ownership.
- Principal recommended actions and priorities (selected):
  - CP1.2 Objectives, Autonomy, Powers and Resources:
    - Adopt legislative changes that would remove MoFE influence over CBK decisions on licensing, closure, and certain other remedial actions.
    - Amend the Central Bank Law to allow for sharing of supervisory information between domestic regulators and between domestic and foreign banking supervisors.
  - CP3 Licensing Criteria / CP4 Ownership:
    - Give banking supervisors the authority to reject applications for banking licenses when owners do not meet the “fit and proper” test.
  - CP10 Connected Lending:
    - Expand the definition of connected lending to include affiliates and related parties connected to a director’s interest through common ownership.
  - CP22 Remedial Measures:
    - Consider establishing a graduated formal framework for dealing with problem banks that is transparent, allowing stakeholders to know CBK requirements for maintaining a banking license.
  - CP24 Host Country Supervision / CP25 Supervision over Foreign Banks’ Establishment:
    - Approve legislation allowing supervisory authorities to share confidential information with domestic regulators and foreign supervisors; following enactment, enter into MOUs with domestic and foreign counterparts for sharing of confidential information.

*Source: IMF staff report excerpt, “Changes in the stock market’s operations may help to improve its functioning,” and associated FSAP/Basel Core Principles assessment.*

### 28.      The authorities generally welcomed the assessment and are evaluating its suggestions

### _cr04151 - 28.      The authorities generally welcomed the assessment and are evaluating its suggestions

### Authorities’ Response to the Assessment
- The authorities generally welcomed the assessment and are evaluating its suggestions for strengthening the existing supervisory regime.
- They noted that pending legislation in the National Assembly, including proposed amendments to the CBK Law, would address deficiencies relating to:
  - information sharing,
  - share transfers involving ownership changes,
  - consolidated supervision, and
  - international cooperation.
- Translations of draft legislation shared with the assessor tend to support the view that the proposed measures would further strengthen an already broadly sound supervisory regime.
- The authorities agreed that the draft legislation remains to be enacted and implemented before the effectiveness of such measures can be evaluated against the Basel Core Principles.
- The assessment has been discussed with the responsible authorities, who have broadly agreed with the findings. The authorities have already begun to formulate plans to improve the regulation and supervision of the securities sector.

### IOSCO Objectives and Principles of Securities Regulation — Scope and Methodology
- The assessment of the securities regulatory system in Kuwait was performed as part of the FSAP assessment for Kuwait in July and September 2003.
- The assessment aims to determine the extent of observance of the IOSCO Principles and to suggest areas where measures may be appropriate.
- Information and methods used:
  - review of laws, rules and regulations;
  - interviews (government officials, KSE management and staff, legal experts, representatives of the securities industry, and some investors);
  - a self-assessment report prepared by the KSE;
  - additional reference materials and publicly available information.
- The assessment was conducted by Ashraf Shamseldin, IMF Securities Advisor, in July and September 2003.
- The assessment is based on the methodology developed by IOSCO (as revised in April 2003).

### Market Structure, Participants, and Infrastructure — Key Facts
- Legal and institutional framework:
  - Securities market Amiri Decree-Law of 1983 governs the market.
  - The MC and KSE are responsible for supervision of the securities secondary market; the CBK supervises investment companies; the CD of the MoCI supervises the primary securities market (issuers).
- Market characteristics and participants:
  - The securities markets are beginning to play a role, albeit still marginal, as a source of medium- and long-term finance.
  - The primary market is not active; the bulk of the secondary market is in equities.
  - There are few institutional investors; individual investors exhibit speculative behavior.
  - At the end of 2002, there were 13 licensed brokerage firms and 71 investment companies (comprising 33 investment funds and 38 conventional and Islamic investment companies).
  - Institutional investment is mainly passive; standards for market entry and prudential pre-requisites for licensing are not sufficient.
- Exchange, clearing, and settlement:
  - The KSE is the only national stock exchange in Kuwait; it is a government entity and operates as a cash market.
  - A parallel system was introduced in 1998 for forward trading; activity in this market remains limited.
  - No derivatives are traded in the Kuwaiti market.
  - In 1988, investment barriers were removed for citizens of GCC countries; in August 2000, the market was opened to all foreign investors.
  - Equity and debt trades on the KSE are cleared and settled through the KCC, which also acts as the securities depository and registry.
  - Under the KCC system, securities are immobilized and not dematerialized.
  - Banks provide custodial services for non-Kuwaiti investment.

### Preconditions and Main Findings on Regulatory Environment
- General preconditions:
  - The regulatory environment generally does not conform to IOSCO preconditions; developmental aspects of the securities market are neglected.
  - The level of authority delegated to the regulating agency does not correspond to its responsibilities.
  - Essential legal aspects, notably protection of minority shareholders and prohibition of market manipulation and insider trading, are missing.
- Fragmentation and capacity issues:
  - Lack of an orderly regulatory framework has led to significant fragmentation of responsibilities.
  - From a statutory viewpoint, the MC is an independent agency, although in practice it is not; the government appoints the director-general and the majority of the board.
  - The MC has limited powers; most licensing, supervision, and sanction powers lie elsewhere.
  - Inspection, investigation, and surveillance powers of the MC and KSE are not adequate and lack a clear process.
  - Power to set technical standards is fragmented and not well coordinated.
  - Staffing of the MC and KSE needs strengthening to increase efficiency.
- Cooperation and dematerialization:
  - Information sharing and coordination with other regulators is legally permitted, but there is no formal protocol for cooperation with foreign agencies and among national agencies.
  - Design of the clearing and settlement system largely prevents payment default, but dematerialization cannot be properly implemented without necessary legal basis.
- Licensing and intermediaries:
  - Licensing requirements for market intermediaries are few and broad.
  - Except for brokers (supervised by KSE), other intermediaries are regulated by different agencies.
  - The term “Investment Company” is not clearly defined; regulations related to intermediaries are inadequate.
- Self-regulatory organizations:
  - Although the KSE may exercise a few functions of an SRO, effective self-regulation is not practiced.

### Summary of Principles Assessment — Core Deficiencies
- Strength of the regulator:
  - Market regulated by more than one agency; division of responsibility risks inefficiencies and gaps.
  - Laws and regulations do not form a comprehensive legal framework.
  - MC’s power and jurisdiction limited and confined to the stock exchange and member brokers.
  - KSE not operationally independent of external political or commercial interference.
  - Sanctioning system insufficient; rule-making process unclear; no consolidated master reference for rules and executive decisions.
  - Inspections are not regular; insider trading is not prohibited or penalized.
  - Information sharing procedures not formalized through MOUs.
- Issuer regulation:
  - Regulations and procedures for public offerings (including tender offers) are not adequate.
  - Responsibilities of regulators for control of public and private offerings, sale, and distribution of securities need clearer definition.
  - Rules governing mergers and acquisitions are not in place; corporate governance principles not fully addressed.
  - Need to strengthen minority shareholders’ protection and compile a list of eligible auditors.
- Investment fund regulation:
  - Regulation and supervision of CISs segmented among three agencies.
  - Fit and proper assessments insufficient; rules for investor protection, funds’ investment policy, and enforcement inadequate.
- Market intermediary regulation:
  - Entry standards for intermediaries need establishment for each service type.
  - Prudential rules needed from incorporation to liquidation; licensing and inspection should be the responsibility of one regulatory agency.
  - Code of ethics and internal procedures required for intermediary firms.
  - Criteria for capital adequacy and solvency should be established, supervised, and monitored by the regulator.
- Secondary market regulation:
  - MC and KSE are not fully separate institutions; current arrangement does not adequately avoid conflicts.
  - Non-prohibition of insider trading is a serious defect.
  - Systems to deter and detect unlawful practices are weak; KSE lacks sufficient sanctioning ability.
  - Lack of ultimate dematerialization and automated book entry raises risks.
  - While KSE is authorized to supervise the KCC, no formalized system of supervision is in place.

### Recommended Actions and Priorities
- Priority reforms:
  - Create an independent and accountable authority with full powers to develop and regulate the securities market and industry.
  - Prohibit insider trading and market manipulation.
  - Establish adequate enforcement powers.
  - Define entry standards for all types of market intermediaries.
- Specific recommended actions:
  - Enact a comprehensive and unified law that clearly defines the objectives, functions, responsibilities, and powers of the securities market regulator consistent with objectives to:
    - protect investors;
    - assure that markets are fair, efficient and transparent; and
    - reduce systemic risk.
  - Law should give the regulator full, comprehensive, and overall power to develop, organize and regulate the securities market and industry, and to set rules and enforce them in consultation with market participants and the public.
  - Create by law an independent and accountable authority with a clear organizational structure; define independence in terms of resources and ability to take final and enforceable decisions.
  - Empower the regulator with a wide spectrum of sanctions including cash fines and the ability to impose them.
  - Prohibit insider trading and market manipulation; establish confidentiality rules and an explicit code of ethics for regulatory personnel.
  - Empower the regulator to oversee the primary market, IPO and PO processes, and to issue rules on accounting requirements for disclosure, tender offers, and mergers and acquisitions.
  - Set rules for protection of minority shareholders and compel listed companies to implement corporate governance principles.
  - Build regulator capacity to examine auditors and audited companies for compliance with accounting and auditing standards; provide continuous training programs for staff.
  - Establish entry standards and prudential regulations for all types of market intermediaries; require fit and proper assessments for owners and officers; empower regulator to inspect books, records and business operations and to impose relevant sanctions.
  - Pending legal amendments, supervisory agencies should formalize procedures for consultation and exchange of information, combine inspection and investigation efforts, and make similar arrangements for international cooperation.

### FATF (AML/CFT) Assessment — Key Findings (selected)
- The Report on the Observance of Standards and Codes covers FATF 40 Recommendations and 8 Special Recommendations; prepared by Mr. Richard Chalmers (MFD), Ms. Joy Smallwood (LEG), and an independent law enforcement expert.
- The detailed assessment reviewed AML/CFT laws and regulations, supervisory and regulatory systems, oversight of the gold market and charitable organizations, and criminal law enforcement capacity.
- The assessment is based on information available as of mid-October, 2003.
- Main findings:
  - Kuwait’s vulnerability to money laundering is relatively low compared with many financial centers, given domestic orientation of banking and investment services and limited transit flows.
  - Vulnerabilities include absence of key controls in the fast-growing stock market (e.g., outlawing of insider dealing and market manipulation) and challenges in AML regulation of the gold market.
  - Financing of terrorism has not been criminalized; authorities have taken measures to regulate charitable organizations.
- Criminalization and enforcement gaps:
  - Law 35/2002, with subsidiary rules by regulators, provides the legal basis for countering money laundering; currently covers banks, investment companies, money exchange operators, and insurance agencies, but the intended “umbrella” resolution to extend coverage to the wider market has not been issued by the Minister of Finance.
  - Kuwait has not ratified the Palermo Convention or the 1999 Suppression of the Financing of Terrorism Convention and has no specific CFT legislation.
  - There are no specific provisions for freezing, restraint and forfeiture of assets associated with terrorist financing; authorities must rely on general Penal Code provisions and a statute against illegal societies, raising doubts about effectiveness for CFT purposes.
- FIU and STR processes:
  - The FIU is part of the CBK with no distinct organizational structure; powers to receive, analyze and investigate STRs are derived solely from the PPO on a case-by-case basis, leading to operational inefficiencies and limited ability to share information with foreign counterparts.
  - The standard for filing STRs is “reasonable belief” that money laundering has occurred (not mere suspicion), which has limited filings and placed an investigative burden on banks, increasing risk of “tipping off.”
  - The two-day period specified under regulations for freezing transactions during an investigation is rarely sufficient, resulting in banks covertly extending freezes and placing them at risk of civil action.

*Source: _cr04151 - 28.      The authorities generally welcomed the assessment and are evaluating its suggestions*

### 53.      The PPO has the responsibility for investigating and prosecuting money laundering

### _cr04151 - 53.      The PPO has the responsibility for investigating and prosecuting money laundering

### Investigation and prosecution powers
- The PPO has the responsibility for investigating and prosecuting money laundering cases.
- The PPO has extremely wide powers to investigate crimes and can obtain bank or other records by means of a simple letter request.
- The PPO and Ministry of Interior’s Criminal Investigation Division (CID) work closely on all criminal cases.
- Law enforcement techniques such as undercover operations, controlled delivery, use of informants, and wire-tapping are permitted with the PPO’s approval or when authorized by the court, although they have not yet been used in the investigation of money laundering.

### International cooperation
- Law 35/2002 creates a mechanism for providing mutual legal assistance in money laundering investigations or prosecutions when there is a multilateral agreement or bilateral treaty.
- Kuwait’s ability to provide timely and effective assistance is hampered by the requirement that assistance can only be given when a request comes from a “competent judicial authority.”
  - Only in very rare circumstances will a prosecutor’s office be such an authority, and thus most countries will be required to use “letters rogatory,” a process that is generally very slow.
- Regulatory co-operation at both the domestic and international level is severely restricted by statutory secrecy provisions.
- Amendments to the CBK law to introduce information-sharing provisions are currently before the parliament, but these will not extend to the other regulatory authorities in Kuwait.

### Preventive measures for financial institutions
- The CBK is charged with the prudential supervision of the banks, investment companies, exchange companies and mutual funds.
- The MoCI has similar responsibilities for the insurance sector, oversees the gold market and regulates the securities market together with the KSE.

Prudentially-regulated sectors
- An Islamic bank, the second largest financial institution in Kuwait, is currently not under the same regulatory regime as the other banks.
  - Legislation to correct this comes into force in December 2003, after which the bank in question will have six months in which to register as a bank.
  - The bank has indicated that it has already voluntarily followed the CBK’s AML instructions, but there has been no independent verification, since the CBK currently has no right of access to the bank’s operations.
- There are no controls over the ownership of any regulated financial institutions, and the CBK only has powers to apply “fit and proper” tests to the management of banks.
  - Amendments are before parliament to address the issue of ownership with respect to the banking sector, but not more generally.
- The CBK’s AML instructions to the banks are generally soundly based and closely mirror international standards.
  - The CBK has applied a systematic process, supported by written procedures, to check compliance with its requirements, but no revised instructions have yet been issued to the investment companies, which continue to follow regulations issued in 1993.
  - Instructions issued by the CBK to the licensed exchange companies impose customer identification requirements similar to those applicable to the banks, and measures have been implemented to control large cash remittances overseas through this sector.
  - The KSE has issued a resolution on AML/CFT which could be strengthened.

Non-prudentially-regulated sectors
- Authorities have taken a robust approach to overseeing charitable organizations:
  - Licensing arrangements for individual projects.
  - Outlawing of cash contributions (requiring all donations to be put through the banking system).
  - Introduction of audit requirements.
  - Proposals to use Kuwaiti embassies abroad to monitor the use of funds in recipient projects.
- Customer identification and record keeping requirements were extended to the gold market by Ministerial Order in 2002.
  - There is a general lack of application of the obligations within this sector, apparently stemming from a lack of awareness of the requirements.

### Summary assessment against the FATF Recommendations
- The enactment of AML legislation in 2002, supported by regulations issued by the authorities, has provided a basis for compliance with several of the Recommendations.
- However, the failure specifically to criminalize the financing of terrorism, and the uncertainty about the effectiveness of alternative mechanisms to prosecute such cases, is detrimental.
- The current structure of the FIU, the exceptionally high burden of evidence for filing STRs, and the legal constraints on international cooperation currently present obstacles to compliance with many important Recommendations.
- Key priorities:
  - Ensure that AML legislation covers the broad financial sector.
  - Exercise more control over ownership of financial institutions.
  - Strengthen procedures for international cooperation in AML/CFT.
  - Criminalize the financing of terrorism.

### Recommended actions mapped to FATF references (selected highlights)
- General framework (FATF 1-3)
  - Introduce provisions within all the regulatory laws to permit the authorities to exchange information with both domestic and foreign counterparts.
  - Enact legislation allowing mutual legal assistance with non-judicial authorities, including assistance in confiscation matters.
- Scope of the criminal offense of money laundering (FATF 4-6)
  - (No specific new text beyond table headings in source.)
- Provisional measures and confiscation (FATF 7)
  - (No specific new text beyond table headings in source.)
- General role of financial system in combating ML (FATF 8-9)
  - Introduce AML regulations for investment companies.
  - Issue the Ministerial Order to extend the coverage of Law 35/2002 to all relevant institutions.
- Customer identification and record-keeping rules (FATF 10-13)
  - Extend the CBK’s instructions to: (i) address risk variables in the customer identification process; (ii) confirm the current operational practice on acceptance of introduced business; and (iii) require the identification of significant shareholders of corporates.
- Increased diligence of financial institutions (FATF 14-19)
  - Review the procedures for filing STRs to lower the level of suspicion required to trigger a report, and to guard against inadvertent tipping-off.
  - Require all financial institutions to have a specific AML/CFT compliance function.
- Measures to cope with countries with insufficient AML measures (FATF 20-21)
  - Provide guidance on the jurisdictions in relation to which financial institutions should take special care.
- Other measures; Implementation & role of regulatory and other administrative authorities (FATF 22-29)
  - Publish guidance by the FIU to assist financial institutions to understand their broad obligations under the STR regime and the processes to be followed.
  - Introduce statutory controls to ensure that all significant shareholders and owners, and all directors and management staff of all financial institutions are subject to “fit and proper” tests by the regulators.
- Administrative cooperation—Exchange of information relating to suspicious transactions (FATF 32)
  - Enact legislation to permit the FIU to request from, and share information spontaneously with, its foreign counterparts through administrative procedures.
- Other forms of cooperation—Focus of improved mutual assistance (FATF 36-40)
  - Enact appropriate laws and procedures to provide the widest possible range of mutual legal assistance in AML/CFT matters in a timely fashion.

### Special recommendations on terrorist financing (selected)
- I. Ratification and implementation of UN Instruments
  - Ratify and implement the Palermo Convention and the 1999 Convention on Suppression of the Financing of Terrorism.
- II. Criminalizing the financing of terrorism and associated money laundering
  - Enact legislation to criminalize terrorist financing.
- III. Freezing and confiscating terrorist assets
  - Enact legislation to provide for the identification, freezing, seizure, and confiscation of terrorist assets.
- IV. Reporting suspicious transactions related to terrorism
  - Enact legislation to criminalize terrorist financing, thereby making it a predicate offense for reporting.
- V. International Cooperation
  - As for FATF 36-40 above.
- VII. Wire transfers
  - Issue instructions to the banks on the handling of incoming wire transfers.
- VIII. Non-profit organizations
  - (No specific new text beyond table headings in source.)

### Other recommended actions
- Enact new legislation to create an independent, adequately resourced FIU that will receive, maintain, analyze, and evaluate STRs and currency reports, and will have the power to co-operate with foreign counterparts.
- Amend Law 35/2002 to include the reporting of outbound cross border movements of currency, gold or other precious materials.
- Raise awareness of AML obligations among the gold dealers.

### Authorities’ response
- The authorities were in broad agreement with the assessment.
- Several revisions were made to the detailed assessment in response to their comments on technical matters.

*Source: _cr04151 - 53.      The PPO has the responsibility for investigating and prosecuting money laundering*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04151.pdf_