Bahrain's central bank's move to change its liquidity management guidelines to a formal rule will encourage banks to compete more for deposits, prompting them to offer higher rates to attract customers, bankers said.

The Central Bank of Bahrain (CBB) will require all banks to have a loan-to-deposit ratio of 75 per cent – meaning they would have to have 75 loans covered by 100 deposits.

Previously the central bank had a voluntary code for banks to have the ratio of 60-65 per cent for most banks and 70-75 per cent for those without large investments outside loans and it would only ask banks to lower their ratio if they were above expected levels. Now all banks must comply.

The CBB, which oversees a regional banking centre catering mostly to the oil wealth accumulated in the region, is currently in a consultation process with banks to formalise its new liquidity management rules.

"This will force banks with less access to customer deposits to compete against each other over the same pool of deposits," said Vistasp Soparivala, head of finance at Futurebank.

"Bahrain is a small economy and there is only the small pool of assets floating around," he said.

Khalid Hamad, Executive Director for Banking Supervision at the CBB, said in an interview last month that the new rules would formalise liquidity ratios that the central bank has used before in its supervision. Hamad then said banks could achieve the new ratio over a grace period in consultation with the CBB, as during the financial crisis ratios rose beyond those limits.

The loan-to-deposit ratio of Bahraini retail banks stood at 109 per cent in August, according to central bank data, but this ratio includes only their local currency deposits.

There is no aggregate data available for a loan-to-deposit ratio, including foreign currency deposits.

The CBB has said in its consultation paper that the deposit ratio serves to prevent liquidity problems in case a large amount of deposits is unexpectedly withdrawn. Banks in Bahrain have posted losses or lower earnings during the crisis, but the CBB has not been forced to inject liquidity.

Abdulkarim Bucheery, Chief Executive of retail bank BBK, said the CBB's ratio was on the conservative side in regional comparison, compared with 100 per cent in the UAE and 85 per cent in Kuwait.

"The ratio that the central bank on this in particular is trying to achieve is a little bit on the stringent side and I would say it is a bit restrictive," he said.

A lower ratio is more restrictive because banks need to hold more deposits for each loan they lend out to customers.

"They [the banks] will strive to raise their deposits, which is the denominator in this case and for that they may be forced to offer higher rates to attract these deposits," he said.

Bucheery said CBB should consider expanding what it considers as stable funding.

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