Bahrain's first commercial bank, a branch of the Britishowned Eastern Bank, opened in 1921. Two decades passed before a second bank, the British Bank of the Middle East, set up an office. It was not until 1957 that the first bank wholly owned by Bahraini citizens--the private National Bank of Bahrain-- commenced activities. Prior to 1965, when the government introduced the Bahraini dinar (for value of the Bahraini dinar-- see Glossary), the Indian rupee had functioned as the most commonly accepted currency for local transactions. The lack of an indigenous currency probably impeded the development of the banking sector. Once the Bahraini dinar replaced the Indian rupee and established itself as a strong, internationally convertible currency, banks began to find the island a more attractive location by 1974 fourteen commercial banks operated in Bahrain.

The increase in the number of banks after independence prompted the government to consider creating a central monetary authority to regulate banking activities. In 1973 Shaykh Isa ibn Salman issued a decree that established the Bahrain Monetary Agency (BMA) as a legal entity possessing the powers of a central bank. In addition to its regulatory responsibilities, BMA issues currency, sets the official exchange rates for the Bahraini dinar, serves as a depository for government funds from petroleum production and its foreign currency reserves, and manages thegovernment's investments.

In 1975 BMA promulgated regulations for the creation of offshore banking units (OBUs) modeled on those operating in Singapore. OBUs are branches of international commercial banks exempted from foreign-exchange controls, cash reserve requirements, taxes on interest paid to depositors, and banking income taxes that are required of other banks in Bahrain. In return for these privileges, OBUs pay the government annual license fees, are prohibited from accepting deposits from citizens and residents of Bahrain, and must refrain from transactions involving Bahraini dinars. The OBU program has been successful twenty-six OBUs were established during the first year. The civil war in Lebanon probably stimulated the OBU boom because several international banks based in Beirut transferred their Middle East operations to Bahrain after 1975. By the early 1980s, a total of seventy-five OBUs having assets in excess of US$62 billion were operating out of Bahrain.

Beginning in 1985, falling oil prices and a corresponding decline in oil revenues dramatically reduced the funds deposited in both onshore banks and OBUs. Several banks decided not to renew their OBU licenses, resulting in a net loss of OBUs. Nevertheless, a majority of OBUs, including those that are branches of leading United States, Arab, European, and Japanese banks, continue to operate from Bahrain-based offices. In 1990 a total of fifty-five OBUs were located on the island. Despite the fluctuations in gulf financial markets of the 1980s, Bahrain is well established as the principal banking and financial center of the gulf region.

Data as of 11c f January 1993