Once seen as the Middle East’s banking center, Bahrain’s financial sector is in terminal decline. Seeking to finance its budget deficits, Manama has increasingly turned to its banks and their credit profiles are now inescapably intertwined.

Since the outbreak of the Arab Spring in 2011, Bahrain’s banking and finance sector has faced a considerable slew of challenges – challenges that show no sign of abating.

The government’s finances have been hit hard by the...