The fledgling yet vibrant Islamic Banking industry in Oman, has lately been attracting a lot of attention for its vigorous legislative, regulatory and market developments.
Right from the time, when in 2011 a Royal Decree was issued to incorporate Islamic Financial System, which paved way for the promulgation of regulatory framework, and subsequent realization of 2 Independent Banks and Six window operations operating in the Monarchy – a lot has been written with a hunch of optimism on the prospects and the promise that Islamic Banking in Oman has got to offer. Presently, almost all of the eight Islamic Banking Institutions (IBIs) in Oman have completed an year of operation, and account for a signifcant 3.24% (OMR 745 Bn) of the overall Banking Assets in the country. Apart from the two fully integrated Islamic banks – Bank Nizwa and Al izz bank – the country’s biggest commercial banks have also set up their own Islamic banking windows which iclude Bank Muscat’s Meethaq, National Bank of Oman’s – Muzn, Bank of Sohar’s – Sohar Islamic, BankDhofar’s Maisarah, Ahlibank – Hilal Islamic and Oman Arab Bank’s – Yusr have been competing for the faith driven consumer segment.This calls for a factual assessment of the performance of IBI’s against the visualized goals, and subsequently present a strategic review of prospects and challenges ahead. Oman being classified as an oil-based economy, heavily reliant on the dwindling oil reserves, which drove around 80% of its revenue in 2012(S&P, Dec 2013) and subsequenty exposed to oil price oscillation.
Recognizing the risk, the government has been keen to to diversify into non-oil economy (tourism and mining primarily) through higher investments.
It is a youthful Muslim monarchy with strong faith driven population comprising of 95% muslims. Over 60% of 2.78 Mn people in Oman are aged between 15 to 45 Years (World Bank, 2011)
Favorable demographics, recovery in the oil prices coupled with a pro growth and employment initiatives, and expansionary fiscal policy augur well for the fortunes of the financial sector and specifically for the budding Islamic Banking Industry. The GDP growth during 2000 to 2012 has averaged around 5.6%. Recent government directives raising wages and employment amongst the masses have been conducive for consumption and the deposit base of the banking industry. This is also evident from a 10% YOY growth in banking Assets to surpass OMR 23 Bn mark. A large public investment program has been conceived in the Eighth Five-Year Development Plan (2011-15). Domestic and foreign investments are planned to be mobilized to complement government spending to trigger non-oil sector growth and diversification. USD 50 billion is projected to be spent over the next decade, of which USD 28 billion is expected to be chanelled between 2013 and 2015 to drive growth and the resultant credit off-take in the nation.
Banking Sector in Oman
The Banking Sector in Oman is playing a phenomenal role in terms of financial inclusion, development and inter mediation, with a high Advance to deposit ratio of over 93%, deeply rooted into private retail and corporate sector. Over 63% of the deposits is raised from the private sector, out of which 84% is channeled to the private sector credit outlay. The schematic representation (Figure 1) defines the banking system in terms of breakup of asset, deposits, equity and other key indicators. The total Banking assets in Oman are around OMR 23.20 Bn with a breakup of an equity of OMR 2.67 and deposits of OMR 16.47 Bn(CBO Annual Report 2012 & Monthly Report February 2014). Total credit of OMR Rs 15.38 Bn turns it into 93% Advance to Deposit Ratio (ADR) banking sector. More encouraging is the fact that approx. OMR 13Bn (out of OMR 15 Bn) is channeled into private sector. Despite of a small population, households have a high contribution both as a provider and user of funds. Banking industry in Oman has been well capitalized with a leverage of 7.8x. Ne spreads are around 4.24%, given the reasonable share of zero cost deposit and highly priced household lending. The nascent Islamic Banking Industry can use the construct of the overall banking industry to set the boundary conditions in terms of profit spreads, deposit and asset mix and leverage etc.
Islamic Banking in Oman – Is It Living Up To The Expectations?
Analyst, commentators and the overall thought leadership have been optimistically speculating the Industry Size in terms of Islamic Banking assets either on the basis of regional market growth stories (e.g. Qatar, KSA, UAE etc) or on their professional intuition without much reference to the grounded realities of the local banking industry. The table below, quotes few of the prominent sources to quantify their respective verdicts in terms of asset size in future vis-à-vis the required growth rate to achieve the projected asset levels. The required growth rate should be viewed in the backdrop of the fact that Oman’s Banking Sector has been growing at an YOY rate of 10% in the past years. Nevertheless, given the market appetite and smaller base the projected industry size can not be ruled out all-together.
Islamic Banking in Oman: Reviewing the Take-off
Islamic Banking Industry in Oman, operating with an initial equity of OMR 348.5 Bn, and a branch network of 32 Branches representing Six Islamic Banking windows and two Independent Islamic Bank – has managed to grab a perceptible ~3.24% share of the overall Banking assets. This is by all definitions a remarkable beginning. In its first year of operation the industry is operating at an Advance-to-Deposit ratio of over 129%, against the banking industry average of 93%. Meethaq claims a huge share i.e. 40% of the Islamic Asset base of OMR 745 Mn, which matches with its parent bank’s share in the overall banking industry. Despite of the low retail/core banking activity, the overall stage is all prepared for the get-set-go thrust, with all sorts products launched, IT infrastructure, branches functioning and Human resource in place. In the table below , a detailed review of the bank-wise core activity is carried out by presenting equity, deposits & financing breakup and number of branches.
Almost all banks have well developed and presented product suite for deposit side, with well defined call, timed, remunerative and non-remunerative deposit products, bundled with other benefits tailored for the targeted customer base. Broadly, deposits are mobilized on the underlying contract of Qardh (for Current Account) and Mudaraba (for savings and terms deposits). Moreover, following IBRF guidelines, majority of IBs have ensured adequate reporting of prudential reserves, profit sharing ratios, product weight ages and other disclosures related mudaraba investment pool management. Financing Products Generally, the asset side products have been design for retail and Business clientele, wherein Corporate/SME segment comprises of trade, working capital and term/project finance Vehicle Finance solutions. On the other hand retail segment has Home Finance, Credit Cards, Personal Finance on offer. Digging it deeper reveals that the overall industry seems to have general consensus over the product structures; i.e. Ijarah for term financing to the corporates and Murabaha for Vehicle Finance & Working Capital Finance. Conversely, the case of Home finance is somewhat diversified with Banks employing Murabaha, Ijarah, Diminishing Musharaka, Istisna and even Sale – Lease Back. Interestingly, Personal Financing has only been on the shelves of Nizwa Bank and Alizz Islamic Bank offered on the basis Murabaha and Ijarah. It is only Meethaq and Alizz which are offering Credit Cards, on the basis of Ujrah and Murabaha. Meethaq Bank maintained its differentiation by offerings Diminishing Musharakah based Home Financing solution, against the prevalent ijarah structure. In the table below; retail or corporate financing products and their underlying shariah contract are reviewed:. Business and Household financing products along with their underlying Shariah Contract
Generally, the asset side products have been design for retail and Business clientele, wherein Corporate/SME segment comprises of trade, working capital and term/project finance Vehicle Finance solutions. On the other hand retail segment has Home Finance, Credit Cards, Personal Finance on offer. Digging it deeper reveals that the overall industry seems to have general consensus over the product structures; i.e. Ijarah for term financing to the corporates and Murabaha for Vehicle Finance & Working Capital Finance. Conversely, the case of Home finance is somewhat diversified with Banks employing Murabaha, Ijarah, Diminishing Musharaka, Istisna and even Sale – Lease Back. Interestingly, Personal Financing has only been on the shelves of Nizwa Bank and Alizz Islamic Bank offered on the basis Murabaha and Ijarah.
It is only Meethaq and Alizz which are offering Credit Cards, on the basis of Ujrah and Murabaha. Meethaq Bank maintained its differentiation by offerings Diminishing Musharakah based Home Financing solution, against the prevalent ijarah structure.
There are a lot of strategic dimension to it, including the legacy of the existing banks (operating through windows), regulatory stance, product innovation, niche segments identification, cross selling or Banking the unbanked and most importantly the Shari’a assurance.
More than ‘A Three Horse Race’
Dubai-based Arqaam Capital Research predicts that Bank Muscat will have 36 per cent of the country’s Islamic banking market by 2017, followed by Nizwa with 33 per cent and Alizz with 23 per cent. This is an interesting claim on the face of it, as Meethaq has the lowest equity of OMR 26 Mn against OMR 150 Mn of Nizwa and OMR 100 Mn of Alizz. However the present state of affair (Meethaq holds 40% of total Islamic Banking Assets), validates the lofty assertions on Meethaq made by the research company. Arqaam further suggested that remaining 8 percent shall be shared by Sohar, Maisarah and Muzn, with no mention of Oman Arab Bank’s Yusr. It would be premature to drive any generalisation about the market shares of the Eight players, given the vigor and enthusiasm that have been exhibited by them. However, in the longer term it would be the Shari’a compliance, product innovation and the service level that would create the difference.
The Sacrosanct Shari’a Adherence
Islamic Banking is a fresh endeavor in Oman, creating its early impressions on the consumer base. The regulator has taken a stringent, yet principled instance on Shari’a Compliance. It would be the first mover, in the right direction that is going to turn the tables. A review of prior research, establishes the fact that ‘Shari’a Compliance’ is one of the key purchase reasons of Islamic Banks consumer base. Islamic Banks should ensure a meticulous Shari’a governance framework vis-à-vis brand image and ensure income cleansing to charity funds with all its due presentation as stipulated by AAOIFI and CBO’s IBRF, to assure their share of the faith based consumer base.
Regulator – Principled Yet Pragmatic
Islamic Banking Regulatory Framework (issued by Central Bank of Oman – CBO) has been acknowledged as a comprehensive framework incorporating the best practices and standards from AAOIFI and IFSB etc. Paying full heed to Shari’a governance, has recently announced formation of National Shari’a Board serving as a supervisor and point of reference, to the boards of individual Islamic banks. Despite of all hue and cry and concerted lobbying efforts, the regulator stood firm by its fundamental stance against the alleged use of commodity murabaha and tawaruq for Short Term Liquidity management. However, the Central Bank being cognizant of the dearth of liquidity management venues has relaxed ceilings of foreign placements to the Islamic banks. Besides, the Central Bank is also keen to issue Government Sukuks which may also add up to the options for liquidity management for the local Islamic Banks. Islamic Banks and windows have somewhat sorted out the matter of liquidity management by domestic and oshore interbank wakalah arrangements as reected on the balance sheets as well. Trade Based Products Structures Oman is a thriving trade economy with overall trade accounting for 103% of the GDP. Export account for OMR 20.05 Bn, whereas Imports amounts to OMR 11.01 Bn. It is worth noting here that, around 30% of the total exports comprises of Non-oil (OMR 3.6 Bn) and re-exports (OMR 2.5 Bn). Besides the large Oil portion, Oman exports comprises of Mineral (OMR 422 Mn), Base Metals (OMR 671 Mn) and interestingly OMR 175 Mn was from live cattle. In addition to the mainstream Oil based Trade, Islamic Bank can strike in to the Non-oil trade and re-export segment. Islamic Financing contracts inherently are suited to be applied on trade transaction. Oman with its huge volumes of documented trade , posses an opportunity for Islamic Banks to structure trade financing transaction on the basis of Murabaha, Salam and Istisna. Re-exports transaction can also be structured either on the basis of Murabaha finance to the trader, or back to back Murabaha for the buy side and salam/Istisna for processing and export transaction.
Parallel Salam and Istisna may also be structured where the Islamic Bank can capitalize on its independent role as a buyer and seller. Rather then sticking only to the basic Murabaha, a whole suite of Shari’a compliant trade financing solutions, to cater the needs of Packing, Pre and Post shipment Export Financing and even bill discounting, can be effectively commissioned – In the most compliant manner, and in complete coherence with the covenants of documentary credits. Further, forward covers to hedge currency risk can also be oered to the customer on
Small Enterprises-Big Opportunities
Around 91,000 SMEs are known to operate in Oman contributing 13.8% to the GDP. The regulator recognising the significance of has directed to lend to SME for at least 5% of their aggregate Advances. For an emergent Islamic Banking, SME segment is especially suitable as it offers smaller per party risk exposures topped by higher yield, and thus furnishes a well diversified and
fragmented portfolio. Moreover, Islamic Banking can provide a reasonable thrust to the Country’s vision towards a lower oil dependency and diversification towards non-oil GDP. the SME’s segment generally is graded as relatively more faith driven and have been considered sizably unbanked (such as agriculture and fisheries)in Oman (Bank Muscat, SME Presentation 2012). Furthermore, the purpose driven and asset backed nature of Shari’a compliant products, makes it good it for Islamic Banks to penetrate in to this segment.
Efficiency Versus Cannibalisation – Window Operations
While, it is generally believed that Islamic windows of existing conventional banks will likely be well placed to capture market share, given their ability to leverage much of the existing infrastructure, employees, partly common back office and the brand of the parent franchise – In my personal experience, windows virtually have a limited play field, with the existing large scale corporates and even the High networth individuals being earmarked as a NO-GO area, if they are already working with their conventional parent bank. Window’s endeavors to bid a competitive proposition to penetrate in to the market, is viewed as invasive and tantamounts to cannibalisation. There appears to be tacit agreement amongst the C-level management to not to compete from within. For example, one can foresee Bank Muscat’s Meetaq experiencing a very limited market, as its parent Bank being the market leader with 38% of the overall market share. It must have been on board with almost all of the large accounts, and might have been graded as a strategic bank by most of the Large scale business enterprises them, owing to its penetration, access, services and scale. This would leave its window ‘Meethaq” with a limited market to dwell-in and may hamper its progress. On the brighter side, it may also turn in to a blessing-in-disguise, with windows pursuing the unbanked and underbanked segments, thus complementing the financial inclusion and broader diversification objectives of the sultanate.
The 60-40 Hinge
Interestingly, an unweighted mean of the major industry players approximates a 60:40 CASA: Term deposit breakup to be a prevalent norm. Similarly, a 60:40 on the Corporate: Retail Credit portfolio mix has also been observed in the industry. The table below furnishes a sector-wise breakup of asset deposit in addition to yield and adequacy The variables in Table 3 are highly interdependent; the deposit mix versus the credit mix defines the spread, which subsequently sets the yield. The credit mix along with the overall leverage drives the capital adequacy, which
eventually lay down the overall risk appetite of the bank. As apparent in the example of National Bank of Oman (NBO) wherein the Risk Weighted assets (RWA) is significantly higher than
the industry averages, probably due to greater share of the retail lending on the asset side. The 60-40 benchmark may enable Islamic Banks to sway their strategic goals, while they follow their respective organic growth. As an indicative yardstick, it can be an overarching frame to avoid any major deviations in shape costly deposit mix or lower-than-the optimum credit portfolio. Moreover, the overall industry is leveraged around 8 times the equity, which can be used to make a ballpark estimate of the future industry size to be around OMR 2,700 Mn at the present equity levels of OMR 334 Mn. The size of around OMR 3 Bn (or 8% of the Banking Assets share in 5 years) is also coherent with the earlier estimates made on the basis of Moody’s and E&Y expectations.
Earnings Dynamics Banking Sector in Oman reportedly enjoy a handsome spread of around 4.2% with weighted average cost of deposits of 1.177 and whereas the corresponding lending yields 5.4%.
The higher spread may be attributable of to a lucrative deposit distribution, with one third of zero cost deposit and a similar fraction in low cost saving account. On the asset side, over 45% of the private credit ows to the highly rewarding household portfolio. Though the regulator has been careful on rationalising the household credit portfolio by capping the consumer portfolio overall pricing and diverting the ow to House loan from general personal lending products. It is evident that Oman’s banking industry is heavily reliant on the fee based income averaging around 20% of the net income. Despite of all its peculiarities, the existing tried and tested structural norms of the conventional counterpart, others a lot to learn for the Islamic Banks. In view of the above, Islamic
Banks should be targeting fee based income, by pushing cross sell initiatives, customer oriented service levels to route highest ancillary business through its counters. Technology services and conventional commission and processing fee based income as apparently is going to be a critical factor in the overall effciency of IB industry in Oman.
Capital – Making the most out of it!
A critical review of the risk weighted assets (RWA) as a percentage of the actual assets reveals that higher credit portfolio outlay to the retail segment leads to greater RWA and thus pressures
the capital adequacy of the Bank. It is the same reason that makes bigger Banks like Bank Muscat and Bank Sohar with retail portfolio in 30 to 40% band enjoy relaxed capital adequacy ratio owing to lesser RWA. On a broad-brush basis, IBs in Oman should be capping retail/house hold lending to 40 to 45% levels to optimise their risk adjusted yield and overall risk appetite. With eight IBs and their 32 branches, as asset base of over OMR 750.00 Mn, Equity of 349.00 Mn, operation, it would be safe to claim that Islamic Banking Industry has taken off – and taken off well. e journey onwards would surely depend much on factors including niche marketing, product innovation, market segmentation, capital optimisation and Shari’a governance. Strategic imperatives can be deducted by a close assessment of the Islamic Banking Industry and its convergence with the overall financial scene. e trade-o of Stability and Efficiency in the longer run can only be achieved with the right proposition of asset and deposits, comprehensive product suite and adequate client coverage. Indeed, it is going to be the early mover, in the right direction that would take Islamic Banking Industry in Oman to newer heights.