Islamic Banking in Oman Today and The way forward part 1&2 [published] cpi financials issue 85&86

A SPECIAL REPORT

Islamic Bankingin OmanToday and the Way Forward

cont. overleaf

In 2011 a Royal Decree was issued to establish an Islamic financial system, which paved the way for the promulgation of a regulatory framework, and the subsequent establishment

of two independent banks and six window operations in the Sultanate.

The Sultanate of Oman is one of the recent entrants into the Islamic banking and finance scene, with a well-established regulatory framework roll-out and nascent industry players comprising of two independent Islamic banks and six Islamic banking windows. Since the Royal Decree adjusting the

In this first of a two-part special, Muhammad Arsalan Aqeeq reviews the progress of Islamic

finance in Oman since inception in 2011.

Omani banking law to allow the Shari’ah-compliant format of banking was announced, competition has been seen tough among the local banks.

Apart from the two fully integrated Islamic banks – Bank Nizwa and al izz bank – the country’s leading commercial banks have also set up their own Islamic banking windows, including:• alhilal Islamic ahlibank• Maisarah Bank Dhofar• Meethaq Bank Muscat• Muzn National Bank of Oman• Sohar Islamic Bank Sohar• Yusr Oman Arab Bank

Much has been written on the prospects, potential and promise of Islamic Banking in this GCC country, with analysts generally optimistic on the prospects for the overall growth of the industry both in terms of absolute Islamic assets as well as market share.

Above: Mosaic detailing in the Sultan Qaboos Grand Mosque, Muscat, Oman (Philip Lange). Cover: Entrance to the Sultan Qaboos Grand Mosque (Ivan Pavlov).

www.cpifinancial.net 21ISSUE 85 | Islamic Business & Finance

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The fledgling yet vibrant Islamic banking industry in Oman has been attracting a lot of attention for its vigorous legislative, regulatory and market developments. Presently, almost all of the eight Islamic banking institutions (IBIs) in Oman have completed a year of operations, and account for a significant 3.24 per cent (OMR 745 billion) of the overall banking assets in the country.

This two-part research paper takes a descriptive and exploratory approach to encompass the progress of Islamic banking in Oman against the backdrop of the dynamics of the local economy and the overall banking industry. An objective, as well as a strategic review of the banking industry is carried out to identify the opportunities and challenges facing the nascent faith-based format of banking.

Oman has been classified as an oil-rich economy, heavily dependent on dwindling oil resources, which were responsible for around 80 per cent of its revenue in 2012 (S&P, December 2013). Thus, aligned with its regional peers, Oman’s economy and external position are exposed to commodity prices. However, the Government has been framing a variety of initiatives to diversify the non-oil economy (tourism and mining primarily) by means of high investment supported by higher public and private consumption.

Oman is a youthful Muslim monarchy with a faith-driven population of some 2.78 million (World Bank, 2011).

GROWTH STORY INTACTThe Sultanate’s favourable demographics (60 per cent of the population is between the ages of 15 to 45 years) coupled with a pro-growth and employment backdrop, augur well for the fortunes of the financial sector. Oman’s GDP growth during 2000-2012 averaged around 5.6 per cent. Recent government regulations raising minimum wages and expanding employment have also been supportive of consumption and the deposit base of the nation’s banks. This has also translated positively into a 10 per cent year-on-year growth in banking assets to surpass the OMR 23 billion mark.

In recent years, the strength of the crude oil price and rising production have coincided to enable supportive government expenditure and an accommodative monetary policy portending well for growth in the country and of its banks. Expectations of a continuing expansionary fiscal policy to sustain the current momentum in growth provide an optimistic outlook for the medium-term future. Obvious risks include a substantial fall in

oil prices. However, years of fiscal prudence have yielded adequate reserves to ensure continued pro-growth initiatives remain unhampered, even in the event of a mild fiscal deficit.

The Eighth Five-Year Development Plan (2011-15) emphasises a large public investment programme. Non-oil activities are expected to grow by an annual rate of six per cent at constant prices, according to the Central Bank of Oman (CBO), and private sector involvement through domestic and foreign private investment is expected to complement government spending. With estimates for the future dwarfing past activity, $50 billion is projected to be spent over the next 10 years, of which $28 billion is expected to be awarded between 2013 and 2015, driving growth and the resultant credit off-take in the nation.

BANKING SECTOR DYNAMICS & DRIVERPrima facie, Oman has a thriving, efficient and stable financial intermediation system, with a high advance-to-deposit ratio and is deeply rooted into the private retail and corporate sectors. Around 63 per cent of deposits are raised from the private sector, which is re-channelled to the private sector to an even higher level of 84 per cent in shape of credit outlay.

Total banking assets in Oman are around OMR 23.20 billion with a breakup of equity of OMR 2.67 billion and deposits of OMR 16.47 billion. Total credit of OMR 15.38 billion turns it into a 93 per cent advances-to-deposits ratio (ADR) for the banking sector. More encouraging is the fact that OMR 13 billion (out of OMR 15 billion) is channelled into private sector. Albeit a small population, households contribute heavily on both on the deposits and asset side.

A number of useful insights may be drawn to identify opportunity pockets, potential challenges and discrepancies by modelling against the existing banking industry’s norms.

ISLAMIC BANKING – FORECASTS AND REALITIESA lot has been touted about Islamic banking and the Omani market’s appetite based on growth stories elsewhere in the GCC (e.g. Qatar, KSA, UAE etc.). These projections are, broadly, based on cognitive reveries, heuristics and optimism driven by broad generalisations with but little reference to the dynamics of the local banking industry, regulatory paradigm and balance sheet structures.

To quote a few, Moody’s reports are optimistic for Islamic Banking in Oman, making a ballpark

$50 billion is projected to be spent over the next 10 years, of which $28 billion is expected to be awarded between 2013 and 2015, driving growth and the resultant credit off-take in the nation

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22 Islamic Business & Finance | ISSUE 85

cont. from pg 21

cont. on pg 24

projection in its ability to grab six to eight per cent share of system assets within the next three to five years. Quantifying this verdict by Moody’s, Islamic banking assets should reach around OMR 3 billion, assuming 10 per cent YOY growth of overall banking assets, eight per cent penetration of Islamic banking in a period of five years. EY (previously Ernst & Young) holds to a more conservative stance, and sees Islamic banking surmounting $6.00 billion (OMR 2.3 billion) in a matter of few years. Arqaam Capital, a Dubai-based investment bank, offers the most optimistic forecast, suggesting that by 2017 Islamic banking in Oman would account for around 15 per cent of all loans by 2017.

A careful factual review of the foundation and projected growth of Islamic Banking Industry based on industry dynamics and consumer profiles appears to be non-existent. This study reviews Oman’s Islamic banks (mostly operational for one to four quarters) and endeavours to model growth and progress against established industry benchmarks, with due weighting to the specifics of Islamic banking.

FIGURE 1: Structure of Oman’s Banking Industry: Equity, Leverage, Financing and Deposit Activity

Data Sources: CBO Annual Report 2012, Monthly Report February 2014

The CBO has been actively tweaking the reins of the banking industry to ensure stability and the efficiency of the financial system. A summary of recent CBO directives shows:

Action/Directive Detail

Ceiling on Personal Loan Pricing cut from 8.5 per cent to seven per cent

Minimum SME lending for banks set at: five per cent

Overall portfolio cap on Personal Loans cut from 40 per cent to 35 per cent

Cap on Housing portfolio relaxed increased to 15 per cent from 10 per cent

RECENT REGULATORY DIRECTIVES

Islamic banking assets should reach around OMR 3 billion, assuming 10 per cent YOY growth of overall banking assets


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23ISSUE 85 | Islamic Business & Finance

cont. overleaf

Free Based Income OMR 60 m20% of Net EarningsNet earnings

OMR 305 m

Time-33%

Saving -33%

Household 48%

Non FinancialCorporates 29%

Deposits - Government & Public Sector - 35.2%

Deposits - Private Sector 63%

Private Sector Credit OMR 13.00 bn

Public Sector Enterprise OMR 2.00 bnDemand -33%

Equity Capital OMR 2.67 bn

Total Credit (TC) OMR 15.38 bn

Total Deposits (TD) OMR 16.47 bn

Household Credit 45%

Non Financial Corporates 47%

Total Banking AssetsOMR 23.20 bn

Net Spread 4.237%

Weighted Average Cost ofDeposits 1.116%

Weighted Average LendingYield 5.353%

Advance: Deposits 93.4%

Total Assets: Equity 7.8%

Deposits: Equity 5.7%

ISLAMIC BANKING IN OMAN: START-TO-DATEOman’s Islamic banking industry, with an initial equity base of OMR 348.5 billion and a network of 32 branches representing two independent Islamic banks and six Islamic banking windows has managed to grab a 3.24 per cent share of the overall banking assets. Interestingly, the Islamic banking industry is operating at an advance-to-deposit ratio of over 129 per cent, which is well above the overall banking industry average of 93 per cent. These advances, predominantly are retail- and real estate-centric, but will, it is to be hoped, rationalise as the industry takes on momentum. Progress should be viewed against the backdrop of the embryonic phase that the Omani Islamic banking industry is going through.

The Islamic asset base of OMR 745 million is largely dominated by Meethaq (Bank Muscat’s Islamic banking window) with a 40 per cent share. This may not come as a surprise as Bank Muscat happens to claim an equally dominant share (38 per cent) of overall Omani banking assets as well. As of December 2013, not much can be seen in the core banking activities in the shape of retail deposits’ mobilisation or private sector lending. Nevertheless, the stage is all set for a get-set-go thrust, with all sorts of products launched, branches functioning, IT infrastructure and human

Research Origin Claimed Estimates – Projection * Asset sizeEY Islamic banking to reach $6 billionin next few years [assuming 5 years i.e.

2018].OMR 2.3bn

Moody’s Islamic banking to grab 6-8 per cent share of system assets within the next three to five years i.e. 2018 [assuming eight per cent share in 5 years].

OMR 3.00bn

Arqaam Capital Islamic financial institutions as a whole to generate around 15 per cent of all loans by 2017.

OMR 5.05bn (of which, credit OMR 3.35bn)

TABLE 1: Projections on the size of the Omani Islamic banking industry by assets

*The quantification of the broad estimates by various research companies has been based on Oman banking Industry-wide norms such as leverage of 8x, ADR of 93 per cent, YOY growth of 10 per cent, etc.

Bank Muscat’s window Meethaq (with a meagre capital of OMR 20 million) has been very quick to inflate its balance sheet to leverage over 10x against the overall industry norm of 8x leverage. Interestingly, this steep growth is primarily attributed to its inherited Musharaka (retail housing) portfolio amounting to OMR 168 million which latterly has grown to a level of OMR 280.66 million as of December 2013. The asset side is dominated by this long-term Musharaka portfolio. On the other hand, the unusual growth in deposits on the balance sheet is mainly comprised of deposits from banks and financial institutions which contributed OMR 134 million whereas the remaining OMR 66 million have been driven from the Government sector. With over seven branches, the bank has not been able to mobilise any significant retail or private sector deposits till Dec 2013.

This idiosyncratic balance sheet structure makes it a difficult situation for the asset-liability maturity profile to manage, wherein 65 per cent of the assets are over five years’ maturity, which is funded by very low maturity deposits. This leads to asset/liability mismatches.

However, given the monopolistic penetration and legacy that its parent bank enjoys with over 38 per cent of the market share, it shouldn’t pose much of a problem to ‘tweak’ the matter. Moreover, the high yield (6.3 per cent) of the retail Musharaka assets, keeps it affordable for the bank to manage its liquidity through interbank markets wherein it can engage relatively low cost liquidity, while keeping its spreads intact.

The uniqueness of Meethaq doesn’t ends here, when the bank. being smart enough, recognised the troubles ahead it unveiled another out-of-the-box strategy. Instead of going for aggressive deposit mobilisation to rationalise its deposit mix, the bank opted for an altogether distinctive route. In an extraordinary Board meeting in March 2014, the Board announced the setup of an OMR 500 million Sukuk programme for Meethaq. This can be viewed as an innovative business model, where the bank instead maintaining saving and term deposit accounts can use a flexible Sukuk structure to fund its assets.

However, Meethaq has not lost sight of its core banking business lines. The bank intends to expand its branch network to 15 branches to ensure its outreach to a broader consumer base.

MEETHAQ, THE MAVERICK!


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NIZWA AL IZZ MEETHAQ SOHAR MUZN ALHILAL AL YUSR MAISARAH Total

NATURE Independent Window

Parent Bank

Bank Muscat

Sohar Bank

National Bank of Oman

Al Ahli Islamic Bank

Oman Arab Bank

Bank Dhofar

Equity (OMR million)

150 100 26 10 15 25 10 12.5 348.5

Launch date

Dec 2013

Sept 2013

Jan 2013 Apr 2013 Jan 2013 Dec 2013 July 2013 March 2013

Deposit Base (OMR million)

As of Dec 2013

Dec 2013

Dec 2013 Dec 2013 Sept 2013 Dec 2013 Sept 2013

Sept 2013

Current 13 0.5 4.6 3.7 1.4 5.5 NA 1.968 30.668

Savings/Timed

6.9 0.6 Saving: 10.4

15.6 15.1 4.0 NA 264.6

Term: 212.0

Financing Assets (OMR million)

Consumer 12.0 0.5 275.61 9.5 8.3 36 0.2 10.092 352.202

Commercial 3.703 5.1 20.4 29.203

Total Assets (OMR million; assumed as sum of equity and deposits, in case of data unavailability)

170 100 298.3 52 25.1 75.2 10 14.4 745

Profits (OMR million)

(2.405) (3.232) 6.2 (0.65) (0.6) (0.3) (0.5) (1.3) (2.787)

Profit-sharing Ratio (Bank/Depositor)

50:50 NA 80:20 70:30 NA NA NA NA

Number of Branches

7 2 7 3 2 7 2 2 32

Product Participation Weights [1 Month to 12 Month ]

a) 1M 45 NA 0.3 0.14 NA NA NA NA NA

b) 12M 70 NA 2.0 0.21 NA NA NA NA NA

Absolute Rates Offered

1M 0.42 NA 0.15 NA NA NA NA NA -

12M 0.95 NA 1 NA NA NA NA NA -

% Dispersion = (b-a)/a x100

56% NA 567% 50% - - - - -

TABLE 2: Assets, Equity, Deposits, Financing, Profitability and Deposit Rates Disclosures


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cont. overleaf

disclosure of profit distribution management has been extremely transparent and regularly updated, with monthly disclosures along with the reporting of profit sharing ratio (PSR). In terms of PSR, Meethaq seeks the highest Mudarib’s share i.e. up to 80 per cent of the income.

Commendably, Meethaq took a step further towards the transparency by publishing the participation weightages assigned to the bank’s equity contributed to the Mudaraba Pool along with balances in Profit Equalisation Reserves. With the exception of Nizwa, Meethaq and Sohar, none of the Islamic banking operations have had formal deposit products-related disclosure on their website, not even the basic profit sharing ratio, despite the fact that almost all of them have mobilised Mudaraba-based deposits as reflected on their balance sheets.

In contrast to many regional jurisdictions, and in compliance with AAOIFI and the CBO’s IBRF, the Investors Account Holder Equity has been reported separately between the liabilities and shareholder equity, instead of being reported as a mere liability, considering its profit/loss sharing of the underlying Mudaraba contract.

Tying up with Takaful services to bundle BancaTakaful products and provide Takaful coverage for the consumer base has also been picking up lately in Oman. Meethaq was the

resource in place. TABLE 2 takes a micro view of core activity, presenting financial statements’ data on equity, deposits and financing together with number of branches as measure of physical outreach. Additionally, this table also elaborates on the deposit profit management practices by presenting profit-sharing ratio, absolute profit rates offered, deposit product weights assigned and the percentage dispersion of these weights across various deposit products.

DEPOSITSMost of the innovation has been seen on the deposit-side, and very rightly so as it takes deposits for banks to lend and earn profits. Almost all of the banks and windows have well-defined call, timed, remunerative and non-remunerative deposit products, bundled with other benefits aligned to the targeted customer base. Broadly, deposits are mobilised on the underlying contract of Qardh (for Current Account) and Mudaraba (for savings and terms deposits).

MARKET DISCIPLINEMeethaq and Nizwa have taken the lead, with well-articulated and properly disclosed profit-sharing ratios, product weightages and respective yields across various time-volume based slabs. Bank Nizwa’s and Meethaq’s presentation and

Product weighting is a bank’s management discretionary tool, and can be used to tune in the deposit profit rate profile. As a rule of thumb, higher tenor/volume deposit classes get higher weightages, translating in to higher profit rates.

In effect, the spread of the weights from the normal saving account vis-à-vis higher term/volume account, can be indicative of the bank’s inclination for longer term/higher volume depositors. However, irrationally high dispersion leads to disadvantaged customers which may be viewed as somewhat incoherent when compared to Shari’ah ideals.

Similar instances of unreasonable weightages have been addressed in Pakistan by the Central Bank, the State Bank of Pakistan, which issued a directive saying, “The maximum weightage to the Mudaraba-based deposit of any nature, tenor and amount shall not exceed three times the weightages assigned to saving deposits.”

It is worth highlighting here that for Meethaq this spread multiple is as high as 6.7x. The dispersion of weights (see TABLE 2) of 567 per cent against its peers’ (Sohar Islamic and Nizwa Bank) average of 50 per cent, might cause some concern to the bank and its depositors. This is evident from the uncompetitive profit rate of 0.15 per cent offered by Meethaq being dwarfed by the 0.42 per cent offered by Bank Nizwa in the one-month term deposit category.

DISPERSION OF PRODUCT WEIGHTS – DOES IT MATTER?

Almost all of the banks and windows have well-defined call, timed, remunerative and non-remunerative deposit products, bundled with other benefits aligned to the targeted customer base


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cont. from pg 25

INVESTMENT DEPOSITS ACCOUNTS – DISTRIBUTING NET OR GROSS PROFIT?The CBO’s Islamic Banking Regulatory Framework (IBRF) has adopted a gross income method as a standard for income determination and profit distribution to Investment Account holders. However, there is another (AAOIFI-defined) income distribution method, the net income method, wherein the net income including the fee-based income, adjusted for management overheads is subjected to profit distribution to depositors. This method may have been a viable choice, especially for an emerging market, like that of Oman with scarce liquidity management venues and a developing lending book. Both methods come with inherent trade-offs. Nevertheless, this option might have added to the sustainability and stability of the nascent Islamic banking industry in the country. As a trade-off, displaced commercial risk could have been a concern, arising when a bank isn’t able to offer market competitive returns.

IMPLICATIONSTrade-offs of including fee-based income versus management overheads is a strategic balance to strike, however the gross income method is prevalent across all major Islamic banking jurisdictions, and rationalises the CBO’s choice.

Nevertheless, it is important to note here that the generally in-loss Islamic banks/windows in Oman have almost no fee-based income streams and relatively high overheads on their P&L. This situation turns in to a relatively disadvantaged equity shareholder with negative EPS, in comparison to an earning Investment Account Holder.

first Islamic banking operation in the Sultanate to package a BancaTakaful product suite in its offerings. More recently, Maisarah announced its collaboration with Al-Madina Takaful to offer BancaTakaful services.

ASSETSBroadly speaking, asset-side products have been desigedn for retail and SME/corporate clientele, wherein vehicle finance, home finance, credit cards and personal finance are offered for the retail segment. The corporate/SME segment comprises of trade, working capital and term/project finance. A deeper analysis of the product offerings reveals that the overall industry seems to have a general consensus over certain product structures and their respective underlying Shari’ah contracts; i.e. Murabaha for vehicle finance and working capital finance, Ijarah for term financing to the corporates.

Conversely, home finance is somewhat more diversified with banks employing Murabaha, Ijarah, Diminishing Musharaka, Istisna and even Sale/Lease Back. Interestingly, personal financing is offered by Bank Nizwa and al izz Islamic Bank on the basis of Murabaha and Ijarah. Only Meethaq and al izz offer credit cards, on the basis of Ujrah and Murabaha.

Meethaq stands out among those offering home finance, doing so through underlying contract based on Diminishing Musharaka, against the prevalent norm of employing Ijarah/Forward Ijarah for housing finance as adopted by the rest of the Industry players.

MAISARAH – BREAKING THE MURABAHA MOULD

Bank Dhofar’s Maisarah, with just two branches and equity of OMR 12.5 million, has nevertheless been amongst the few, not only in Oman but across the world, which have been able to break the Murabaha mould. Maisarah, boasting of its commitment to the ideals of Islamic finance, launched a Mudarabah-based (equity-based profit/loss sharing model) working capital financing solution for its commercial banking product suite.


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cont. overleaf

ABOUT THE AUTHORMuhammad Arsalan Aqeeq is a qualified and experienced Islamic Finance Practitioner and enthusiast, specializing in Shari’ah-compliant product structuring, corporate lending, Credit risk assessment and project finance, having served both conventional and Islamic financial institutions. He has diversified experience in managing products, client segments, P & L, sales, marketing, training, and channels.

He holds a Bachelor of Engineering degree from NED University, an MBA from Institute of Business Administration, Karachi. He is a qualified CDIF from CIMA, UK. He has experience of structuring corporate lending products including the Shari’ah-compliant models of Murabaha, Salam, Istisna, Ijarah and Sukuk.

Arsalan is a staunch believer in the prospects of Islamic Finance as a viable financial alternative which, according

Retail Finance Products SME/Corporate Finance ProductsCar Finance

Home Finance

Personal Financing/

Credit Card

Working Capital Financing

Infra-structure Finance

Long Term/ Project Finance

Treasury

NIZWA Murabaha Ijarah/Murabaha

Ijarah/Murabaha

NO* NO NO NO NO

AL IZZ Murabaha Ijarah Ijarah/Murabaha

Murabaha Murabaha/IMB

IMB/Forward Ijarah

Sale-Lease Back /DM

Waad-Forward Contract

MEETHAQ Murabaha Diminishing Musharaka

NO Ujrah Murabaha Ijarah DM ND

MAISARAH NWA*** NWA NWA NWA Musharaka* NWA NWA NWA

SOHAR ND Ijarah/Murabaha

NWA NO NWA NWA NWA NWA

AL YUSR Murabaha/Ijarah

DM NO NO Murabaha Ijarah NO NO

ALHILAL Murabaha Murabaha/IMB/DM/Istisna

NO NO ND ND ND ND

MUZN Murabaha IMB/ Sale-Lease Back for Conversion

NO NO Murabaha IMB/ Forward Ijarah/ Sale-Lease back

TABLE 3: Retail & Corporate financing products and their underlying Islamic finance contract

* NO - Product Not Offered ** ND - Product offered on the Bank’s Website/press, but underlying Shari’ah contract Not Disclosed *** NWA - No website available DM- Diminishing Musharaka , IMB – Ijarah Muntahia Bi Tamlik

to him, solicits a transformation from ‘Shari’ah-compliant’ to ‘Shari’ah based’. He has recently established WAAD Associates, a research and training entity founded by like-minded professionals, engaged in pragmatic, action-oriented research and training endeavours in collaboration with counterparts based in UAE, Qatar and KSA.

He has been serving as a faculty and corporate trainer for the Institute of Bankers Pakistan, PAFKIET, SZABIST, Dubai Islamic Bank etc. Arsalan has contributed to numerous international and domestic training programmes and courses on Islamic banking, Islamic accounting standards, credit analysis and corporate finance, etc.

He may be reached at [email protected] and at pk.linkedin.com/in/arsalanaqeeq/


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cont. from pg 27

A SPECIAL REPORT

Islamic Banking in OmanToday and the Way Forward

In this concluding instalment of a two-part special, Muhammad Arsalan Aqeeq looks to the

future for Islamic finance in Oman The stage is now set for the eight Islamic banking players in Oman. The next few years are going to be critical in shaping the industry. There are a lot of strategic

dimensions, including the legacy of the existing banks (operating through windows), regulatory stance, product innovation, targeting of niche segments, cross selling, banking the unbanked and, most importantly, Shari’ah governance and assurance.

Cover: Grand Mosque, Muscat (Philip Lange/Shutterstock); above: Traditional Shipbuilding, Sur, Oman (Wolfgang Zwanzger/Shutterstock).


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cont. overleaf

Will it be windows or the independent banks that are going to thrive? Opinions differ with some suggesting windows have an inherent advantage of infrastructure, penetration and scale efficiencies. Whereas others perceive it to be a three horse race, with Nizwa, al izz and Meethaq leading market share.

MORE THAN A THREE-HORSE RACE?Research by Dubai-based investment bank Arqaam Capital 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 al izz with 23 per cent. This is an interesting claim on the face of it, as Meethaq has the lowest equity of OMR 26 million against OMR 150 million for Nizwa and OMR 100 million for al izz. However the present state of affairs appears to validate the lofty assertions regarding Meethaq made by Arqaam, which also suggested that the remaining eight per cent will 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 vigour and enthusiasm that have been exhibited by them. However, in the longer term it will be Shari’ah compliance, product innovation and service levels that will create the difference.

The Central Bank of Oman’s IBRF stipulates that the invoice issued by the supplier will be in the name of the licensee i.e. Islamic bank, as the commodity would be purchased by an agent on behalf of the licensee.

Compliance to this clause may not be difficult in the case of household financing (automobile, housing, etc.). However, this is going to be a challenge in the case of SME and commercial lending, wherein mass procurement of raw materials is being financed by the bank. As a matter of recurring business practice, invoices are usually raised in the name of the customer (eventual buyer) and are practically not possible to be raised in favour of the bank (The same challenge was faced by Pakistan, in its drive for compliance with AAOIFI standards and has been documented as an exception).

SHARI’AH COMPLIANCE FOR MURABAHA IN LETTER & SPIRIT

SACROSANCT SHARI’AH COMPLIANCEIslamic banking is a fresh endeavour in Oman, creating early impressions on the consumer base. The regulator has taken a stringent, yet principled stance on Shari’ah compliance (most prominent being on the use of Tawarruq and commodity Murabaha), and now it is the turn of the industry to follow. A review of prior research clearly establishes the fact that Shari’ah compliance is one of the key purchase reasons put forward by Islamic banks’ consumer base. Islamic banks should ensure a meticulous Shari’ah governance framework vis-à-vis brand image and ensure income cleansing to charity funds with all due presentation as stipulated by AAOIFI and the Central Bank of Oman’s (CBO) Islamic Banking Regulatory Framework (IBRF).

PRINCIPLED STANDThe CBO’s IBRF is a commendably comprehensive and principled framework, which has integrated the best practices and standards from AAOIFI and IFSB etc. A review of the regional regulatory frameworks that have been in the business for decades, would further endorse the quality of the IBRF. Paying full heed to Shari’ah governance is the formation of a National Shari’ah Board serving as a supervisor and point of reference, to the boards of individual Islamic banks.

Despite concerted lobbying efforts, the regulator stood firm on its fundamental stance against the use of commodity Murabaha and Tawarruq for short-term liquidity management. However, the CBO, being cognisant of the dearth of liquidity management venues (except for interbank Wakalah arrangements), has relaxed ceilings of foreign placements to the Islamic banks. Besides, the CBO is also keen to issue Government Sukuk which may also add to the options for liquidity management for Oman’s Islamic banks. Both the independent banks and the windows have addressed the issue of liquidity management through domestic and offshore interbank Wakalah arrangements as reflected in their balance sheets.

TRADE-BASED PRODUCT STRUCTURESOman is a thriving trade economy with overall trade accounting for 103 per cent of Gross Domestic Product (GDP). Exports account for OMR 20.05billion, whereas imports amount to OMR 11.01 billion. It is worth noting here that around 30 per


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Surprisingly, none of the Islamic lenders in Oman have offered corporate financing products based on Salam or Istisna. It is worth mentioning that Salam and Istisna financing is a widely adopted debt-based financing contract across various Islamic banking jurisdictions, and has been authorised by the CBO’s IBRF.

NON-EXISTENT SALAM AND ISTINA PRODUCTS

cent of total exports come from non-oil exports (OMR 3.6 billion) and re-exports (OMR 2.5 billion). Oman’s non-oil exports include minerals (OMR 422 million), base metals (OMR 671 million) and interestingly OMR 175 million in live cattle.

In addition to mainstream oil-based trade, Islamic banks may target the non-oil trade and re-export segment. Islamic financing contracts are inherently suited to be applied to trade transactions. Oman with its huge volume of documented trade, offers opportunities for Islamic banks to structure trade financing transactions on the basis of Murabaha, Salam and Istisna.

Re-exports transactions may 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 transactions. Parallel Salam and Istisna may also be structured where the Islamic bank can capitalise on its independent role as a buyer and seller.

Rather than sticking only to basic Murabaha, a whole suite of Shari’ah-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 may also be offered to the customer via Wa’ad contract.

The wholesale and retail trade segment which contributes around OMR 2.2 billion or 7.3 per cent of the GDP is another potential sector that Islamic banks may delve into. With sale-based product structures Islamic banks are fully poised to penetrate in to this segment, by offering supply chain financing solution.

It is worth highlighting here that, the majority of the trade is sourced in or destined to neighbouring


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cont. on pg 26

The wholesale and retail trade segment which contributes around OMR 2.2 billion or 7.3 per cent of the GDP is another potential sector that Islamic banks may delve into

countries such as India, China, KSA, UAE, with GCC countries accounting for a major share of the trade. Thus, this trade sector can potentially integrate and magnify Oman’s nascent Islamic banking industry in the context of the wider ambit of a Halal economy.

ISLAMIC WINDOWS – OFFERING EFFICIENCY OR CANNIBALISATION?It is generally believed that the 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. However, in my personal experience, windows virtually have a limited playing field, with existing large scale corporates and even high net worth individuals being earmarked as NO-GO areas if they are already working with the conventional parent bank. A window’s endeavours to offer a competitive proposition to penetrate into the market, may be viewed as invasive and tantamount to cannibalisation of existing market share.

There appears to be tacit agreement amongst C-level management not to compete from within. For example, one may foresee Bank Muscat’s Meethaq experiencing a very limited market, as its parent conventional bank is already the market leader with a 38 per cent share of the overall banking share. It is likely to have existing relationships with almost all the large accountes in the country and be viewed as a strategic bank by most large

scale business enterprises, 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 STRATEGY – BENCHMARKING THE BANKSInterestingly, an unweighted mean of the major industry players approximates a 60:40 term deposit:current account/savings account (CASA) mix. A similar 60:40 mix between the corporate and retail credit portfolios has also been observed in the industry.

The variables in Table 4 are highly interdependent; the deposit mix versus the credit mix defines the spread, which subsequently sets the yield. The credit mix along with overall leverage drives capital adequacy, which eventually affects the overall risk appetite of the bank: apparent in the example of National Bank of Oman (NBO) wherein risk weighted assets (RWA) are 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

*Stats sourced from Oman Arab Bank Investment Management Group Report as of October 2013.

Industry Averages

(Unweighted)

Bank Muscat

Bank Dhofar

Bank Sohar

National Bank of Oman

Ahli Bank

Deposit Distribution (% of total)

CASA (% of total)

42.0 64.0 39.0 38.0 46.0 23.0

Term (% of total)

58.0 36.0 61.0 62.0 54.0 77.0

Loan Distribution

Corporate 58.2 61.0 59.0 67.0 51.0 53.0

Retail 41.8 39.0 41.0 33.0 49.0 47.0

Returns ROE % 14.5 14.3 13.7 14.7 13.9 15.8

ROA % 1.7 1.8 1.7 1.5 1.5 2.1

Assets: Equity 8.2 7.14 7.3 9.6 9.3 7.7

RWA: Asset % 100.2 93.0 101.0 95.0 109.0 103.0

Fee Income: Net Income % 51.4 59.0 36.0 45.0 72.0 45.0

TABLE 4: Review of conventional banks


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to avoid any major deviations that could result in a costly deposit mix or lower-than-the-optimum credit portfolio.

Moreover, the overall banking industry is leveraged around eight times equity which can be used to make a ballpark estimate of the future industry size at around OMR 2,700 million, at the present equity levels of OMR 334 million. The size of around OMR 3 billion (or an eight per cent share of banking assets in five years) is also consistent with the earlier estimates made on the basis of Moody’s and EY expectations (see part one, Islamic Business & Finance, #85, p.24).

SMALL ENTERPRISE, BIG OPPORTUNITY?Around 91,000 SMEs are known to operate in Oman accounting for 13.8 per cent of GDP. The regulator, recognising the significance of the sector, has directed banks to lend to SMEs at least five per cent of their aggregate advances.

On the conventional banking front, Bank Muscat apparently has the most established, well-staffed product suite on offer for SMEs, branded Al-Wathbah, including working capital, equipment, point-of-sale receivables, contract and trade financing products.

Meethaq, with this legacy of SME/transaction banking and with its fast growing deposit base, is apparently very well positioned to exploit the SME potential in a Shari’ah-compliant mode as well.

For an emergent Islamic banking industry the SME segment is especially suitable as it offers smaller per party risk exposures topped by higher yield, and thus furnishes the prospect of a well-diversified portfolio.

Moreover, Islamic banking can provide a reasonable boost to the country’s vision towards lower oil dependency and diversification towards non-oil GDP growth. With private sector credit almost half of GDP and a 96 per cent Muslim population, Islamic banking is poised to mobilise financial inclusion of the faith-driven SME segments, and subsequent growth of what have been, perhaps, previously ignored or underserved business sectors such fisheries and agriculture.

The SME segment generally is graded as relatively more faith-driven and has been considered significantly unbanked in Oman (Bank Muscat, SME Presentation 2012). Furthermore, the purpose driven and asset-backed nature of Shari’ah-compliant products, makes Islamic banking solutions a good fit to penetrate into this segment. For the Islamic

Oman’s Ministry of Commerce and Industry (MOCI) is operating a Loan-Guarantee programme with Oman Arab Bank and Bank Muscat as its channel partners, wherein 50 per cent of the loan amount is guaranteed and the banks earn six per cent on the remainder 50 per cent of the loan, turning it in to a three per cent subsidised loan to SME obligor.

Shari’ah-compliant products may be structured for such subsidised financing by Islamic banks in Oman (as has been rolled-out in other jurisdictions, for example the Islamic Export Refinance Scheme is offered in Pakistan to extend subsidised funding to preferred export sectors. This is achieved by means of a Musharaka pool between the State Bank of Pakistan and the channel bank, which subsequently extend the financing to the borrower through a Shari’ah-compliant mode of Murabaha, Istisna or Salam. A similar structure in Oman would enable Islamic banks to penetrate swiftly into the SME segment, offering partly guaranteed financing at very attractive pricing.

MOCI’S SME LOAN GUARANTEE PROGRAMME – DOES IT WORK FOR ISLAMIC BANKS?


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cont. from pg 25

lender, the trade-based nature of working capital financing, provides an opportunity for referral marketing. The bank, through its existing clientele, tends to get introduced to both suppliers (Murabaha) and buyers (Salam/Istisna). Besides, this segment also offers cross-selling opportunities including, payroll accounts, personal financing bundled for staff, etc.

EARNINGS DYNAMICSThe banking sector in Oman reportedly enjoys a handsome spread of around 4.2 per cent with

weighted average cost of deposits of 1.177 per cent whereas the corresponding lending yields 5.4 per cent. The high spread may be attributable to a lucrative deposit distribution, with one third zero cost deposit and a similar fraction in low cost savings accounts. On the asset side, more than 45 per cent of credit flows to the highly rewarding household portfolio. Though the CBO has been careful in rationalising household credit portfolios by capping consumer portfolio overall pricing and diverting credit flow to housing loans and away from general personal lending products.

It is evident that Oman’s banking industry is heavily reliant on fee-based income which averages around 50 per cent of net income. Despite peculiarities, the existing tried and tested structural norms of the Sultanate’s conventional banking sector holds many lessons for Islamic financiers.

Islamic banks should be targeting fee-based income, by pushing cross-selling initiatives and customer-oriented service levels to route highest ancillary business through its counters. Technology services and conventional commission and processing fee-based income will also be critical factors in the overall efficiency of Islamic banking in Oman.

OPTIMISING CAPITALA critical review of risk weighted assets (RWA) as a percentage of 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

The IBRF underscores the CBO’s creditable recognition of the unique risk profile of Islamic banks, and its directives for capital adequacy are tailored to be consistent with Basel as well as IFSB guidelines. The IFSB’s pragmatic approach to incorporate the profit/loss sharing nature of Investment account holder funds with a certain degree of displaced commercial risk (as measured by the variable ‘alpha’), would ease the capital adequacy requirement (CAR). The ‘alpha’ is supposedly set on supervisory discretion and Oman’s IBRF has taken a moderate path (as compared to other regional jurisdictions) by fixing it to 0.3. It is pertinent to mention here that Alpha oscillates in between the 0 to 1 range with Alpha=1 implying an investment deposit to behave like a fixed return and capital guaranteed deposit and Alpha=0 referring to a perfect profit/loss sharing Mudaraba-based investment.

IMPLICATIONS The easing out of the CAR, should have a direct and positive impact on the overall efficiency of Islamic banks, enabling better allocation of expensive capital into profitable venues. Against a backdrop of balanced CAR regulations, the managements of Oman’s Islamic banks have the opportunity to carry out smart and efficient allocation of capital for an optimum risk-adjusted return on the overall portfolio.

CAPITAL ADEQUACY STANDARDS: TAILORED TO ISLAMIC BANKS

The banking sector in Oman reportedly enjoys a handsome spread of around 4.2 per cent with weighted average cost of deposits of 1.177 per cent whereas the corresponding lending yields 5.4 per cent

cont. on pg 28


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Oman’s eight Islamic banking institutions, with 32 branches, built an asset base of OMR 745 million, equity of OMR 349 million, deposits of OMR 295 million and advances of OMR 381 million in their very first year of operation

Muhammad Arsalan Aqeeq is a qualified and experienced banker, Islamic finance practitioner and enthusiast, specialising in Shari’ah-compliant product structuring, corporate lending, credit risk assessment and project finance; having served in both conventional and Islamic financial institutions. He has diversified experience in managing products, client segments, P & L, sales, marketing, training, and channels.

He holds a Bachelor of Engineering degree from NED University, an MBA from Institute of Business Administration Karachi. He is a qualified CDIF from CIMA, UK. He brings with him years of experience of structuring corporate credit products including

Sohar with retail portfolios in the 30-to-40 per cent band enjoy relaxed capital adequacy ratios owing to lesser RWA. On a broad-brush basis, Islamic banks in Oman should be capping retail/house hold lending to 40-to-45 per cent levels to optimise their risk-adjusted yield and overall risk appetite.

CONCLUSIONOman’s eight Islamic banking institutions, with 32 branches, built an asset base of OMR 745 million, equity of OMR 349 million, deposits of OMR 295 million and advances of OMR 381.00 million in their very first year of operation.

It would be safe to claim that the Sultanate’s Islamic banking industry has taken off, and taken off well. The journey from here onwards will surely depend on banks striking the right balance, based on many factors including niche marketing, product innovation, market segment identification, capital and yield optimisation, regulatory and Shari’ah governance. This paper has envisaged a pragmatic and action-oriented outlook for the Islamic banking industry in Oman through which the right moves may be made in the right direction to grow the industry successfully.

ABOUT THE AUTHOR Shari’ah-compliant modes of Murabaha, Salam, Istisna, Ijarah and Sukuk covering a variety of sectors, including: coal, edible oil, textile, rice, food grain processors, tannery and sugar manufacturers, ethanol, FMCG, pharmaceutical, distributions and automobile assembly.

Arsalan is staunch advocate of the prospects of Islamic Finance as an ethical-yet-viable alternate financial system – which to him solicits a transformation from ‘Shari’ah-compliant’ to ‘Shari’ah-based’. He has recently established WAAD Associates, a research and training entity founded by likeminded professionals, engaged in pragmatic and action-oriented research and training endeavours - in collaboration with counterparts based in the UAE, Qatar and KSA.

Recently, he received a Chevening Scholarship from the UK Government to carry out post-graduate research at Durham University, Institute of Islamic Economics and Finance. He has been serving as a Faculty and corporate trainer in the Institute of Bankers Pakistan, PAFKIET, SZABIST and Dubai Islamic Bank, among others. Arsalan has contributed to numerous international and domestic training programs and courses on Islamic banking, Islamic accounting standards, credit analysis and corporate finance etc.

He may be reached at [email protected] or pk.linkedin.com/in/arsalanaqeeq/ and tweets @arsalanaqeeq.


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cont. from pg 27

Islamic Banking in Oman Today and The way forward part 1&2 [published] cpi financials issue 85&86

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Transcript of Islamic Banking in Oman Today and The way forward part 1&2 [published] cpi financials issue 85&86