All change: Separation of Islamic finance and credit restrictions head the recent adjustments to the system

Several important regulatory moves impacted Qatar’s banking system in 2011 within the framework of ongoing initiatives to reduce risk and household debt exposure while moving towards the long-debated goal of a single regulatory authority. The first of these major changes was a February 2011 regulation that obliged conventional banks to close their Islamic windows by the end of the year. The Qatar Central Bank (QCB) announced the move, immediately freezing conventional banks’ ability to open new Islamic branches and deposits, and conduct new Islamic finance operations. In addition, the existing Islamic portfolios had to be wound down, either by selling them off to Islamic institutions or converting them to conventional branches and accounts. Any deposits still awaiting maturity on December 31, 2011 could be kept until maturity in a separate account or transferred to an Islamic finance house.

A KEY CONTRIBUTOR: Until the new regulation, many of the country’s conventional banks offered sharia-compliant products to their customers, either through dedicated branches or through windows at their usual outlets. This had been a healthy business too, with the Islamic window accounting for a significant slice of some conventional banks’ overall business. Islamic assets accounted for some 31% of total banking sector assets at year-end 2010, according to the IMF, while Islamic windows accounted for around 12% of the total assets of conventional banks.

This ratio was slightly higher for the Qatar National Bank (QNB), which reported at the end of 2010 that assets held by its QNB Al Islami division stood at QR32.2bn ($8.8bn), out of QR223.4bn ($61.3bn) for the whole group, or 14% of the total. The second-largest Islamic window by assets belonged to Commercial Bank of Qatar (CBQ), which reported its Islamic banking segment as having QR4.36bn ($1.2bn) in assets at the end of 2010, out of a total QR48.7bn ($13.4bn), around 9%. The third largest was Doha Bank (DB), with its 2010 annual report putting its total assets in the Islamic banking segment at QR3.8bn ($1.04bn), 8% of the QR47.23bn ($12.97bn) total. Al Khaliji Bank’s Al Islami Islamic banking section reported total assets of around QR990m ($272m) at the end of 2010, from total assets of QR20.4bn ($5.6bn), or around 5%. Ahli Bank, meanwhile, reported QR1.77bn ($486m) of Islamic banking assets at the end of 2010, or around 10% of a QR17.96bn ($4.93bn) total.

CURRENT STATE: By the end of 2011, however, all the conventional banks were able to report that they had ceased Islamic banking operations. One, International Bank Qatar (IBQ), had transferred its Islamic retail portfolio to the Islamic Barwa Bank, while a deal was also announced to transfer its corporate portfolio to Qatar Islamic Bank. In its 2010 annual report IBQ gave the total assets of its Islamic operation, Al Yusr, as QR1.5bn ($413m), around 6% of IBQ’s total assets of QR24.12bn ($6.62bn). According to a March 2012 HSCB Global Research Report, CBQ stated that by December 31, 2011 sharia-compliant loans accounted for 7.5% of total CBQ loans, and Islamic deposits represented 4.2% of total customer deposits, down significantly from 11.4% a year earlier.

Others had either converted Islamic accounts to conventional ones, or their Islamic customers had closed their accounts and moved elsewhere. The impact this had, however, seems to have been generally offset by the fact that conventional banks’ overall balance sheets saw vigorous growth in 2011 in other lines of business. This meant that overall profitability was largely unaffected (see analysis).

Similarly, Islamic banks have not seen a huge surge as a result of the move either – with the exception of a short-lived jump in their weighted stock prices in the first few months under the new regulation (see Islamic Financial Services chapter). This was matched by a brief decline in the stock prices of the conventional banks, down around 15% in January-February 2011, before regaining all lost ground by August of that year.

As for the rationale behind the move, there is a school of thought that sharia and non-sharia products cannot be offered by the same bank, due to the likelihood of contamination, while another school suggests that the source of funds is not important, but that it is the way they are used that matters.

On the regulatory side the argument is clearer. As Islamic and non-Islamic finance works to different sets of international regulations, combining the two in a single balance sheet can make for complex calculations. It also makes international comparisons – and valuations – more difficult. There is also a widespread view that Basel III, to which Qatar’s banks are currently moving, may diverge further from international Islamic Financial Services Board standards. Thus, separating the two types of banking will make for more straightforward regulation in the future.

LOAN RANGERS: The second big regulatory change in 2011 was the introduction in April of a string of new limits on loans and interest charges by the QCB. Aimed at curbing credit growth in retail banking, the move targeted retail’s dominant product, personal loans. These are typically secured against the customer’s salary, which is assigned to the bank. According to the IMF, in February 2011 these accounted for 18-20% of total loans in the banking system.

After a previous credit-tightening move in 2008, a limit of QR2.5m ($687,000) had been imposed on the amount of credit that could be extended to a Qatari national. At the same time, the maximum ratio of monthly repayment to monthly salary – the equated monthly instalment (EMI) – was set at 50%, with a maximum loan repayment period of seven years.

In April 2011 the QCB changed the upper limit to QR2m ($549,000) for Qatari nationals and QR400,000 ($110,000) for expatriates, with a maximum repayment period of 72 months for nationals and 48 months for expatriates. The EMI for Qataris was set at 75% and at 50% for foreigners. In September of 2011 the QCB announced that it had no plans to raise the lending limit for nationals despite a major hike in the salaries of Qatari government employees.

At the same time, the QCB set maximum rates of interest or return, namely, the QCB lending rate plus 1.5 percentage points, for loans to all. There were also limits to credit card withdrawal of double net total salary, with a maximum interest rate of 1% per month, and 0.25% on arrears of credit card debts. Both represented declines from many banks’ existing charges. Credit card issuance was also tied to assignment of salary, with those cards issued without this non-renewable at expiry unless the customer assigned his or her salary to the bank.

BRIDGING THE GAP: The moves were also aimed at correcting a growing disparity between borrowing and lending rates, as the QCB had been progressively lowering its own policy rate – down to 0.75% by August 2011 from 5.15% pre-global crisis – yet banks had been charging 18-20% interest on credit cards and around 8% on car loans. These rates had been falling recently, however, due to price competition in the busy sector.

The regulations have had their critics. Some argue that the caps restrict banks’ ability to price loans according to their own assessment of a customer’s risk – an assessment now helped by the establishment of a credit bureau (see overview). This potentially leads to flat rates being charged, regardless of the level of risk. Others see the move as having made a tough market – retail – even tougher, with those banks particularly dependent on personal loans hit hardest.

The QCB argues that the move was necessary to restrict the levels of risk households – and the economy in general – were being exposed to, as well as moderating banks’ balance sheet risks. The QCB looked back at previous periods, such as 2008, when debt became a social issue, and opted for a conservative approach. Steve Troop, CEO of Barwa Bank, said, “There has been a realisation recently in Qatar and the region as a whole that retail lending may be having overheating implications on the economy and some negative social implications. This has been demonstrated in recent decisions aimed at restricting retail lending. But as the economy evolves there is anticipation that measures will be implemented to boost retail lending in the coming future.”

The impact has also been ameliorated by the general strength of economic growth in both the country and sector, and the fact that most Qataris are still leveraged well below the maximums set. According to a May 2011 report from HSBC Global Research, at that time Qataris had on average around QR1m ($275,000) of loans per retail customer.

There was also a major hike in public sector salaries in autumn 2011. These went up by 50-120%, with the higher end reserved for military officials. This helped boost demand for new loans, and raised existing borrowers’ capacity to gain more credit, given the percentage terms of the EMI. The move was also a statement by the QCB that it is watching credit growth closely and that banks should expect it to take a careful approach to continued loan expansion.