Borrowing for basics: Lending is on the rise as the minimum wage and employment increase

Recent regulatory changes aimed at Oman’s banking sector are likely to cause significant shifts in the lending market in 2014, with potential impacts including increased credit access for small and medium-sized enterprises (SMEs) and perhaps a broader jump in the pace of loan growth and the competitiveness of the lending market. The changes are aimed at further aligning lending with overall macroeconomic goals. Oman wants to diversify its economy and create employment opportunities for its local population, and has tabbed an increase in credit access for SMEs as a way to help accomplish those goals. It also wants to prevent imports from rising too high too quickly, and to ensure that consumers do not take on too much debt.

Revised Rules

These goals are behind a series of regulations issued in recent years by the Central Bank of Oman (CBO), the sector regulator. It has instituted a rule that 5% of banks’ loan books must be dedicated to SMEs by December 2014, a minimum that is likely to rise to 10% at some point in the next few years, according to the central bank. It has also adjusted ceilings on consumer debt – as of June 2014 loan books cannot comprise more than 35% personal loans and 15% housing loans. Previous targets were 40% and 10%, respectively.

The CBO has also introduced a cap on the debt-burden ratio for consumers: a bank cannot lend to a consumer if the loan takes that person’s monthly debt-servicing cost above 50% of his or her income (an additional 10% above that is acceptable for housing loans). Although not certain, the market also expects a lowered cap on the maximum interest rate applicable on retail loans, although a date for the change has not been set. That ceiling is 7% now.

Consumer Status

As of late 2013, most banks had already hit the thresholds of 35% consumer lending in their overall totals, and therefore were unable to extend more personal loans without corresponding increases in borrower salaries and in corporate lending. Many consumers are approaching the debt-burden ratio of 50%. In addition to housing and cars, Omanis have in recent years been offered personal loans at maturities of up to 25 years. After repayment has begun they are also given the choice to take on more debt – a loan top-up – in which more credit is extended within the terms of the original loan, and up to its original amount.

That does not mean that the retail market is set to shrink. Demand is still likely to grow, due to a mix of new consumers and rising salaries. The ranks of bankable Omanis are growing thanks to greater employment opportunities, in particular in the public sector. Those already employed will benefit from an increase to the minimum wage for the second time in three years. The hike in July 2013 boosted the minimum for monthly salaries from OR200 ($518) to OR325 ($842). One in 2011 raised it from OR140 ($363) to OR200 ($518). That leaves the lending market attractive to potentially thousands of Omanis looking to borrow. In 2012 car sales touched a record high, for example. But demand goes beyond vehicles. Many of these potential new customers are in their early 20s, a demographic in which consumers are expected to marry and establish households of their own, which means loans for housing, furniture and appliances, all financed by borrowing.

Strong Fundamentals

At the end of 2012, credit to households totalled 47%, according to CBO data. That suggests that within the financial system there is limited room for banks to lend more unless they increase their capital first – perhaps through foreign investment – and then boost lending to commercial entities at roughly the same pace as to the retail sector. This seems a likely outcome, in large part because banks have historically preferred to lend to retail customers, and are unlikely to change that predilection. Omanis employed in public sector jobs enjoy a high degree of job security, making them less likely to default. Retail lending margins are higher. The current capped interest rate of 6% is roughly 0.5 percentage points higher than the average borrowing rate in the market, which indicates that banks profit less from interest on commercial borrowers, who command lower rates. However, banks benefit from other income associated in banking transactions with the commercial entities. The weighted average borrowing rate in Oman was 5.2% as of the end of 2012, according to the CBO annual report.

Another reason banks prefer to lend to retail clients is that there is less documentation required, and in the event of a default Omani laws make winning judgements and recovering assets easier if the defaulter is a person as opposed to a corporation.

Consumer Spend

In the event that banks do not choose to increase capital, consumers will have several alternative sources for credit. The first option is the two newly licensed Islamic banks, Bank Nizwa and Bank Al Izz. Both would have plenty of room to lend to consumers because as new banks they have abundant capital to deploy before hitting the 35% or 15% ceilings. Sharia-compliant loans are expected to come at a slightly higher cost to the consumer, as they often do. Islamic banks offer essentially the same service as their conventional counterparts – access to capital – but making sure the transaction does not violate the rules of Islamic law comes with an added cost. Islamic finance is too new to the sultanate to know how big a proportion of customers will accept a higher-priced product.

Another option is to make use of non-bank financial companies – a well-defined market segment in the sultanate. The six licensed actors in this market niche are mostly engaged in asset-backed financing, such as car loans or financing assets by small businesses. Commonly known as leasing companies, they typically have a higher cost of funds than the banks – often borrowing from them and lending on to consumers – and also higher default rates. Though regulated by the CBO, they are not subject to the specific lending restrictions that banks are, and therefore have capital to lend to consumers. As with the Islamic option, cost is a key question, in this case for two reasons. The first is that they can charge any interest rate they want, whereas banks must heed the 7% cap. As a result, leasing companies are typically a more expensive option for consumers. The second reason is that the cost of capital for leasing companies could be on the rise in 2014. One of their main sources of capital is the banks themselves, and among their main clients are SMEs.

SME Options

The lending market has historically been one in which banks do not lend directly to SMEs, but have indirect exposure because leasing companies end up a de facto intermediary. However, the CBO’s new rules could create a situation in which banks redirect the loans they had extended to the leasing companies straight to the SMEs. That would take a common source of funding from lending companies and create new competition.

This strategy has the support of some sector insiders and could help improve the SMEs themselves. Abdul Aziz Al Balushi, the CEO of Ahli Bank, told OBG, “For SMEs to be properly supported and developed the public and private banks must work together.” The possibilities for such collaboration exist, as does the development of new products. According to Abdul Kader Askalan, the CEO of the Oman Arab Bank (OAB), “When it comes to SMEs banks must focus on areas where financial institutions cannot compete. This means tailoring products to help develop and support SMEs. This strategy will benefit the local communities.” SMEs are unlikely to find money at a lower cost in global markets, because of Oman’s low interest rates. However, equity sales on the Muscat Securities Market could also be an option.

Slow & Steady

The changing market dynamics made possible by these new regulations are expected to manifest themselves in time. The flow of new retail customers will probably be a gradual phenomenon rather than a large and short burst. Though the government had announced in 2011 an intention to add 50,000 public sector positions, it has been filling them at a measured pace. According to data from the Muscat-based investment firm Gulf Bader Capital Markets, the government added 20,000 workers to its payroll in 2011, the most recent year for which information is available.

It remains unclear whether Omanis are in a rush to buy, particularly in the car market. While 2012 represented record sales, for some the numbers were underwhelming. That is because 2012 marked the five-year anniversary of Gonu, a cyclone that flooded Muscat and its surroundings in 2007 and destroyed about 5000 cars. On the assumption that Omanis earning minimum wage look to buy a new car every five years, those purchased in 2007 to replace those destroyed by the storm were due to be replaced in 2012. That left some dealers disappointed in the sales figures for the year and wondering whether 2014 would bring a sales bonanza.