Looser capital adequacy requirements and mergers aim to boost liquidity in Oman

Since the start of the economic slowdown in 2015, there has been much talk about consolidation in Oman’s banking sector, and in 2018 major Omani banks announced plans for potential mergers. Oman Arab Bank, the country’s only unlisted bank, and Alizz Islamic Bank signed a memorandum of understanding in October 2018 to consolidate the two entities after receiving approval from their respective regulatory boards. Alizz will continue to operate as an independent Islamic bank post-merger to retain its Islamic-oriented customer base. The new bank will enjoy a larger combined asset base of $7.6bn and higher income-generating capacity.

Another major merger announcement in 2018 came from Bank Dhofar and the National Bank of Oman (NBO), which, if carried out, would create Oman’s second largest bank. These mergers entail significant cost and revenue synergies, and hence potential for shareholder wealth creation. For instance, NBO has a strong retail franchise which would help mobilise low-cost deposits, while Bank Dhofar has better asset growth and is expected to help drive overall expansion. Amid an economic slowdown, GCC banks are now seeing increased moves to consolidate, with the aim of increasing scales and revenue bases while trying to address growing competition in funding.

Relaxed Regulations

As part of further efforts to encourage liquidity and spur growth in the banking sector, the Central Bank of Oman (CBO) relaxed its capital adequacy and liquidity requirements in April 2018. The central bank lowered the required capital adequacy ratio (CAR) by one point from 13.9% to 12.9%. Without the capital buffers, the new minimum CAR dropped from 12% to 11%. It was estimated that the eased requirement will create room for an additional OR2.6bn ($6.8bn) in lending, equal to about 11% of current loans. In addition, the CBO has allowed banks to include net interbank borrowings in their deposit base, thereby giving them more room to expand their loan books. The CBO has also allowed banks to run bigger mismatches in their asset and liability portfolios. With these relaxations, banks will be able to manage their liquidity with greater flexibility.

Considering that the CARs of larger banks are well above the CBO’s minimum thresholds, Omani banks are well capitalised. For instance, Bank Muscat’s CAR is 18.6%, NBO’s is 17.3%, Bank Dhofar’s is 15.4% and Bank Sohar’s is 16.2%. In addition, bank lending ratios are also well below the ceilings defined by the CBO, so there is ample room to grow loan volumes. We believe that the CBO’s eased measures will serve as an additional catalyst, boosting credit growth, enhancing liquidity flows, and encouraging the private sector to borrow and invest more aggressively.

Rebound Ready

In 2018 credit ratings agency Moody’s maintained a negative outlook on Oman’s banking sector due to the sector’s softening asset quality and relatively tight funding, but stated that the economy is set to rebound the following year. Despite the weak credit rating, banks in Oman are well positioned to benefit from an economic recovery driven by higher oil prices and improved domestic liquidity. Another important factor that will impact fundamentals is the gradual rate hikes by the US Federal Reserve. The broader market anticipates one rate hike in December 2018, three in 2019 and another one in 2020. The increase in US rates should feed through into the GCC banking system in the form of higher net interest margins, which will in turn increase banks’ profitability.

Bank stocks, however, remain depressed, demonstrated by Bank Muscat, Oman’s largest bank, which traded at more than a 30% discount on its book value as of early November 2018. Such low valuation was mostly the result of foreign selling, despite stable profits and dividends. Hence, Omani banks are offering compelling valuations at current prices for long-term investors as the economy is set to rebound. In November 2018 the IMF forecast GDP growth of 5.0% in 2019, which would lead to a pick-up in credit expansion and credit quality.