Islamic financial services have tremendous growth potential

The burgeoning Islamic financial services (IFS) industry in Oman is expected to have a major impact on the domestic banking sector and the economy as a whole in the coming years. Since the launch of the country’s first sharia-compliant bank in late 2012, the sector has grown rapidly. As of September 2014 the sultanate was home to two full-fledged Islamic banks, Bank Nizwa and alizz islamic bank, and six Islamic “windows”, which are owned and operated by conventional banks. “Islamic banking is still in the early stages in Oman,” said Lloyd Maddock, CEO of Ahli Bank, a conventional lender that operates an Islamic window, in August 2014. “While there is considerable demand for sharia-compliant products, primarily from retail borrowers, the sector faces challenges, including the training of employees and explaining the propositions to the populace.”

At the end of 2013, 3.6% of total banking sector assets were held by sharia-compliant entities, according to the Central Bank of Oman (CBO). While this is up considerably on the end of 2012, it remains low compared to initial projections of future IFS uptake in the sultanate made in 2012, when the CBO introduced the Islamic Banking Regulatory Framework (IBRF). “The growth of Islamic banking has been slower than expected, but the interest is there and the market is expanding steadily,” Gautam Datta, the CEO of Al Madina Takaful, a local sharia-compliant insurance firm, told OBG. Issues that have hampered the growth of the industry in recent years include relatively tight restrictions on the type of banking products that can be offered in the sultanate and continued scepticism about sharia-compliant finance among the general population.

History 

The fact that IFS institutions account for nearly 4% of banking assets in Oman is a very recent phenomenon. Even as IFS took off around the Gulf region in the early and mid-2000s, Oman’s central bank chose to hold off on issuing regulations on sharia-compliant finance. However, in 2012, as a result of rising demand for Islamic banking and investment products and services among local companies and individuals alike in the wake of the 2008-09 global economic downturn, the CBO released the IBRF, a 500-page document that was introduced as a “detailed and comprehensive document covering all aspects of Islamic banking”.

Most of the rules and regulations laid out in the IBRF are broadly in line with the Islamic regulatory frameworks in place in many other Gulf countries. For example, under the 2012 framework IFS institutions are required to maintain a sharia advisory board, consisting of three sharia scholars. Similarly, under the IBRF conventional banks have been allowed to open Islamic windows alongside their traditional offerings. However, key details of the IBRF differ from sharia-compliant frameworks put in place in neighbouring countries in recent years. In Oman, for example, sharia scholars are allowed to serve on only one advisory board at a time, whereas in much of the rest of the region they may sit on numerous boards. Under the CBO’s framework, Islamic institutions must also hire three additional scholars to fill three other required positions: sharia compliance officer, sharia advisor and sharia auditor. Additionally, under the IBRF conventional banks are not allowed to operate Islamic windows from the same building as conventional products; instead, they must set up a separate branch network.

Products & Services 

One of the most pressing challenges facing Islamic institutions in Oman is the limited number of products and services currently allowed by law. Under the IBRF banks and other sharia-compliant financial companies are not permitted to make use of commodity murabahafinancing structures, for example, which are used to manage balance sheets on a short-term basis at many Islamic banks around the world. Consequently, most of Oman’s Islamic institutions rely primarily on wakala, or Islamic agency agreements, to meet their funding needs.

By the end of 2013 Islamic institutions in Oman had around OR170m ($440m) in deposits and OR550m ($1.42bn) in equity capital. Much of this is currently sitting unused, however, due to the general lack of sharia-compliant investment products in the sultanate. “There is a lot of excess liquidity in the market at this moment,” Jamil El Jaroudi, CEO of Bank Nizwa, told OBG. “This is a major challenge for the entire sharia-compliant sector right now.”

The CBO has worked to address this issue on a number of fronts. In May 2014, for example, the central bank was in the midst of a project aimed at identifying a handful of appropriate short-term financing instruments for sharia-compliant institutions.

Planned upcoming sukuk (Islamic bond) issuances by Bank Nizwa, Bank Muscat and the government itself, among others, are expected to attract considerable attention from the sharia-compliant sector (see Capital Markets chapter). Other products that could eventually be deemed sharia-compliant by the CBO include real estate and oil receivables, both of which are regularly used to back sharia-compliant finance deals in other markets throughout the Gulf.

In the meantime, in 2013 the CBO relaxed the rules on foreign investment for Islamic banks, thereby allowing many institutions to put a substantial amount of their capital to use outside Oman. As an increasing number of sharia-compliant products and services come on-line in the sultanate in the coming years, the CBO will likely tighten up foreign investment regulations.

New Institutions 

Bank Nizwa, Oman’s first fully fledged sharia-compliant bank, opened for business in January 2013 with three branches. As of mid-2014 the institution had seven branches.

When it began operations Bank Nizwa offered a handful of retail products, including car, home and land financing instruments, and sharia-compliant savings and investment accounts. Since then it has worked to move into corporate products as well, which are considered a major growth area for the Islamic banking segment in the coming years.

In the first quarter of 2014 Bank Nizwa reported OR1.64m ($4.25m) in revenues, up substantially from just OR175,275 ($454,000) during the same period the previous year. “We are growing very quickly, in line with the IFS sector as a whole,” said Jaroudi.

Alizz islamic bank began operations in September 2013, offering a wide variety of retail and corporate financing and deposit products under one roof via a comprehensive digital platform. Indeed, both alizz and Bank Nizwa are currently focused on reducing operating costs – in many cases through the targeted use of technology – in an effort to ensure that the price of Islamic banking products and services is on par with conventional products. “Islamic insurance companies have to compete with conventional firms on price,” said Datta, Al Madina Takaful’s CEO. “While some individuals and small and medium-sized enterprises may be willing to pay a premium for sharia-compliant products and services, most of the big corporates have little incentive to do so. Consequently, we have to compete on price and service – we cannot rely on our Islamic status to maintain our market share.”

Most of the conventional banks in Oman have set up sharia-compliant windows in recent years. Meethaq Islamic Banking falls under the umbrella of Bank Muscat, Oman’s largest bank, for example, while Muzn is overseen by the National Bank of Oman, Maisarah is managed by Bank Dhofar, Al Hilal falls under Ahli Bank and Sohar Islamic is overseen by Bank Sohar.

Moving Forward 

According to data compiled by the official Oman News Agency, net Islamic banking revenues in the sultanate had reached OR16.6m ($43m) by the end of June 2014, up 147% from OR6.7m ($17.3m) at the end of June 2013. Deposits into sharia-compliant accounts grew 133% during the same period, from OR154m ($399m) to OR358.7m ($929m). Bank Muscat’s Meethaq had attracted the lion’s share of sharia-compliant customer deposits by the end of the second quarter of 2014, with OR179m ($464m), compared to OR74.5m ($193m) at Bank Nizwa, OR31.8m ($82.3m) at Ahli’s Al Hilal and OR26.9m ($69.7m) at Bank Dhofar’s Maisarah, for example.

While IFS has expanded steadily in Oman over the past few years, so far the industry has not met initial projections. In the period following the release of the IBRF in 2012, the nascent sharia-compliant segment was widely forecast to account for 15-20% of total banking assets within a year or two, primarily as a result of Islamic assets that were expected to pour back into the country from abroad, but this expected repatriation of capital has yet to take place. Most local players attribute the relatively slow growth of the sector so far to the challenging operating environment, the lack of potential investment diversity and a general lack of awareness of the benefits of Islamic finance, particularly among corporate entities.

Despite these issues, the sector is expected to continue to grow. According to an August 2014 statement by ratings agency Moody’s, “Islamic banking operations in Oman could capture a 6-8% share of system assets within the next three to five years.” Given this outlook, and taking into account the high level of liquidity in the industry at the moment, most local players are broadly optimistic about future revenues.