Oman: Regulating Islamic finance

The recently released Islamic Banking Regulatory Framework (IBRF), a 500-page document setting out the regulations that will govern Oman’s financial sector, is set to open the door for both conventional and Islamic banks to market sharia-compliant products. In a statement accompanying the regulations, the Central Bank of Oman (CBO) described the IBRF as “a detailed and comprehensive document covering all aspects of Islamic banking”.

While conventional lenders will be allowed to conduct Islamic banking operations, the IBRF requires them to open separate branches for the two different products and make clear the sources of their funds and what they are used for. The requirement for individual branches for both conventional and Islamic operations will impose additional costs on banks seeking to operate in both segments, although the strict reporting requirements should limit any concerns regarding crossover of funds from non-accepted sources.

The regulations do not put in place a centralised body to supervise and vet Islamic products, allowing each bank to have its own sharia board to oversee products. Each board is required to have a minimum of three scholars – each with a proven knowledge of legal and financial matters and a minimum of 10 years of experience.

All such scholars will be subject to performance assessments throughout their terms of office and will be limited to serving two consecutive three-year terms. These requirements are tighter than many applied in other Gulf countries, as is the restriction on board members being allowed to work for two competing Islamic financial institutions.

Another area where the regulations are more stringent than those in other markets is tawarruq or commodity murabaha, the buying of an item or product from a bank through a deferred payment arrangement by a person or entity, who then sells the item to a third party for cash. The IBRF rules out this instrument, saying, “Commodity murabaha or tawarruq, by whatever name called, is not allowed for the licensees in the sultanate as a general rule”. Tawarruq has come under criticism by some scholars for not being fully compliant with Islamic financial requirements.

Oman’s banking sector has long been awaiting the CBO’s regulatory framework, after Sultan Qaboos bin Said Al Said issued a decree in May 2011 authorising the establishment of Islamic banking. Currently, seven conventional lenders – Ahli Bank, Bank Dhofar, Bank Muscat, Bank Sohar, the National Bank of Oman, the National Bank of Abu Dhabi and the Oman Arab Bank – are planning to offer services in the sharia-compliant segment, along with the two dedicated Islamic banks in the market, Bank Nizwa and Alizz Islamic Bank. With the IBRF now in place, most will be looking to open their Islamic windows early this year.

Though banks have been lining up to enter the market, Oman’s new sharia-compliant banking sector will face a number of challenges and potential pitfalls in its early stages, according to Khalid Yousaf, the director of Islamic finance advisory services at KPMG in Oman, a financial services firm.

“The biggest challenge will be for the industry to educate their customers and general public about the essential, basic facts about Islamic finance, and the biggest threats may be the shortage of skilled resources as well as the shortage of available products for banks to place their surplus liquidity,” Yousaf told media in December.

As Oman does not have a history of formal sharia-compliant banking, it has a shallow pool of experienced staff and Islamic scholars well versed in financial matters. However, banks will be able to tap experts from other Gulf states for rulings on regulatory issues, and many lenders have already begun training courses for staff in anticipation of opening their Islamic banking windows.

The Fitch ratings agency has also suggested it may not be plain sailing for the Islamic banking sector, saying in a note issued in October that it will be some time before stand-alone Islamic banks in Oman will be able to compete effectively with their conventional rivals, which will have their established networks, brand names and operational scales of efficiency to back up their own Islamic windows.

“Newly created Islamic banks in Oman will face competition from incumbents such as Bank Muscat and HSBC Bank Oman, which are setting up Islamic banking arms in preparation for the upcoming rule changes,” Fitch’s note said. “While the established banks will need to keep their existing and Islamic operations separate at the point of contact with the customer, there will be plenty of opportunities for cost savings at the operational level.”

While the report identifies that there is a market for dedicated Islamic banks, with higher government spending and economic growth opening doors in the retail banking segment, the agency said many clients would chose to remain with their existing lenders, even if they shift to sharia-compliant accounts.

Oman already has a competitive banking sector and the opening of the Islamic segment of the market will only serve to make it more so. The success of the two dedicated sharia-compliant banks, and that of the segment as a whole, will likely depend on how well new products are promoted and services are provided.