Mobilising savings: A clearer regulatory framework would benefit the expanding Islamic banking sector

The growth of Islamic banking in Jordan is bringing several economic benefits for both customers and the country. A greater variety of sharia-compliant products and services, as well as increased geographical penetration throughout the kingdom, has helped mobilise large amounts of savings that otherwise would not interact with the banking system. This is good news for Islamic banks, and should have wider benefits for the economy overall, as the increased deposits can be leveraged to support growth.

While there are challenges to sustaining growth and attracting customers away from conventional banks, the recent opening of two new Islamic banks that have international experience has created a more dynamic and competitive industry.

STRUCTURE: There are four Islamic banks in Jordan: Jordan Islamic Bank (JIB), Islamic International Arab Bank (IIAB), Jordan Dubai Islamic Bank (JDIB) and newest entrant, Al Rajhi Bank, which started operations in March 2011. According to the Association of Banks in Jordan (ABJ), Islamic banks accounted for 13.8% of all credit facilities in the country in 2009. This share is likely to be much larger now, given the high rate of historical growth, the entry of Al Rajhi Bank and strength of JIB, which alone accounted for 12.2% of total available credit in 2011.

The sector is dominated by JIB. Established in 1978, JIB is not only the largest Islamic bank, but also the third-largest lender in the kingdom overall. JIB’s assets in 2010 amounted to a total of JD2.88bn ($4bn) and credit facilities reached JD1.7bn ($2.4bn), or 12.2% of total credit facilities available from licensed banks, according to the ABJ. According to results released by JIB, performance in 2011 was strong, with revenue of JD78m ($109.6m) and net profit of JD28.3m ($39.8m). JIB’s shares on the Amman Stock Exchange (ASE) declined by 8.3% over 2011, which was in line with the performance of the sector as a whole.

Beginning operations in 1998, IIAB is another leading Islamic banking institution in Jordan and the region. As of the close of 2010, the bank’s investment portfolio reached JD368m ($517.1m) and its assets accounted for 3.79% of total banking sector assets in the kingdom. IIAB also performed well in 2011, seeing its profits before tax rise 52% over 2010, from JD10m ($14.1m) to JD15.2m ($21.4m).

SECTOR GROWTH: The arrival of two new sharia-compliant players within the last four years has helped to increase sector deposits, broaden the customer base and further raise awareness of Islamic banking products in the kingdom. JDIB was established in 2008 following the privatisation and conversion of the Industrial Development Bank. This followed negotiations between, on one side, Dubai Islamic Bank and its partner Jordan Dubai Capital, and, on the other side, the government of Jordan and shareholders of the Industrial Development Bank. The process involved restructuring and converting the company into a fully-fledged Islamic bank. After turning a profit in 2009 the bank suffered losses the following year as it dealt with further debt restructuring, but has since recovered to report revenue of JD18.6m ($26.1m) and a net profit of JD5.77m ($8.1m) in 2011.

JDIB offered two stock dividends in 2011, helping to increase capital to JD89m ($125.1m). Credit facilities also grew to reach JD233m ($327.4m) by the third quarter of 2011. However, the value of the bank’s shares on the ASE declined by 32% over 2011.

Al Rajhi Bank in Jordan was established in early 2011 and is part of the largest Islamic banking group in the world with assets of approximately $46bn, according to company sources. Jordan joins recent openings of the Saudi-based bank in Kuwait and Malaysia. Al Rajhi offers a full range of sharia-compliant personal and housing finance products, as well as corporate banking services. As part of an experienced group of Islamic banks operating in developed markets, Al Rajhi looks set to bring a new level of sophistication and service delivery to the sector and should broaden the appeal of Islamic banking to both retail and corporate clients.

DIVERSIFYING PRODUCTS: Investments held by Islamic banks tends to be more varied than conventional banks in terms of risk, liquidity and maturity. The majority of investments are in murabaha, a relatively short-term and low-risk liquid equity. This model utilises a fixed charge on capital, typically used for car loans, and is the most popular type of Islamic financing product. As these transactions are largely commodity-based, one downside is they do not provide the type of growth in equities Islamic banking could theoretically be providing. This would require more profit sharing utilising musharaka, which is less liquid, longer-term and higher risk. The conservative nature of Jordanian banks extends to the Islamic banking sector and so the vast majority of products are still murabaha.

The benefit of introducing more musharaka is that it operates like a direct investment and can have a stronger impact on economic development. The downside is that the benefits are not always captured in the rate of return to the bank, but felt over a wider portion of society. Thus, banks have little incentive to increase exposure to musharaka. One solution would be to encourage businesses to rely more on equities rather than credit, which would necessitate increased provision of mutual funds and other types of equity that are currently not available in Jordan. A more readily available product is ijara, referring to the Arabic word for renting or leasing, used commonly for housing purchases or to finance holidays or pilgrimages such as hajj or umrah. Ijara refers to an exchange transaction in which a benefit from an asset is made available for a payment, but where ownership is not transferred.

LEGISLATION UPGRADE: While all providers offer a range of products, the coverage, particularly for corporate investment vehicles, is limited. One key constraint is the multitude of interpretations of sharia compliance. While some countries have institutions that provide guidance and regulation of sharia-compliant or halal products, no such bodies exist in Jordan. Conventional regulators, such as the central bank, cannot rule on issues pertaining to the sector, such as whether or not a bank is sharia-compliant.

Tareq Akel, the CEO of Al Rajhi Bank, said that this was one of the major obstacles to developing new products: “Islamic finance is a major growth industry in Jordan. To realise its potential, however, the sector needs a more comprehensive and stringent regulatory framework that can overcome differences in interpretation.” Regulatory clarity and harmonisation would not only help the sector develop new products, but also increase transparency and provide necessary consumer-protection legislation.

GROWING PAINS: One further challenge for the industry is convincing retail customers to switch from conventional to Islamic banks. Jordan’s population is 95% Muslim so there is no inherent barrier to increasing penetration other than competitiveness and awareness. Part of the problem is that the established banks in the kingdom have already had time to build their customer base in the large cities, particularly Amman, and then open smaller branches in rural locations.

For existing banks, most of the growth potential comes from gaining new customers in these areas. But the newer Islamic banks must establish a presence in the capital and also expand geographically to tap into new customers. Not only is this expensive, it also takes time, putting them at a disadvantage.

In an attempt to attract existing bank users away from conventional providers, Islamic banks are offering tailored transfer services to help customers in making the switch. As an example, JDIB offers what it calls the Al Yusur programme, which supports customers to settle all existing financial liabilities with their existing bank and then refinance with JDIB.

Conventional banks have several other advantages, including greater flexibility to invest in non-sharia-compliant vehicles, the variance they can then bring to interest rates rather than fixed rates, and less need to educate the public about their products, which means they can spend less on advertising.

FOCUS ON PRODUCT & SERVICE: But while conventional banks enjoy some competitive advantages, Islamic banks are untainted by the global financial scandals that have rocked conventional banks. As Akel told OBG, “If Islamic lenders can achieve the same price and quality as traditional banks, they will enjoy a ‘moral’ advantage in the marketplace.” Certainly, in these tight economic conditions customers look first and foremost for keenly priced products and good service, and this is what the sector is aiming to achieve, rather than relying solely on attracting customers by appealing to principles.

Ultimately, prospects look bright for this expanding segment of the banking industry. The market has enough providers to ensure a truly competitive operating environment, and players have the ability to draw on international talent and experience from abroad to create the innovative products that are needed for long-term growth. There is tremendous latent demand in Jordan and more clarity on regulation would greatly help the sector, providing greater legitimacy and certainty to operations for both banks and customers.