New frontiers: The arrival of Islamic financial services is changing the sector’s landscape

One of the most significant recent developments in Oman’s banking sector has been the arrival of Islamic banking, bonds and insurance – some rapidly growing global industries that were previously non-existent within the sultanate. The development of the Islamic financial services sector has been welcomed by many Omanis, while also giving impetus to capital markets and interbank competition. In the meantime, the move has opened up great potential for those able to deliver sharia-compliant investment products as Islamic banks search for places to park their assets.

Islamic Banking Policies

In May 2011 Sultan Qaboos bin Qaboos Al Said issued a royal decree setting the wheels in motion for the introduction of Islamic banking in the sultanate, opening the way for Oman to take a share of an expanding global business. Indeed, in September 2012, financial services firm Standard & Poor’s predicted that Islamic financial assets worldwide would increase in size between 2011 and 2015, from a current $1.3trn to as much as $3trn. Standard & Poor’s also suggested that GCC countries and Malaysia would drive this change.

Following the royal decree, in June 2011 the Central Bank of Oman (CBO) issued Circular BM 1081, announcing that the licensing of Islamic banks and of Islamic windows in conventional banks could begin.

Islamic Banking Licenses 

Since then, two institutions have come forward to acquire Islamic banking licences, while all the established conventional banks have made moves towards establishing Islamic windows. The two currently licensed Islamic banks are Bank Nizwa and Al Izz International Bank, both of which were required to fulfil a number of criteria in the process of gaining their licences.

Most of these were concerned with ensuring compliance with sharia laws. Islamic banks seeking licences are required to set up their own sharia boards and ensure the products offered were in compliance. Another criterion is that new Islamic banks start with a minimum of OR100m ($260m) in capital. Such new entrants are required to raise part of this via initial public offerings (IPOs) of at least 40% of their shares, to be listed on the Muscat Securities Market (MSM).

Of the two, Bank Nizwa was first off the mark with its IPO, which was launched in May 2012 and garnered some OR681m ($1.77bn) in bids – 11.3 times the OR60m ($156.4m) sum it was initially trying to raise.

The bank’s listing went live on June 12, and debuted strongly, up 12.75% on an otherwise highly subdued MSM. In late September 2012, Al Izz International had just begun its IPO, with 400m shares on offer at 102 baisa ($0.27) per share. It was oversubscribed 1.15 times, according to Reuters.

Islamic Windows

Meanwhile, the conventional banks have all made moves toward opening Islamic windows. The National Bank of Oman (NBO) launched a sharia-compliant brand known as Muzn; Bank Muscat launched Meethaq; Ahli Bank launched Al Hilal, and Bank Sohar enlisted consultancy Dar al Sharia to help set up its window. These moves are in compliance with the Islamic Banking Draft Framework (IBDF) drawn up by Ernst & Young and the CBO for the regulation of Islamic banking windows.

In addition to the sharia compliance requirements, the IBDF also sets a 12% minimum capital adequacy ratio, with a minimum paid-up capital of OR10m to open a window. The conventional banks have also therefore been mobilising capital to back up their new windows. This has been evident in a number of rights issues by the banks on the MSM.

The regulations also emphasise that there must be a clear distinction at all times between Islamic and conventional products and operations, to avoid comingling. In this regard, the regulations state that Islamic banking windows must have dedicated branches, with the conventional banks already nominating which branches will convert and be re-branded.

In addition, the regulations state that sharia boards must consist of at least five members, with three experienced Islamic scholars and two with either Islamic law or accounting backgrounds. Thus, as the sector entered the third quarter of 2012, the banks, windows and personnel were largely ready to begin work – yet the exact shape of the final regulations on Islamic banking remained unclear.

One debate that had apparently been resolved was over regulation, with opinion divided over whether there should be a higher sharia board supervising all the banks’ own sharia boards. In September 2012 it appeared this would not be established, with banks left to devise their own standards of compliance.

Yet final regulations on particular products, such as mortgage financing and tawarruq in general, were still being anticipated in the third quarter of 2012. This was clearly a concern for those banks that had already raised capital. Draft regulations had been sent to the banks for consultation, with most sector players foreseeing the final decree likely before the end of the year. The Islamic banking rules will not form a separate banking law, but will rather be an addition to the existing law on conventional banks.

In October 2012, too, the Ministry of Finance was reportedly considering altering the tax code to accommodate Islamic banking practices more fully, particularly with regard to mortgage taxes.

Whatever the final shape of the regulatory framework may be, it appears that Islamic banking will be highly popular with Omanis. In late 2011 the consultancy Islamic Finance Advisory and Assurance Services (IFAAS) conducted a survey of Omani attitudes toward retail Islamic banking, finding that around 85% of Omani consumers were interested in having access to Islamic financial services, with some 59% expressing a strong interest. “In the short term we will see a huge expansion in the market for Islamic finance,” said Shaher Abbas, the director of sharia compliance and product development at IFAAS. “In Oman, there is such pent-up demand for this.”

Main Sources Of Deposits

The Islamic banks and windows are likely to benefit from three sources of deposits. First, there will be those existing conventional bank customers who transfer to sharia-compliant accounts, with Islamic windows set up to try and catch the majority of these, rather than lose them to the fully Islamic banks.

Second, there are those currently outside the banking system altogether who may enter – an effect that may be particularly significant in the conservative regions of inner Oman. Third, there is likely to be a wave of repatriated funds from abroad, as many Omanis have placed their accounts in neighbouring countries where Islamic banking has long been available.

At the same time, being late into the field, Oman’s new Islamic finance intermediaries will be able to learn from the mistakes and successes of others. The smaller banks also welcome an arena in which there may be a much more level playing field.

“Big banks such as Bank Muscat will be on a more equal footing with newcomers,” Ashish Sood, the deputy CEO for retail and private banking at Ahli Bank, told OBG. “Bank Nizwa and Al Izz will come in with five or six branches each, and so will Bank Muscat, so competition can be on pricing and services, not just on the convenience of going with the biggest bank.”

Raising The Bar 

Indeed, once initial enthusiasm wears off and the market develops further, pricing and products will likely become the main battlefields. Preparation for this heightened competition over deposits could be seen in the narrowing spreads in interest rates among the conventional banks prior to the entry of the new Islamic banks.

Ultimately, the success of Islamic banking in Oman may well depend on the astuteness of those banks when it comes to pricing their products. It will also depend on the future path of regulations. On the latter, there is some speculation that Central Bank requirements for strict separation of capital between Islamic and conventional windows – and indeed, even separate SWIFT codes to further separate different types of funds – may oblige the current Islamic brands within conventional banks to separate completely from their parent companies in the years to come.

“Islamic financial institutions will not completely overtake but rather compete fiercely with conventional banks for market share,” Sulaiman Al Harthy, the group general manager for Meethaq, the Islamic banking arm of Bank Muscat, told OBG. “In several years after establishment the growth curve should even out and it will be competition based on markets forces.”

On The Horizon

At the same time, the introduction of Islamic banking and insurance will present a steep learning curve for banks, regulators and customers alike. For the first two groups, human resources have already been mobilised, with many Omanis who previously worked in Islamic banks overseas now bringing their expertise back to the sultanate.

For customers, though, much remains to be done, as awareness of the benefits of Islamic banking may still need to be increased. Looking ahead, however, Oman seems likely to catch up with its neighbours to become a significant market for this global industry.