Partnering up: The government is paving the way for sector growth

Islamic services have long been part of the financial mix within Brunei Darussalam. For the past two decades, Islamic banking, takaful (Islamic insurance) and Islamic capital market products have been taking root and growing. These services now compete strongly against their conventional counterparts and continue to grow market share. With the government promoting shariacompliant products and hoping to position the country as a regional centre for Islamic financial services, it seems that conventional banking and insurance products might find themselves in the minority within the Sultanate in the not too distant future.

GRABBING MARKET SHARE: Indeed, in September 2012, Javed Ahmad, the managing director of Bank Islam Brunei Darussalam (BIBD), told a seminar at the University of Brunei Darussalam that sharia-compliant banking is set to reach a market share of 55% to 60% within the next five years, a significant leap from its current share of 40%. According to Ahmad, with more aggressive marketing, the Sultanate has great potential to fulfil its vision of becoming an Islamic financial centre. The sector has progressed since the establishment of the first Islamic financial institution, Tabung Amanah Islam Brunei Darussalam (TAIB), in 1991. Two further sharia-compliant banks, Islamic Bank of Brunei Darussalam (IBB) and Islamic Development Bank of Brunei Darussalam (IDBB) followed in 1993 and 2000, before they were given permission to merge in 2005 to become Bank Islam Brunei Darussalam (BIBD), which began operations in 2006. Despite a tough environment, including low profit rates, new regulations on personal financing limits and a general dearth of financees in an economy dominated by a wealthy government, the Islamic banks are performing solidly.

INDICATORS: Sharia-compliant operators have maintained a sound and financially robust position. In terms of capital adequacy, the Islamic operators had a regulatory capital to risk-weighted assets ratio of 24.7% in 2011, above the overall sector average of 19.4%, according to the IMF. The regulatory Tier 1 capital to risk weighted assets was 24.9%, compared to 20% for the sector overall. Beyond this equity position, the Islamic banks were also highly liquid, positioning them well to deal with systemic shocks, either domestic or international. In 2011 the Islamic operators had an average liquid asset ratio of 55.1%, high by global standards although below the sector average of 63.3%.

This suggests that the Islamic operators have done a better job of placing their cash than the conventional banks and in particular foreign banks (which had a liquid assets ratio of 70.8%). Indeed, TAIB and BIBD have been recording decent earnings and profitability. These institutions have successfully generated profit-earning assets. In 2011 the Islamic institutions had a return on assets (ROA) before tax of 1.4%, above the combined market average of 1.1%. The return on equity (ROE) after tax matched the sector as a whole, at 8.4% for the year.

This suggests that despite the limitations in the market, both Islamic financial institutions continue to do good business. Much more so than their conventional counterparts, the Islamic institutions have generated earnings from financing and profit, or profit sharing as it is constructed under sharia law, rather than from fee-based income. The Islamic banking sector had a financing margin to gross income of 89% in 2011, compared to 68.5% for the banking sector as a whole.

BIBD: The largest Islamic financial institution in the Sultanate – and indeed the largest bank across both the conventional and Islamic sector – is BIBD. The bank captures a significant proportion of government business and is the main bank for government payroll. BIBD has 14 branches throughout the Sultanate and the largest network of ATMS, with 54 in the country.

As with the wider market, both Islamic and conventional, BIBD has had to think on its feet and react to the new impositions on personal financing in the market. Regulations limiting the size of personal financing to 30% of an institution’s total financing portfolio, along with restrictions on the scale of financing of individual financees (a maximum of 12 times gross monthly salary repayable over six years) has meant that the sector has had to take a long hard look at where it generates financing income. This has been compounded by restrictions on credit cards in 2010, tying them to a deposit account and capping limits according to a customer’s salary. The Authoriti Monetari Brunei Darussalam’s (AMBD) regulation mandates that financing exceeding the new limits needed to be rolled into new personal financing to be paid over a 36-month period. A product rolled out by BIBD supports this directive.

CHALLENGES & OPPORTUNITIES: These new regulations may have presented a challenge, but they have also offered an opportunity. BIBD, for example, has aggressively targeted capturing a large share of these new personal financings in the market. Ahmad told OBG that this has allowed the bank to become a significant player in the credit card market.

According to Ahmad, the new portfolio is performing adequately and even if, priced as it is at 4.75%, it does not generate significant earnings, it will allow the bank to build a stronger and larger customer base in the highly competitive consumer-financing segment. Indeed, once these financings reach maturity in the middle of 2013, there will be significant opportunities to market new products to these customers.

However, the high profit rate and high non-performing financing scenario that drove much of the overall sector’s consumer earnings and high returns on equities has been modified by the new financing regulations. As such, banks have been reassessing their position and looking at new ways to grow business. This has included a focus on debit cards and fee-based income. Given the limited share of non-interest-based income for Islamic banks in 2011 (11% of gross income, according to the IMF), this is certainly a departure.

LOCAL FINANCING: Unlike many of the conventional and foreign banks in the market, BIBD already has a wellestablished position in the corporate segment. With the government pushing for local industry – a substantial share of which is state-owned – to use Islamic financing tools, this will remain an important driver of growth for the bank. BIBD has performed well building local financing. The institution has been comfortable in meeting central bank regulations for onshore assets, adhering to the asset-maintenance ration of 3:1 outlined by the AMBD, as part of its deposit protection regulations.

Beyond financing growth, the bank is looking at better places to invest and bolster returns. Ahmad told OBG, “We are looking at the money markets, fixed income securities and diversifying our portfolio. As an Islamic financial institution, it is not that easy. Our investment universe is a lot more limited.” While this will remain a key challenge, especially considering the slow rate of Islamic investment product development within the Sultanate itself, it is unlikely that any of BIBD’s shareholders have misgivings about the bank’s performance.

PERFORMANCE: According to its annual report, BIBD witnessed an increase of net profits of 32% to BN$87m ($67.75m) in 2011. All the basic indicators for the financial soundness and operating performance of the bank look strong. The institution has a Tier 1 capital adequacy ratio of 28.7%, while it continues to grow both assets and deposits. Indeed, the former grew by 24.8% to BN$5.7bn ($4.44bn), while the latter increased by 28% to BN$4.4m ($3.4m) in 2011, according to the report.

The bank is still number one in the market for financing assets, standing at BN$1.6bn ($1.25bn) the same year. The BIBD’s asset base is also performing extremely well. It recorded a ROA of 1.42% and a ROE of 9.08% in 2011, compared to sector-wide (conventional and Islamic) averages of 1.2% and 8.4%, respectively, according to the IMF. This healthy performance is unlikely to wane anytime soon, with double-digit growth expected for 2012. The BIBD has also been gaining an increasingly strong reputation internationally. For example, its institutional banking division conducted some high profile transactions in 2011. The bank served as the mandated lead arranger for a structured syndicated murabaha, a property fiduciary sale, for Türkiye Finans Kat›l›m Bankas› (TFKB), which raised $300m. It also closed a $75m murabaha deal for TFKB, raised so TFKB could provide SME financing. BIBD has also been active in the sukuk (Islamic bond) market, co-leading a $1bn issuance for the government of Indonesia as well as a $350m issue by Kuveyt Türk Kat›l›m Bankas› in 2011.

The bank has also been chosen as the representative bank for the China ASEAN Inter Bank Association (CAIBA). As such, BIBD signed a bilateral cooperation framework agreement with China Development Bank in November 2011, which will focus on cooperation in areas such as the placement of funds, provision of credit facilities, international trade settlement and project financing. The inroads that BIBD is making in regional Islamic finance suggest that the country can play an increasingly important role in this field. It should also provide further opportunities for other Islamic finance providers to operate and conduct transactions regionally and globally on the back of BIBD’s success.

INCREASING COMPETITIVENESS: With government support behind the sector, there are also likely to be significant opportunities to grow corporate business locally. Speaking at a Fajr Capital event in Bandar Seri Begawan in July 2012, the energy minister, Pehin Dato Yasmin Umar, told attendees, “We want to see our local Islamic banking and finance institutions to be more competitive and be able to offer more innovative financing so that they would not only be able to strongly compete, but also be the banks of first choice to customers.” As such, the government has set the tone for state- and semi-government-owned companies to use Islamic institutions to access financing, particularly in the dominant hydrocarbons sector.

This has created ample opportunity for sharia-compliant financial institutions. Two prominent deals of the year involved BIBD Islamic financing facilities extended to Brunei Gas Carriers (BGC) the state-owned liquefied natural gas (LNG) shipping company. In July 2012 BGC signed an agreement with BIBD for an $83m refinancing package for the Abadi, the firm’s first LNG vessel. The deal was structured as an ijara facility, a concept similar to lease financing in conventional banking.

SHIP-SHAPE FINANCING: This refinancing package was used to fund the equity tranche for another Islamic financing deal signed a week later with BIBD, Bank of Tokyo-Mitsubishi UFJ (Malaysia), the Hong Kong and Shanghai Banking Corporation (HSBC) and Sumitomo Mitsui Banking Corporation Europe. The second deal raised $170m in financing through another ijara facility for the construction and deployment of a new 154,800-cu-metre capacity vessel. Calvin Chiew, business development analyst at BGC, told OBG that, “Islamic finance is very suitable for this type of asset-based financing and high capital expenditure financing.”

The company’s financing strategy is in line with the vision of the Ministry of Finance and its push to further penetrate Islamic financial services. This suggests that there will be more opportunities for Islamic financial institutions from government-related companies. While much of this is likely to come from the oil and gas sector, there could be opportunities elsewhere, for example, in the aviation sector, the operations of which lend themselves to the ijara type of lease financing.

TAIB: The other leading Islamic financial institution, TAIB, offers a range of services from retail and corporate financing to a full range of Islamic insurance products through its 100% owned subsidiary, Insurans Islam TAIB. Founded as an Islamic Trust Fund, TAIB offers a range of savings products based on the Islamic contract of guaranteed safe custody (al wadi’ah yad dhamanah). The institution also provides a number of terms of deposit certificates focused on inculcating savings habits in the Sultanate’s populace.

The institution takes a largely conservative position. For example, in April 2012, Hajah Halija Pehin Dato Jaya, the head of TAIB commercial sales and product management & marketing, told an Islamic finance seminar at the University of Brunei Darussalam that as a statutory body, TAIB was cautious about offering microfinance given the non-payment rate. “It is crucial for us to take caution on how we utilise the fund, and with microcredit, there is a tendency for non-payments. And we have an obligation to be able to pay our depositors,” she said.

PRIVATE APPLICATION: Government backing for Islamic financiers is helping to improve the credibility of sharia products at the corporate and retail levels and has helped to pique the interest of conventional players and international competitors. Indeed, as shariacompliant products gain traction in the market and Islamic banks outperform conventional ones, in both ROA and ROE terms, several institutions have announced interest in supplying such products in the Sultanate.

Standard Chartered, which has already established a track record of providing sharia-compliant products in neighbouring Malaysia and Middle Eastern markets under its Saadiq brand, has suggested that it could roll these out in Brunei Darussalam in 2013.

In October 2012, Neeraj Swaroop, the bank's regional CEO for South-east Asia, told the Brunei Times the bank would initially start with retail products such as sharia-compliant personal financing and mortgages. “However, it depends on how the market shapes up.” Swaroop said. Lai Pei-Si, the CEO of Standard Chartered in Brunei Darussalam, told the same paper that the bank would likely take “small steps” into Islamic financing in the country. This could include the introduction of an Islamic mutual fund through its Islamic investment portfolio. Lai suggested that, if negotiations with the regulator, AMBD, progress as expected, the bank could begin offering Islamic products in 2013.

NEW ENTRANTS: The potential entry of new players into the sector will create a challenge for the existing Islamic providers in the market. Ahmad told OBG, “I think we have to be prepared for competition that will come. At the end of the day, it is going to be good for the consumer. However, we have to ask whether we have a competitive advantage compared to other banks. Maybe we do from a certain point of view, but if our pricing is not good, we will not be able to compete. If you look around the market, our pricing is at the lower end. But this is a challenge we are facing as the market is already very competitive.”

Another player that could add to this competition is AmBank Group of Malaysia. In September 2012, the chairman AmBank Group, Azman Hashim, told the Brunei Times that the institution was seeking a licence to begin operations in Brunei Darussalam. Azlan Mike Skinner, country manager of AmCapital, the asset management arm of AmBank Group that already operates in the Sultanate, told OBG, ”We have applied for an Islamic banking licence in Brunei Darussalam. We see the country is focussing more on the Islamic aspect and we feel we’re in a unique position to provide the financial support and technologies to grow.”

According to Azlan, the bank could target Malaysians in Brunei Darussalam of whom there are approximately 30,000, many already AmBank Group customers back in Malaysia. “That’s one of the reasons why we’re applying for the licence,” said Azlan. “We’ll be offering investment products for the public. We know after discussions with the government that this is what they’re looking for.” AmBank Group is hoping to get the licence and launch within the next 12 months.

The group has already had significant success with its asset management arm in the country. Azlan said that growth in Brunei Darussalam has been quite slow compared to other regional markets in terms of volumes and customers, but that they are outperforming expectations in the local market. The company can offer clients a 4% to 6% return in average while investing in compliance with sharia law. Azlan and the group believe the Sultanate will provide good opportunities given the volume of high-income residents. Azman told the Brunei Times, “We see potential there because Brunei Darussalam is a rich country and I think people there are considered to have good income, so it is good for financial services in investment assets.”

The only problem for AmCapital, and new entrants in general, is the ability to bring new products to market. According to Azlan, the approval process, primarily from the AMBD, and to a lesser extent sharia boards, can be laborious and slow. Azlan said this has a huge impact on the group’s profitability and budget. “Our key performance indicators and our goals are all affected,” he said. Nonetheless, Azlan argues that the demand for new and innovative products is there and as the Islamic banking sector gains greater traction and maturity, the investment universe for Islamic products within the Sultanate is likely to widen.

TAKAFUL: Like the banking sector, Brunei Darussalam’s insurance industry is becoming increasingly influenced by sharia-compliant competitors. The three takaful companies, Insurans Islam TAIB (IITAIB), Takaful Brunei Am (TBA) and Takaful Brunei Keluarga (TBK), the latter two subsidiaries of Takaful Brunei Darussalam, have been asserting a growing presence in the market. By 2010, takaful operators accounted for approximately 41.9% of gross premiums in the Sultanate, an increase of just over 10 percentage points in two years. Furthermore, the takaful companies held a fifth of all assets in the industry and 26.3% of total claims.

OUTLOOK: In the coming few years, sharia-compliant products are likely to reach a tipping point in Brunei Darussalam, becoming the predominant and preferred method of financial management across the full range of services. In the two decades since Islamic financial services were first introduced, they have seen a steady rise and now capture a market share exceeding 40% in both banking and takaful. With the government providing full-throated support for sharia-compliant services, the sector is likely to keep growing both in both retail and corporate segments. Islamic financial firms, particularly banks, have demonstrated their profitability and price competitiveness with conventional counterparts, sometimes outperforming them. As such, their inexorable rise is unlikely to abate any time soon.