Omani banks to expand services

Oman’s banking sector appears to have ridden out the recent oil price and economic downturn largely unscathed. While concerns over liquidity arose in the wake of the oil price slump given the government’s status as an important depositor, the situation improved in 2017 as the Omani state borrowed from abroad to avoid withdrawing funds or pushing up funding costs through heavy local borrowing.

The sector is top heavy, with the leading bank by assets much bigger than its nearest competitors, which has given rise to talk of consolidation. This has yet to happen, though, with plans for two institutions to join forces recently called off. However, the non-bank lending segment saw a merger in 2017.

The burgeoning sharia-compliant banking industry, meanwhile, after encountering some growing pains from the outset, is expanding rapidly and moving towards sustained profitability.

Industry Players

The Omani banking sector consists of seven conventional Omani banks, two Islamic banks, two specialised banks operated by the government (Oman Housing Bank and Oman Development Bank), and nine foreign banks. Local banks dominate the industry, with foreign institutions accounting for around 6% of assets, according to figures from the Central Bank of Oman (CBO), which also regulates the sector.

Bank Muscat was by far the largest bank in terms of assets as of September 2017, on a total of $28.9bn. As of end-August 2017, it had a market share of 34.7%, according to data from the bank. The institution’s leading shareholder is Oman’s Royal Court, which holds 23.6%. Shares in the bank float on the Muscat Securities Market (MSM), the national stock exchange, on which it was the largest listed firm by market capitalisation at end-2017.

The second-largest bank is Bank Dhofar, with assets of $10.6bn as of the third quarter of 2017. Dhofar International Development and Investment Company is the institution’s largest shareholder, with a stake of 28%. The bank is also listed on the MSM.

In third place was the National Bank of Oman (NBO), on a figure of $9bn. The main backer of the bank, which is also listed on the exchange, is Qatar’s Commercial Bank, which holds a 34.9% stake in NBO.

The fourth bank by assets is Bank Sohar, at OR2.6bn ($6.8bn) as of September 2017, followed by HSBC Bank Oman, in fifth, with assets of $6.3bn. HSBC Bank Oman is also the largest foreign-backed institution operating in the market, with HSBC Middle East Holdings, a unit of the parent company, London-based HSBC, holding a majority 51% stake in the bank. Both Bank Sohar’s and HSBC Oman’s shares also trade on the MSM.

Consolidation

Consolidation has been a hot topic in the sector in recent years, with some industry figures describing the market as overbanked. Bank Muscat’s dominant share of the market also forms an incentive for other banks to merge in order to gain similar economies of scale and better compete with the dominant institution, as does the need to compete with regional and international banks to finance large projects in the country and elsewhere.

However, long-running negotiations between Bank Dhofar and Bank Sohar, the second- and fourth-largest institutions in the market by assets, respectively, were called off in October 2016, after their shareholders failed to agree on terms. Based on September 2017 figures, the resulting institution would have had combined assets of $17.4bn, equivalent to 60% of Bank Muscat’s asset base.

Banking Assets

The assets of conventional banks were worth a combined OR27.7bn ($71.9bn) as of November 2017, according to the CBO. The figure was up from OR27.1bn ($70.4bn) at the end of 2016. This in turn was down from OR28.2bn ($73.2bn) in 2015, due to a 20.1% drop in the value of securities held by banks, led by a 41.9% decline in the value of foreign securities and a 34.2% fall in that of domestic Treasury bills. Including Islamic banks and the Islamic windows of conventional banks, total assets stood at OR31.4bn ($81.5bn) in November 2017, up from OR30bn ($77.9bn) at the end of 2016.

Lending

The value of conventional bank lending in the sultanate stood at OR20.2bn ($52.5bn) as of September 2017, up 2.4% from OR19.7bn ($51.2bn) at the end of December 2016. The latter figure had risen 7.6% from OR18.3bn ($47.5bn) a year earlier.

Lending has been growing faster than wider economic expansion: bank credit was equivalent to 86.8% of GDP at end-2016, up from 74.8% in 2015 and 57.1% in 2014. This was driven in part by the fall in nominal GDP in 2015 and 2016, but the indicator had also been rising before then, from 48.8% in 2012.

Retail credit forms the largest share of lending in the sultanate, accounting for OR7.9bn ($20.5bn) at the end of 2016, equivalent to 40.1% of the total. Retail credit is tightly regulated, with the amount banks can lend to customers capped at 50% of their commercial loan books, and interest on such loans limited to a maximum rate of 6%. The construction sector was the largest commercial borrower, on a 2016 figure of OR2.3bn ($6bn).

While there have been concerns about tightening liquidity in recent years, banks appear to have retained sufficient room to further expand lending. The lending ratio, excluding government soft loans, relative to deposits and banking capital, stood at 80.8% at the end of October 2017, below the maximum rate of 87.5% imposed by the central bank.

Funding Base

Deposits dominate the funding base of Omani banks, and wholesale financing accounted for just 7% of sector funding in 2016. The value of conventional banks’ deposits was up from OR18.3bn ($47.5bn) at the end of 2016, standing at OR18.6bn ($48.3bn) as of November 2017. Demand deposits accounted for 30% of the total. The private sector accounted for the bulk of deposits, on OR12.5bn ($32.5bn), or 67% of the total. The government also provides a substantial proportion, worth OR4.9bn ($12.7bn), or a share of 26.3%. This has been the source of some concern in recent years, as the fall in the oil price since 2014 and the consequent emergence of substantial fiscal deficits gave rise to fears that the authorities could draw down their deposits, putting pressure on liquidity.

However, the government has indicated that it intends to maintain its deposits through measures such as borrowing from abroad to fund the deficit precisely to avoid such a situation. While state deposits fell in early 2016 to around OR4.6bn ($12bn), they have otherwise been fairly stable at close to or above OR5bn ($13bn) over 2017.

Interest Rates

Weighted average interest rates on rial-denominated lending stood at 5.2% as of November 2017, up from 5.1% at the end of 2016.

The rate has been fairly constant in recent years, ranging from 4.7% to 5.4% in the three-year period beginning in December 2013; the rate was in decline leading up to May 2016, before it started to gradually increase again. The rial deposit rate, meanwhile, stood at 1.7% in November 2017, up from 1.5% at the end of 2016. The deposit rate has been on the rise since January 2016, when it stood at 0.9%, driven in part by competition for deposits as liquidity in the sector tightened, in addition to interest rate hikes by the US Federal Reserve.

Profitability

Omani banks collectively netted pre-tax profits of OR438m ($1.1bn) in 2016, almost unchanged on a figure of OR439m ($1.4bn) the previous year, according to CBO figures. The sector registered an average return on equity (ROE) of 10.5% and a return on assets (ROA) of 1.5%. Both indicators have been on a slight downward trend over the medium term, with ROE and ROA down from 12% and 1.6%, respectively, in 2012. More recent sector-wide figures were not available as of January 2018; however, profitability indicators fell at Bank Muscat, the largest financial institution in the country, during the year to September 2017, with ROA down from 1.64% to 1.59% at the end of 2016, and ROE down from 12.5% to 11.1%.

Higher funding costs are among the factors that have put downward pressure on profits recently. Lloyd Maddock, CEO of Ahlibank, told OBG that despite an improvement in banking system liquidity in 2017, the cost of funding had yet to normalise to historic levels. As a result, he said this had squeezed net interest margins during 2017, though Maddock believed the sector would see improved net interest margins in 2018 and 2019, which would go a long way in supporting profitability.

Liquidity

As previously noted, the large share of bank deposits accounted for by the government prompted concerns that the deterioration in public finances as a result of the 2014-15 oil price fall could see large withdrawals by the state, leading to a liquidity crunch or heavy government borrowing on local markets, crowding out private sector credit. The government has, however, managed this in large part by borrowing from abroad to avoid having to spend locally held cash: in 2016 the authorities issued $2.5bn in eurobonds, following this with a $5bn eurobond and a $2bn sukuk (Islamic bond) in 2017. Banks have similarly been borrowing from abroad. “Liquidity started to tighten in 2016 due to a combination of factors resulting from the reduction in oil prices, which impacted government revenues,” Maddock told OBG. “Subsequent initiatives by the central bank and the government to avail themselves of overseas funding and implement supportive legislation have to led to an improvement.”

Andrew Long, CEO of HSBC Oman said that he was not greatly concerned about the prospect of a fall in government deposits. “Before the government draws from bank deposits in any material way, it will first draw from CBO reserves, look to sovereign debt raising options, cut expenses and look to increase tax revenue. So it is unlikely that the government will dramatically draw from bank deposits,” he told OBG.

The regulatory authorities have also taken various measures to boost liquidity and encourage continued lending in recent years. In September 2015 the central bank froze the issue of certificates of deposit until the oil price situation improved, in order to encourage banks to extend credit, rather than parking funds with the central bank. In April 2016 the CBO modified its rules to allow banks to count some holdings of government securities – namely Treasuries, development bonds and sukuk, worth up to 2% of the deposits of the bank in question – towards their reserve requirements: that is, the proportion of deposits they are obliged to keep with the CBO, which stands at 5%. Previously, such reserves were required to be kept in cash.

The move effectively freed up liquidity in the banking system and encouraged banks to buy more government debt. “With the relaxation in the reserve requirement stipulation, approximately OR400m ($1bn) was freed up for banks to ensure that all legitimate credit requirements of the economy were met adequately,” Tahir Salim Al Amri, executive president of the CBO, told OBG.

In October 2017 the CBO told OBG that various indicators showed that banking system liquidity had increased by 30-40% since the beginning of the year, and that banks retained excess funds; CBO figures put the credit-to-deposit rate at 107.3% at the end of September 2017. This was the highest level registered during the year, but was below the end-2016 figure of 107.9%. Nonetheless, the sector remains significantly below the CBO’s maximum lending ratio, and banks retained an excess of OR500m ($1.3bn) in cash reserves above requirements in 2016. With oil prices on the rise, reaching $62 per barrel for Brent crude as of January 2018, a return to tight liquidity in 2018 appears unlikely.

Indicators

Despite the downturn witnessed by the national economy and other GCC countries since the 2014-15 oil price crash, the banking sector appeared sound in 2016. Non-performing loans (NPLs) accounted for 1.8% of gross loans at the end of December, only marginally up from 1.7% a year earlier, according to figures from the CBO’s “Financial Stability Report” for the year. The net NPL rate stood at 0.5%, and 70% of the value of NPLs was provisioned for by banks. Restructured loans were worth around 1% of gross loans.

However, special-mention loans – which are loans that have not become delinquent but are characterised by imprudent lending practices, such as a lack of adequate documentation – comprised 5.8% of gross loans and rose by 23% in 2016, suggesting a possible increase in the NPL ratio down the line. Indeed, in September 2017 ratings agency Moody’s said it expected the figure to rise to 3% by the end of the year. In line with such expectations, the NPL figure at Bank Muscat rose to 3% at the end of the third quarter of 2017, and up from 2.91% at the end of 2016. Nevertheless, in comparative terms such figures remain on the lower side.

The low NPL rate is underpinned by a variety of important factors, including the fact that a large proportion of borrowing is made up of personal loans, which are strictly regulated through, for example, multiple borrowing limits and requirements for salaries to be paid into the borrowing accounts. Additionally, many personal loans are made to government employees, whose jobs are generally seen as stable and secure.

The sector’s capital adequacy ratio (CAR) stood at 16.8% of risk-weighted assets as of December 2017, according to CBO figures, comfortably above the Basel III requirement of 12% and the CBO’s mandatory minimum of 12.625%. This figure was up from 16.1% in 2015 and at its highest level since at least 2012. Eight banks registered CARs of above 20% in 2016 and all exceeded 12%.

Regulatory Developments

A significant regulatory change on the horizon for the sector is the implementation of the International Accounting Standards Board’s comprehensive ninth International Financial Reporting Standard (IFRS 9), which came into effect at the beginning of 2018.

Changes introduced by the standard include taking expected losses on financial assets such as loans into account to a greater extent in financial statements, which requires provisioning for potential bad loans even if they appear to be recoverable.

The CBO has requested that banks in the sultanate submit pro forma final statements to help evaluate the likely impact on the sector and will put in place transitional measures recommended by the Basel committee if this is judged to be large.

However, its initial assessments suggest this will not be required, as NPL levels remain manageable and banks have continued to maintain good levels of provisioning. “The impact of IFRS 9 will vary by bank, but it should be limited overall, and we may even need to provision less as a result of the changes,” Maddock told OBG. However, Younis Mohammed Al Belushi, investment manager at Oman-based Al Madina Investment, told OBG that he thought the introduction was likely to make some banks more risk-averse when allocating loans.

The central bank in 2015 launched a new regulatory framework for systemically important banks, to be initially applied to Bank Muscat, as the largest bank by assets in the sultanate. Elements of the new regulatory regime include a 1% capital surcharge, the submission every year by affected banks of recovery and resolution plans, upgraded stress tests and enhanced on-site supervision.

The central bank is also working on a bank resolution framework for all institutions, based in large part on the Financial Stability Board’s Key Attributes of Effective Resolution Regime, which is close to being completed. The framework is based on a process flow that kicks in once banks breach capital conservation buffers, allowing them to be rescued if they remain viable, or wound up in an orderly manner while maintaining financial stability if not.

Fintech

Various initiatives based on new financial technologies are also helping to spur banking sector development, with support from the regulatory authorities. In July 2017 the CBO launched a new interbank mobile switching and clearing system, MpClear, which allows for purely mobile-based, bankless transactions for a wide range of payments, including business-to-business, business-to-person, person-to-merchant and person-to-government (see analysis). The CBO has also granted initial approval to two banks to use blockchain technology – a distributed digital ledger of transactions, on which cryptocurrencies such as Bitcoin rely – for certain business lines, principally focused on remittances. In November 2017 the bank held a four-day symposium on the technology.

Basel III

The sultanate is in the process of implementing the Basel III regulatory framework for banks, which is due to be fully in place by 2019. However, in practice, the sector largely already meets the main metrics, comfortably exceeding Basel III’s CAR requirements, for example. Other aspects of the framework include a liquidity coverage ratio (LCR) that is being phased in on a staggered basis to reach 100% by 2019, and a net stable funding ratio that will be implemented at a rate of 100% from 2018. However, Omani banks also comfortably exceed these requirements.

Other regulatory developments under way include a capital conservation buffer of 0.625% of risk-weighted assets introduced by the CBO in 2014, which is gradually being raised to reach 2.5% by 2019. The introduction of the requirement is helping to push banks to raise more capital, often in the form of perpetual bonds, several of which have been issued in local debt markets in recent years. Industry figures say banks are having no trouble raising such capital where needed.

In 2016 the central bank issued a regulation allowing it to require banks to put in place a counter-cyclical capital buffer of up to 2.5% of risk-weighted assets if it deems that credit is expanding at too rapid a pace, though, as of January 2018 it had yet to put this measure in place for any bank.

In November 2016 the central bank temporarily relaxed earlier requirements that had set the bank provisioning rate for restructured loans at 15% for 2016, reducing the rate to 5% for the year. It plans to increase this in five-percentage-point increments annually to return to 15% by 2018.

Islamic Banks

Oman’s Islamic banking industry is relatively young, having effectively launched in 2013 when the CBO licensed the country’s first two sharia-compliant banks: Al Izz Islamic Bank and Bank Nizwa. This followed the implementation of an Islamic banking regulatory framework the previous year. Al Izz and Nizwa remain the only two standalone Islamic banks in the country.

Conventional banks are permitted to operate sharia-compliant windows under the framework, which six currently do, namely Bank Muscat (whose Islamic window is known as Meethaq), Bank Dhofar ( operating the Islamic window Maisarah), NBO (Muzn), Bank Sohar (Sohar Islamic), Oman Arab Bank (Al Yusr) and Ahlibank (Al Hilal). Such windows accounted for 70% of segment assets at the end of 2016.

The CBO has operated a sharia board that advises it on related matters since 2014. It does not permit some products that Islamic banks are allowed to sell in other parts of the GCC as it does not consider these sharia-compliant, including, for example, commodity murabaha (cost-plus financing). While the segment is in its infancy, it has nonetheless developed substantial clout. “Islamic banking is growing faster than the rest of the industry, and it may represent up to 20% of total banking assets by 2020,” Khalid Al Kayed, CEO of Bank Nizwa, told OBG.

The value of assets held by the sultanate’s Islamic banks and the Islamic windows of conventional banks stood at OR3.7bn ($9.6bn) as of November 2017, equivalent to 11.5% of total banking sector assets. This figure has grown rapidly in recent years, having risen from OR3.1bn ($8bn) at the end of 2016 and OR2.3bn ($6bn) a year before that. The sector accounted for 10.4% of total sector assets at the end of 2016, and 11% of total financing and lending.

The bulk of segment assets were Islamic financing, worth a total of OR3bn ($7.8bn) as of November 2017. Financing in turn was dominated by lending to the private sector, worth OR2.8bn ($7.3bn). “The segment has witnessed tremendous progress since its inception,” Sohail Niazi, chief Islamic banking officer at Bank Dhofar’s Maisarah Islamic Banking Services, told OBG. “When Islamic banking was launched in Oman, the expectation had been that it could reach perhaps 5% of banking assets within five years, but the segment has achieved more than double that in a shorter period, which has taken other countries 15 to years to reach,” he added.

Growth Factors

He attributed the rapid growth to factors including pent-up demand for Islamic banking services, as well as room for expansion in the banking penetration rate, as only 68% of Omanis have bank accounts – a high rate for the region but below developed market rates of close to 100%. “Furthermore, it will continue to grow more rapidly than the conventional banking segment, and while it is maturing in some respects, once it has had more time to develop, the Islamic segment will be better able to compete with conventional counterparts.”

Segment deposits totalled OR2.9bn ($7.5bn) as of November 2017. Government deposits, at OR1.4bn ($3.6bn), are even more important to the Islamic segment than they are to conventional banks, constituting 48% of the total, compared to 26.3% for the conventional segment.

Investment Challenges

A challenge for the segment is a shortage of investable sharia-compliant assets in Oman, with just two corporate sukuk currently listed on the MSM and no government sukuk issued domestically. However, the regulatory authorities have sought to support the sector in this respect, allowing Islamic banks to invest in foreign sukuk. Niazi said that new investment opportunities were also developing. “Sharia-compliant investment options are limited, and the segment needs to work on this if it wants to sustain its growth,” he told OBG, saying the Islamic institutions need to become more active in terms of originating, organising and investing in such asset classes. “However, the Capital Market Authority has launched real estate investment trusts (REITs). Furthermore, there have been several recent sukuk issues, and as local corporates become more familiar with sukuk as a tool, the pace of issues will increase,” he added.

Islamic windows and banks initially struggled to raise deposits from institutional investors due to a paucity of products and the lack of absolute certainty in the level of profit rates. The introduction of a range of Islamic liability products, and greater understanding of the structure and returns of such products, has since resulted in an influx of funds.

Having recorded losses in the years immediately following its launch, the segment is consolidating its profitability, recording pre-tax profits of OR13.6m ($35.3m) in 2016, up significantly from OR1.6m ($4.2m) the previous year. Six of the eight Islamic institutions operating in Oman – five windows and one fully fledged bank – were profitable on a pretax basis for the year, with Bank Nizwa marking its first year in the black. The bank built on this in 2017, posting pre-tax profits of OR2.7m ($7m) for the first nine months of the year, compared to a loss of OR500,000 ($1.3m) in the same period a year earlier.

New Instruments

In order to further facilitate the development of the Islamic banking segment, the CBO is working on the creation of liquidity-management tools such as sharia-compliant overnight deposits and repos for Islamic banking entities, which are not currently available and are expected to have a substantial positive impact.

Another regulatory initiative being pursued is the creation of a deposit insurance scheme for the Islamic banking segment, along takaful (Islamic insurance) principles. As of the beginning of 2018 the proposed scheme was under review and awaiting final approval. The plan is an innovative one, with few such Islamic insurance-based schemes currently in existence outside of banking sectors that are fully Islamic – such as those in Iran.

Non-Bank Lenders

As of end-2017 there were six finance and lending companies (FLCs) operating in Oman. Together they operated 43 branches across the country, up from 40 in 2015.

The segment held assets of OR1.1bn ($2.9bn) at the end of 2016, according to the CBO, up 4.8% on 2015 figures. Asset growth for the segment was down from 12.0% a year earlier, and 16.2% in 2013. Lending and leasing operations account for around 95% of FLCs’ assets, on OR1bn ($2.6bn) in 2016. The segment’s NPL rate stood at 5% for the year, up from 4.3% in 2015. The net NPL rate was 2.9%.

As in the banking sector, profitability indicators have been declining recently. FLCs recorded ROE and ROA of 13.6% and 3.3%, respectively, in 2016, down from 14.6% and 3.7% the year before. The CBO attributed the fall to rising bank financing costs and to growing competition. Most FLC financing comes from banks, with segment borrowing from these and other financial institutions worth OR688.7m ($1.8bn) at the end of 2016. “The risk that tightening liquidity in the banking sector will squeeze leasing company profits still exists, but is less severe than in 2016,” Sunil Pherwani, general manager at Oman Orix Leasing Company, told OBG.

To support the segment, the CBO has allowed FLCs to start accepting six-month term deposits from corporate clients, though in its 2016 FSR the bank said that companies had yet to raise much in the way of financing through the measure; and the segment also issues little regarding traded bonds.

While in decline, the CBO reported profit levels in the segment remain healthy. However, FLCs could struggle to maintain current levels of returns in light of growing competition to the sector from banks – and in particular from the advancement of Islamic banks and windows, which like FLCs, predominantly engage in asset-based financing.

The CBO also suggested consolidation among FLCs could provide substantial value to shareholders. In keeping with this, non-bank lender National Finance in May 2017 announced plans to merge with Oman Orix Leasing Company. The CBO gave final approval to the deal in December 2017, and a final merger agreement is expected in February 2018.

Outlook

The banking sector is already conservatively regulated, which has helped maintain its soundness despite the economic downturn caused by the fall in global energy prices. New regulatory requirements should further consolidate the stability of the industry. The recent improvement in oil prices is expected to help underpin liquidity in the financial system in the coming years. Meanwhile, technological developments and pressure from the authorities will drive financial inclusion. Islamic banking is set to grow rapidly, further increasing its share of industry lending, and supported by moves to bolster the sector, such as liquidity-management tools and the proposed deposit takaful scheme.