Government backing is reinforcing the industry’s strong momentum

Islamic finance has had a growing presence in Brunei Darussalam since the early 1990s, with active support from Sultan Hassanal Bolkiah. Today the Islamic banking and takaful (Islamic insurance) segments are transitioning into the dominant forms of banking and insurance in the country, and the Sultanate’s large foreign investments are increasingly channelled into Islamic products and markets.

Already Brunei Darussalam’s largest bank, Bank Islam Brunei Darussalam (BIBD) is increasingly dominating the domestic market, and at the same time it is also developing into an international player in Islamic finance. The bank was recently a co-lead manager in two international sukuk (Islamic bond) issues and a syndicated Islamic structured finance facility, and it is hoping to accelerate its international fundraising in the year ahead.

Sector History

Islamic finance got its start in Brunei Darussalam in 1991 with the establishment by the government of the Perbadanan Tabung Amanah Islam Brunei (TAIB).

Originally envisioned mainly as a vehicle for encouraging Bruneians to save for the Hajj pilgrimage to Mecca, TAIB is technically an Islamic trust fund (as “tabung amanah” means in Malay), rather than a commercial bank. However, TAIB rapidly developed to become, for all practical purposes, a fully fledged Islamic bank, and it is counted among the Sultanate’s banks in the official statistics. The Islamic sector grew further with the conversions into Islamic banks in 1993 and 2000 of two government-owned, formerly conventional banks. They were then merged in 2006 into what is now BIBD.

Takaful

Meanwhile, takaful got its start in the Sultanate in 1993 when TAIB created a subsidiary, which is currently named Insurans Islam TAIB. The two banks that were converted into Islamic banks also each entered the takaful market, and alongside the bank merger in 2006, the related takaful companies were likewise merged into Takaful Brunei. Takaful Brunei is not a subsidiary of BIBD but is closely related: it is 69% owned by the royal family’s Sultan Haji Hassanal Bolkiah Foundation and 31% by BIBD, which is in turn jointly controlled by the government and the foundation.

As required by a 2008 reform, and in line with international industry practice, each of the two takaful firms has split its general insurance business and its family takaful (equivalent to life insurance) business into separate subsidiaries. Insurans Islam TAIB General Takaful and Takaful Brunei Am compete in the general takaful market, while Insurance Islam TAIB Family Takaful and Takaful Brunei Keluarga compete in the family takaful market.

Regulation

Another key step in the sector’s development came in 2006 with the establishment of the Sharia Financial Supervisory Board (SFSB), a government body that determines which financial services are in compliance with sharia law and may be offered by Islamic financial institutions in Brunei Darussalam. The SFSB is one of two key regulators of Islamic finance, alongside the Autoriti Monetari Brunei Darussalam (AMBD), the central bank, which regulates the banking and insurance sectors.

Market Size & Structure

The Sultanate’s two Islamic banks had combined assets of BN$7.9bn ($6.2bn) at the end of 2013, according to the AMBD, representing 41% of total bank assets. That was up from 37% in 2010, and demonstrates that Islamic banking is making steady progress toward its declared goal of a majority market share.

Consolidated Islamic banking assets, including BIBD’s finance company subsidiary, BIBD At-Tamwil, came to BN$8.3bn ($6.51bn), according to OBG calculations based on AMBD data and BIBD’s annual report. That too is equal to 41% of consolidated banking sector assets, including conventional finance companies. Finance companies specialise in financing personal car purchases, and raise funds both from parent banks and by taking their own deposits.

Leading The Way

BIBD carries most government and public employee payroll accounts. It is by far the bigger of the Sultanate’s two Islamic banks, with some BN$6bn ($4.71bn) of bank assets at the end of 2013, and BN$6.4bn ($5.02bn) of consolidated banking assets, including BIBD At-Tamwil, according to its annual report. TAIB’s assets at the end of 2013 can be calculated as BN$1.9bn ($1.49bn) by subtracting BIBD’s published assets from the sector total. TAIB offers financing for automobiles directly and has no finance company subsidiary.

Total takaful assets came to some BN$444m ($348m), or 33% of total insurance and takaful assets, at the end of March 2014, up from BN$184m ($144m) – or 18% of sector assets – at the end of March 2011, according to AMBD data.

However, takaful is already dominant in the general insurance sector, while family takaful is small but catching up quickly. Takaful had a 67% share of general insurance and takaful assets as of March 2014, up from 62% in March 2011, while takaful had only a 19% share of life insurance and family takaful assets in March 2014, but up from just 12% in March 2011, according to AMBD statistics. Neither of the takaful groups publish financials.

There is also believed to be a growing Islamic share in the non-bank asset management industry, although few statistics on this are currently available. Some of Brunei Darussalam’s 11 licensed investment advisors offer Islamic investments, including AmCapital and CIMB Investment Bank – both of which are units of Malaysian banking groups – in addition to government-linked advisors that handle sovereign wealth fund investments.

Among Brunei Darussalam’s three licensed fund managers and administrators is SBI (Brunei), which is jointly owned by the Bruneian government and Japan’s SBI Group. It manages the SBI Islamic Fund (Brunei), an Islamic private equity fund focused on Asia. While most sovereign wealth fund investments are secret, many of those that have been made public in recent years have an Islamic focus, such as a stake in Dubai-based Fajr Capital, jointly held with the Malaysian and Abu Dhabi sovereign wealth funds.

More Aggressive Lenders

While Islamic banks have not yet reached a majority of banking assets, they may already make up more than half of domestic loans, judging from the limited data available. Islamic banks are more aggressive than most of Brunei Darussalam’s conventional banks in putting their funds to work in the domestic economy.

That is the case chiefly because the Islamic banks are government-linked institutions with mandates to support domestic business. Although one government-linked conventional bank, Baiduri Bank, has a similar risk profile to the Islamic banks, the other five of Brunei Darussalam’s conventional banks are foreign-owned, and take a more cautious approach to lending. Another reason for the difference is that BIBD handles most public employee payroll accounts, and since 2010 banks have been forbidden from making consumer loans to people who do not receive their primary income into an account at the bank.

Liquidity

The difference can be seen in the wide gap in liquidity ratios between the Islamic banks and the conventional banks. Liquidity ratios are very high across the banking sector, mainly because the economy’s dominant sector, oil and gas, finances itself almost wholly internationally, which means that demand for bank deposits far outweighs the demand for corporate borrowing. Therefore, even Islamic banks had 50% of their assets in liquid assets (cash and equivalents) as of September 2013, according to AMBD statistics provided to the IMF.

Conventional banks, however, had a much higher ratio of 63% of their assets in cash and equivalents. The risk profile difference is also visible in the average ratios of gross non-performing loans (NPLs) to total loans, which stood at 9.5% for Islamic banks as of September 2013 and 4.1% for conventional banks, according to AMBD statistics provided to the IMF. Those numbers and the liquidity ratios cited above are for banks only, excluding finance companies.

BIBD alone accounted for 37% of the banking sector’s outstanding loans to the domestic economy at the end of 2013, up from 33% at the end of 2011, according to calculations based on its annual reports and AMBD data. Judging from those numbers, BIBD’s weight within the Islamic banking sector and the liquidity ratios, Islamic banks appeared to have been holding just under half of outstanding domestic loans at the end of 2013. As their share of outstanding loans has been growing, Islamic banks are apparently making more than half of new loans.

Profits Hold Up

Despite the higher ratios of NPLs, Islamic banks lag only slightly behind conventional ones in terms of profitability. Since Islamic banks hold larger volumes of high-earning loans and smaller volumes of low-earning cash and equivalents than conventional banks, Islamic banks earn more interest income. The average return on equity (ROE) of the Islamic banks was 9.2% in the first nine months of 2013, compared to 10.9% for conventional banks, according to the AMBD. Even that difference is largely due to Islamic banks’ higher capitalisation: they had an average ratio of Tier 1 capital to risk-weighted assets of 21.5% as of September 2013, compared to 17.5% for conventional banks.

Nonetheless, a marked deterioration of sector-wide profitability from 2009-12 was a source of concern. Average ROE for conventional and Islamic banks fell steadily, from 11.2% in 2009 to 5.6% in 2012. Yet 2013 saw a dramatic turnaround, with sector-wide average ROE recovering to 10.6%. Those numbers exclude finance companies. BIBD’s ROE ratios, including BIBD At-Tamwil, have run counter to the sector-wide trend, improving from 7.5% in 2010 to 11.3% in 2012 and slipping to 10.1% in 2013, according to the bank’s annual reports. Its profits amounted to BN$114m ($89m) in 2013, down slightly from the BN$119m ($93m) recorded in 2012.

BIBD Profile

While little combined data is available on the two Islamic banks, BIBD, which accounts for about three-quarters of Islamic banking by assets, publishes detailed annual reports.

BIBD’s 2013 report shows that lending accounted for 43% of group assets, including those of BIBD At-Tamwil. Cash and equivalents accounted for 44%, investments (usually foreign) for 11% and other assets, such as fixed property, for 2%.

The bank made a concerted push in 2013 to grow its income-earning assets and reduce its cash. BIBD’s lending portfolio grew by a swift 18% for the year, while investments grew at an even faster pace of 24%. Cash and equivalents, meanwhile, shrank by 9%. Retail lending accounted for 65% of BIBD’s lending portfolio. BIBD At-Tamwil’s automotive loans accounted for 18% of the portfolio, personal property loans 15% and other retail loans 32%. Personal property loans were the fastest-growing segment of the lending portfolio, increasing by 28% for the year, while BIBD At-Tamwil’s car loans grew by 14%.

Corporate lending also grew swiftly at 18% for the year and accounted for 35% of the lending portfolio, with transport (9%), manufacturing (8.5%) and property development (4.4%) the largest target sectors. The biggest problems with NPLs were in property development, tourism and infrastructure, and in personal property and other retail lending.

While BIBD brought down its gross non-performing ratio from 8.8% at the end of 2011 to 5.5% at the end of 2013, this was achieved by writing off BN$76m ($60m) of NPLs in 2012-13. The rate at which loans have been newly classified as non-performing grew over the same period, from BN$20m ($15.7m) to BN$35m ($27.5m).

BIBD’s increasing dominance has its critics, and one conventional bank executive told OBG there were concerns that the government could be deliberately moving towards a fully Islamic banking system, at least in the retail segment. Even government officials say that they would like to see at least one more Islamic bank enter the market, especially since TAIB is seen to be held back somewhat by its trust fund status. A Malaysian bank was rumoured to be discussing opening a new Islamic bank in Brunei Darussalam, but had not yet made a final decision.

Joan de Zilva Moonesinghe, a regulatory consultant at the AMBD’s banks and specialised markets division, told OBG, “I think that there is room for two or three banks in the Islamic segment. We currently have one fully fledged Islamic bank. There is definitely room for more competition.”

Singapore Sukuk

Despite being more active in domestic lending than conventional banks, Islamic institutions have considerable excess liquidity available to invest abroad. However, it is less simple for them to hold offshore assets. Conventional banks can conveniently put funds into Singapore’s conventional banks and capital market, avoiding foreign exchange risk due to the Bruneian government’s commitment to maintaining the longstanding one-for-one convertibility of the Bruneian and Singaporean dollars. Islamic banks must generally look to Gulf and London Islamic banks and sukuk markets, which involves taking on significant exposure to the US dollar. Although the world’s largest sukuk market is next door in Malaysia, Brunei Darussalam’s Islamic banks generally avoid it, as they and their regulators consider the Malaysian ringgit too volatile.

The predicament of the Sultanate’s Islamic banks has created an opportunity to develop a market for Islamic assets in Singapore, denominated in Singaporean dollars. For example, Swiber, a Singapore oilfield services company, launched a $120m sukuk in August 2013, for which BIBD was joint lead manager with Malaysia’s Maybank. Bruneian institutions took 46% of the issue and were considered its anchor investors, according to a Reuters report.

In addition to being a breakthrough for Singapore’s nascent sukuk market, the deal represented a novel way of bridging the traditional division that has existed between Brunei Darussalam’s financial system and the fundraising of the major international energy sector companies.

Another notable deal in 2012 saw BIBD participate in an internationally syndicated Islamic structured financing facility that raised $170m to fund the construction of a new liquid natural gas tanker for Brunei Gas Carriers, an 80:10:10 joint venture of the government, Royal Dutch Shell and Mitsibushi. BIBD was co-lead manager along with Bank of Tokyo-Mitsibushi UFJ, Sumitomo Mitsui and HSBC.

BIBD was also co-lead manager in 2013 of a $500m sukuk issued by Al Hilal Bank, an Abu Dhabi-based Islamic bank. BIBD is looking to make additional big international deals. BIBD’s managing director, Javed Ahmad, told Bloomberg in July 2014 that BIBD was hoping to arrange as much as BN$2bn ($1.57bn) of corporate debt in the next 12 months to finance projects related to boosting oil output.

Domestic Sukuk

The government has also sought to promote the development of a domestic sukuk market using government sukuk issues, which also provide a benchmark for deposit rates and regulate money supply. They are entirely taken up by local banks, including conventional banks, and are treated as close equivalents to cash. There were BN$600m ($471m) of such issues outstanding at the end of January 2014, according to AMBD data.

To date there has been only one domestic corporate sukuk issue, a BN$100m ($78m), six-year sukuk issued in 2006 by Brunei LNG, a 50:25:25 joint venture between the government, Royal Dutch Shell and Mitsibushi that liquefies natural gas for export. Brunei Shell Petroleum, the country’s main oil and gas producer, received approval from the SFSB in 2010 to issue sukuk, but as of September 2014 the company had not announced any issuance plans.

Other Sectors

The rise of takaful in the insurance sector has also been aided by strong support from the government and from close relationships with relatively strong Islamic banks (see Insurance chapter). Takaful competes aggressively on price and is especially dominant in automotive insurance. Similar to conventional insurance companies, takaful companies rely heavily on foreign retakaful, the Islamic equivalent of reinsurance.

In the investment advisory business there is also a push taking place to provide more sharia-compliant products. Azlan Mike Skinner, country manager at investment advisor AmCapital, told OBG, “His Majesty has emphasised his wish that Bruneians’ investments be more sharia-compliant. My emphasis has been to help provide more compliant investment products and services.”

AmCapital has the support of the Islamic banking division of its parent, Malaysia’s AmBank, a dual conventional-Islamic banking group. However, Skinner told OBG that it is a lengthy process to get products formally approved as sharia-compliant by the SFSB. He said that his main task is helping Bruneians’ make sounder investments. “The most important line isn’t between conventional and Islamic investments, it’s been good and bad investments. Too many people have lost money on forex trading and so on.”

Outlook

The rapid and accelerating growth of Islamic finance makes it clear that Brunei Darussalam is transitioning to a financial system in which Islamic banking and takaful will be the dominant forms of banking and insurance. While the aggressive increases in market share come, to some extent, at the cost of profitability, BIBD remains a relatively profitable institution, and its government backers clearly feel they can afford to take some risks. The main question that remains is whether BIBD will become increasingly dominant in the banking sector, which could have its advantages in terms of developing an institution with sufficient heft to be an international player, but could also have drawbacks in terms of reduced competition domestically.