Oman's banking industry remains stable

Strong asset growth and the expansion of the newly launched sharia-compliant segment have been central to developments in Oman’s banking sector in recent years. A small number of institutions account for the bulk of market share, and this concentration is set to increase if a planned merger between Bank Sohar and Bank Dhofar goes ahead. The industry is tightly regulated and widely regarded as stable, though an economic slowdown on the back of low oil prices could see lending growth slow in the coming years.

Assets & Lending

Commercial banking assets were worth OR24.8bn ($64.2bn) at the end of 2014, up from OR22.4bn ($58bn) at the end of 2013, according to figures from the industry regulator, the Central Bank of Oman (CBO).

Between 2010 and 2014 assets grew at a compound annual growth rate of 12%, well ahead of inflation. Strong growth continued into the first half of June 2015, with assets rising to OR27.4bn ($70.9bn). Such expansion has been driven by strong credit growth in recent years, also standing at around 12% a year between 2010 and 2014. Bank lending was worth OR16.9bn ($43.8bn) – of which OR14.7bn ($38.1bn) was to the private sector – at the end of 2014, up from OR15.2bn ($39.4bn) a year earlier, according to the CBO.

As of June 2015 total lending had reached OR17.8bn ($46.1bn). The pace of credit expansion has outstripped broader economic growth; according to CBO figures, bank credit as a share of GDP rose from 47.4% in 2010 to 57.1% at the end of 2014, and was equivalent to 94.8% of non-oil GDP.

Approximately 40% of outstanding credit at the end of 2014 was to individuals, while the top five borrowers together accounted for around 5% of the total. Real estate lending represented about 15% of credit, though the CBO noted that when indirect exposure to the segment is taken into account (through loans reliant on real estate income for repayment, for example), banks’ total exposure to the segment was around 25% – a level the institution described as relatively high.

Interest Rates

Lending rates have been falling steadily in recent years, with the weighted average interest rate for local currency-denominated conventional bank loans standing at 4.86% as of June 2015 (compared to an average deposit interest rate of 0.9%), down from 5.5% in June 2013.

More than half of such lending attracted an interest rate of between 4% and 7%; 35.4% of loans were made at rates between 5% and 7%; and 18.3% were made at rates of between 4% and 5%.

Lending growth is set to remain strong, but levels may slow compared to the expansion recorded in the past few years. Oman’s banking system is currently highly liquid, which the IMF in May 2015 said “augurs well for meeting emerging private sector credit demand and for further financial deepening”, though it noted that a rapid draw-down of government deposits could affect this.

Oil Effects

However, falls in the price of oil since mid-2014 are pushing down economic growth forecasts, suggesting the rate of credit expansion may also weaken.

“There is likely to be a general slowdown in credit growth across the sector,” said Rashad Ali Abdullah Al Musafir, the acting CEO of Bank Sohar. He added that what growth does occur will likely be concentrated in the corporate sector. “Retail lending is already large compared to the regulatory ratios in place, and banks need to be careful about the potential for over-indebtedness among retail customers given the potential for low oil prices to push up unemployment,” he said.

Dynamics in the mortgage market are additionally likely to curb retail credit expansion. Rashad Jaffar Al Shaikh, the deputy head of retail banking at Oman Arab Bank, told OBG that within retail lending, growth had been particularly strong in the mortgage segment in recent years, but that rising land prices were likely to push more people towards renting, curbing market expansion.

Growing Deposit Levels

As with lending, deposit levels have risen rapidly in recent years, well ahead of GDP growth. CBO data put banking deposits at OR17.3bn ($44.8bn) at the end of 2014, up from OR15.6bn ($40.4bn) a year earlier.

As of August 2015 the figure had risen to OR18.2bn ($47.1bn). Bank deposits amounted to 57.1% of GDP at the end of 2014, an increase from 46.5% of GDP four years earlier.

The private sector accounted for OR11.6bn ($30bn) of deposits as of August 2015, split between demand deposits, time deposits and savings, while government and public enterprise deposits were worth OR5.3bn ($13.7bn) and OR1.1bn ($2.8bn), respectively.

The IMF has highlighted the large size of government deposits – specifically the potential for their drawdown as the government enters a period of deficit financing – as a possible obstacle to banking system liquidity. Lloyd Maddock, CEO of Ahlibank Oman, told OBG, “Of the total deposits in the banking sector, approximately one-third are contributed by the public sector. The banking sector has witnessed a tightening in liquidity in the fourth quarter of 2015, with the competition for deposits from all sectors increasing. If continued, this will ultimately result in borrowing costs increasing during 2016.”

Profitability

Total sector profits rose by 4.8% from OR397m ($1.03bn) in 2013 to OR416m ($1.08bn) in 2014, according to the CBO’s May 2015 “Financial Stability Report”.

Return on assets was 1.7% and return on equity was 12.2%, both of them remaining unchanged from the previous year. Performance appears set to remain strong in 2015, with profits at the largest bank in the sultanate, Bank Muscat, growing at roughly the same rate in the first half of 2015 as in 2014, by 4%, to OR89.8m ($232.5m).

Competitive Landscape

There are currently 16 conventional commercial banks in Oman, as well as two fully fledged Islamic banks and two specialised banks. The sector is relatively top-heavy in terms of market share, with the top three banks accounting for 62% of assets and the seven largest for 95% of assets in 2014 – though such figures are broadly in line with other GCC states.

Bank Muscat is the largest bank in the country, with local assets totalling OR9.73bn ($25.2bn) at the end of 2014, equivalent to 39.2% of total sector assets. The bank put its local assets market share at 38.8% as of March 2015. The largest individual shareholder in the institution, which is listed on the Muscat, London and Bahrain exchanges, is Oman’s Royal Court, with a 24% stake, followed by Dubai Financial Group on 12% and the Ministry of Defence Pension Fund on 7%.

Next in line is Bank Dhofar, on assets of OR3.19bn ($8.3bn), followed by National Bank of Oman (NBO) with OR2.98bn ($7.7bn). Bank Dhofar’s major shareholders are Omani investment firm Dhofar International Development and Investment Holding Company with a 27.8% stake, the Civil Service Employees’ Pension Fund on 10%, while those of NBO are Qatar Commercial Bank with a 34.9% stake, the Suhail Bahwan Group on 14.4% and the Civil Service Employees’ Pension fund on 10.73%.

Nine of the banks operating in Oman are foreign-owned. These institutions previously dominated, but they have lost market share in recent years. Their proportion of deposits fell from 15% in 2007, according to figures published by local business news outlet Business Today, to around 7% in 2014, according to CBO data.

Foreign banks are currently focused primarily on corporate business niches, such as trade finance, rather than the retail market. In 2012 the largest foreign player at the time, HSBC Bank Oman, merged with Oman International Bank, effectively becoming an Omani institution.

However, the trend of foreign banks losing market share may now have played out; their share of assets is up from 6% in 2012 and lending by foreign banks grew in line with that of local banks in 2014.

Consolidation

In July 2015 Bank Dhofar and Bank Sohar announced that they had entered into a non-binding agreement to merge, and that they were each undertaking due diligence on the proposed deal. The two banks have been in merger talks since 2013. In August 2015 Al Musafir told OBG that the banks have appointed consultants who will be tasked with carrying out thorough due diligence on both the institutions.

If the deal goes ahead, the new entity will be the country’s second-largest bank, with assets of around $13.7bn, according to Thomson Reuters data, with a significant impact on the composition of the local banking market.

“A larger institution would contribute to the national economy through its ability to fund large projects,” said Al Musafir. “The new entity would also be able to provide greater competition to the higher-tiered banks in the country.”

The authorities have been encouraging consolidation for some time, for these as well as other reasons. “There has been an emphasis on consolidation for the last 15 years or so, as the authorities want banks that can finance large projects and compete regionally,” said Al Musafir, though he added that regional regulators had somewhat reduced the push since the international financial crisis, as they have become more wary of creating institutions that are too big to fail.

Consolidation is also under way in the non-bank lending segment. In June 2015 Al Omaniya Financial Services said that it had made an offer to acquire a 100% stake in fellow financing company United Finance. Al Omaniya was not the first institution to show interest in United Finance; NBO and Bank Nizwa had both separately entered into takeover talks with the company earlier in the year, though the deals were never finalised.

June also saw the CBO approve the merger of two major stakeholders in the industry, namely Oman International Development and Investment (Ominvest), which owns majority stakes in Oman Arab Bank and finance company Oman Orix Leasing, and Oman National Investment Corporation (ONIC), which also owns a stake in Oman Orix.

Stability

As of December 2014 non-performing loans (NPLs) amounted to 2.1% of total lending, according to CBO figures, with 72% of such loans provisioned for (though more than three-quarters of NPLs were classified as losses rather than sub-standard or doubtful loans). The capital adequacy ratio stood at 15.4%, down from 16.2% a year earlier, but still far above the minimum ratio set of 8% set by Basel III standards. Since 1995 the CBO has operated a deposit insurance fund to deal with any banks facing severe difficulties, guaranteeing deposits of up to OR20,000 ($51,800); as of May 2015 the fund contained around OR93m ($240.8m).

Stress Tests

The IMF noted that stress tests suggest that “under a combination of interest rate and market shocks, the solvency of the banking system would be preserved.” Various tests cited by the CBO in its “Financial Stability Report” corroborate this, with the sector as a whole maintaining a capital to risk-weighted assets ratio above the mandated minimum levels set by the regulator, even in the case of all its hypothetical stress scenarios occurring at once, though some individual institutions would fall below the minimum.

However, one potential vulnerability of the segment is the high level of liabilities to the state sector; government and public sector enterprises accounted for around one-third of total deposits in 2014. The IMF noted that a “sudden sharp withdrawal” of these – conceivable if the oil price remains low and the government draws down on deposits to maintain spending – “would put pressure on banking system liquidity”, and called on the government and the central bank to work together to prevent such a scenario.

Liquidity

To this end, the CBO has encouraged banks to diversify their sources of financing in light of the risk. “The market is becoming more challenging because of the low oil price. There is concern that liquidity could start to drain out of the system towards the end of 2015 and into 2016,” Al Musafir said. Yet not everyone sees this as a big threat. “Steps such as the government’s sukuk (Islamic bond) should bring more liquidity into the system by attracting foreign money,” Helmi Haruna Rashid, the general manager of wholesale banking at Bank Nizwa, told OBG.

Project Finance

With the government working to substantially develop Oman’s infrastructure, project finance is regarded as one of the most promising areas for lending growth. “There will be opportunities in project finance in coming years, as there are major infrastructure projects in the pipeline and Omani companies can’t finance work on these in-house,” Haruna Rashid told OBG.

Ramy F Zambarakji, the CEO of Bank of Beirut-Oman, said that business in the segment would likely remain strong even if the sultanate sees GDP growth rates fall on the back of low oil prices.

“In the event of an economic slowdown the government may stop building some types of infrastructure, such as parks, but it will continue to build water and electricity infrastructure, for example,” Zambarakji said.

However, margins in the segment are tight. Heavy competition for business has pushed down rates in recent years, Lo’ai Badie Bataineh, the head of investment management and chief investment officer at Oman Arab Bank, told OBG, though he added that project finance deals were an opportunity for banks to generate additional feebased work with customers. Such competition is also likely to become more intense as the fledgling Islamic banking segment enters the market.

In February 2015 Bank Nizwa signed its first major project finance deal, a $40m loan for the construction of an antimony plant, which Haruna Rashid said would prove that Islamic financing can work well in the sultanate. “We have all the tools necessary to provide 100% sharia-compliant project finance in Oman,” he said.

Non- Bank Lending

There are six financing companies active in the Omani market, according to the CBO. Total lending by the segment stood at OR888m ($2.3bn) in 2014, up 8% on the previous year, according to central bank figures.

Financing firms have posted healthy profits in recent years, with return on assets standing at 3.8% and return on equity at 14.4% in 2014, when pre-tax profits rose 11% year-on-year (y-o-y) to OR33.7m ($87.25m). While NPL rates are higher than in the banking sector, at 5.9% in 2014, these were fully provisioned, according to the CBO.

However, competition between finance companies and banks is at present heavy and growing, with the latter working to step up their car financing activity in particular.

“Banks have been taking a more aggressive position in the new car segment and they are now starting to enter the second-hand segment as well,” said Sunil Pherwani, the general manager for marketing and sales at Oman Orix Leasing Company. “Banks can offer lower interest rates, so finance companies are competing on service and in particular our ability to offer much faster turnaround times.” Such increased competition helps to explain a fall in lending growth rates in 2014 to 8%, from 16% the previous year. Banks’ increasing presence in the car market means that the prospects for growth in the business market – and in the small and medium-sized enterprise segment in particular (see analysis) – are more promising than those in retail, according to Pherwani. He told OBG that finance firms were calling for the authorities to allow them to diversify their product offerings, by, for example, allowing real estate financing and Islamic financing in order to help them compensate for lost business in the car market. However, Al Shaikh said that there would always be a place in the market for finance companies. “The segment is less regulated and finance companies have a higher appetite for risk than banks,” he told OBG.

Most financing for non-bank lenders comes from banks, with bond issues a comparative rarity (see Capital Markets chapter). Leasing firms are allowed to accept deposits from corporate (but not retail) clients, though in practice this is not a major source of sector financing.

The CBO has noted that this reliance on bank funding could constrain profitability should banking sector liquidity tighten. Companies in the segment are also keen to diversify their sources of financing. “Allowing finance firms to accept retail deposits would boost the sector’s ability to compete with banks on interest rates,” said Pherwani.

Industry figures say that the outlook for the segment is dependent on the performance of the wider economy. “Growth depends heavily on government expenditure, and infrastructure projects in particular,” said Pherwani. “Whether or not the government maintains spending in the coming years, regardless of the lower oil price, will be a key determinant; for example, the planned railway project will provide enormous opportunities for financing companies to fund work on it.”

Regulatory Framework

The CBO has a reputation for prudent and sometimes conservative regulatory practices, with strict prudential ratios, as well as a number of price caps and lending ratios in place. For example, the interest rate on loans to individuals is capped at 6%. A debt burden ratio also restricts the amount banks can take as repayments from a customer’s salary.

“Central bank regulations have repeatedly saved the market from getting into trouble,” said Zambarakji. “The CBO is not as conservative as is often thought – its regulations allow banks to compete and are well-suited to the country – but its slightly higher requirements than Basel III have been good for stability, in particular given the risk that low oil prices could see capital start to dry up.”

However, Al Shaikh said that restrictions in the retail sector could sometimes conflict with other goals, such as expanding the reach of bank lending. “It is prudent to have restrictions on borrowing to ensure that customers don’t become excessively indebted; however, some of the pricing restrictions that currently exist mean that banks are less likely to lend to some sectors, which is a constraint on increased financial inclusion,” he told OBG.

For the moment, the CBO looks unlikely to loosen such restrictions. Its May 2015 “Financial Stability Report” noted that household indebtedness in terms of net salary months was high, in particular as regards housing debt, and that it had “shored up regulatory measures to rein in this trend”.

Outlook

Lending growth is likely to decelerate should oil prices remain low and GDP growth slow down as a result. However, a prudent regulatory approach suggests that the sultanate’s banking industry will remain stable and the Islamic banking sector is set to continue to expand rapidly (see analysis). The expected merger of Bank Dhofar and Bank Sohar, if it goes ahead, will create a large new institution, increasing competition among the bigger banks in the sultanate as well as boosting the sector’s capacity to finance large projects.