2014 ISLAMIC BANKING IN OMAN – TODAY & THE WAY FORWARD Muhammad Arsalan 4/23/2014 Intentionally left blank 2 Contents 3 CONTENTS 4 LIST OF TABLES 4 LIST OF BOXES 5 GLOSSARY 6 LIST OF ABBREVIATIONS 7 EXECUTIVE SUMMARY 9 INTRODUCTION 9 GROWTH STORY INTACT 10 OMAN BANKING SECTOR–DYNAMICS & DRIVERS 11 ISLAMIC BANKING IN OMAN – FORECASTS, OUTLOOK AND REALITIES 12 ISLAMIC BANKING IN OMAN: START-TO-DATE 14 Reviewing Deposits Side-Products- 14 Income Determination & Profit Distribution Practices- Market Discipline 15 Reviewing the Asset Side 17 STRATEGIC DIMENSIONS 17 Is it more than a Three Horse Race? 17 The Sacrosanct Shariah Compliance 18 Principled Stand – Islamic Banking Regulatory Framework 18 Trade Based Products Structures 19 Islamic Banking Windows: Efficiencies or Cannibalization? 20 The 60-40 Strategy – Islamic Banks to Benchmark the Scales 21 The Big opportunity In the Small Enterprise Segment 22 Earnings Dynamics 22 Optimizing the Capital 23 3 CONCLUSION List of Tables ................................ ......... 11 Projections on the Islamic Banking Industry Size quantified in terms of Assets 13 .... Bank – wise details of Assets, Equity, Deposits, Financing, Profitability and Deposit Rates Disclosures ........... 16 Retail or corporate financing side products along with their underlying Islamic Finance Contract 20 A review of convention banks, Segment-wise breakup of asset and deposit, yields and capital adequacy List of Boxes …………………………………………………………………….……………………………….…Recent Regulatory Directives – CBO ………………………………………………………………………..……………………….……………………….Meeha , the Ma e i k! ………………………….………………………………………………………….Dispe sio of P odu t Weights- Does it Matter? ……………………………..……..………..…….…….I est e t Deposits Accounts –Distributing Net or Gross Profit? ………………………………….……………….…….………………………………..Maisa ah – Breaking the Murabaha Mould …………………………………..............Shariah Compliance for Murabaha – Trade Transaction in Letter & Spirit ……………………………………..……….….….………………………………………….No E iste t Sala ……………………………………………..……..….…………….Capital Ade ua 4 & Istis a P odu ts Sta da ds: Tailo ed to Isla i Ba ks Glossary 5 List of Abbreviations 6 Executive Summary The fledgling yet vibrant Islamic Banking industry in Oman, has lately been attracting a lot of attention for its vigorous legislative, regulatory and market developments. Right from the time, when in 2011 a Royal Decree was issued to incorporate Islamic Financial System, which paved way for the promulgation of regulatory framework, and subsequent realization of 2 Independent Banks and Six window operations operating in the Monarchy - a lot has been written on the prospects and the promise that Islamic Banking in Oman has got to offer. Presently, almost all of the eight Islamic Banking Institutions (IBIs) in Oman have completed an year of operation, and account for a signifcant 3.24% (OMR 745 Bn) of the overall Banking Assets in the country. This stipulates the need to factually assess the performance of IBI s agai st the visualized goals, to identify prospects, gaps, challenges and impediments and align the strategy to address them. Isla i Ba ki g i O a : P ese t “tate & The Wa Fo ad the pape take a des ipti e a d exploratory approach to encompass the progress of Islamic Banking in Oman in the backdrop of the dynamics of local economy and the overall Banking Industry. An objective, as well as a strategic review of the Banking Industry is carried out to identify the the opportunity pockets and challenges for the nascent faith based format of Banking. In the first section, the paper describes the overall economic scene and its growth dynamics. The following section, presents an illustrustation to define the structure of Omani Banking Industry with a thorough segment wise breakup of asset and liabilities, advance to deposit ratio, leverage, capital adequacy, spreads and efficiencies. In its effort to relate the expectations and realities, a cross-section interpretive analysis of the futu e p oje tio s Mood s, E st & You g a d A aa Capital is carried out, to develop their grounding in the present facts. I a late se tio titled The “i t -Forty Strateg , an insightful discussion on strategic implications and recommendation, based on the circuitous and interdependent relationship of deposit and asset mix, Capital Adequacy and the overall efficiency of a bank is also presented. The benchmarks of the existing conventional banking industry, would enable Islamic Banks to sway their strategic goals, while they follow their respective organic growth. As an indicative yardstick, it can serve as an overarching frame to avoid any major deviations in shape costly deposit mix or lowerthan-the-optimum credit portfolio. 7 The value of the paper is driven by the comprehensive and exhaustive presentation of Financial information, product analysis, profit rates, balance sheet and revenue structures, followed by intuitive analysis to elaborate the strategic and operational dimension of all the eight IBI s ope ati g i O a . A detailed o pa e a d o t ast o e ta , o the deposit a d fi a i g side p odu ts ei g offe ed, their underlying shariah contracts is being presented. In all its rigor, the paper not only explores the progress of overall Islamic Banking industry, but also highlights the performance and distinctive features of Individual IBI. Isla i Ba ki g ‘egulato F a e o k IB‘F issued the Ce t al Ba k, is ai tai ed as a pivotal reference through out the paper, to examine the operations and offerings of the IBIs and underscore the key driver of performance, innovations and probable limitations. In the conclusive se tio of “t ategi Di e sio s , the pape seeks to outli e st ategi i sights (and perhaps future directions) based on competitive positioning, success drivers, product innovations, operational limitations for the manager of Omani IBIs. In its intuitive pursuit, the study also portends practical intricacies in Shariah Compliance, Deposit Pool Management and asset liability management, that IBIs in Oman would come across. The strategic dimensions presented are backed by cases, constructs, propositions and artifacts driven from domestic banking industry or Islamic Banking experience in other jurisdiction. The paper in its pragmatic approach, quotes and elaborate the anomalous growth and the daring business model of Meethaq, the principled stance of the regulator, the product innovation of Maisarah, the opportunity in the SME segment, Shariah Compliant structures to exploit trade intensive and specially non-oil trade in Oman s economy. Shortly, the reader would surely find this paper useful in developing a perspective of Islamic Banking Industry in its independent capacity, as well as a subset of the broader Financial Intermediation scene in Oman. 8 Introduction Oman has been one of recent entrants into Islamic Banking and Finance scene, with a well established regulatory framework roll out and a nascent industry players comprising of two Independent Islamic Bank (IIB) and 5 Islamic Banking (IBW). Ever since the Royal Decree adjusting the banking law to allow the shariah compliant format of banking was announced, competition has been seen tough among the local banks themselves. Apart from the two fully integrated Islamic banks -- Bank Nizwa and Al izz bank -- the country's biggest commercial banks have also set up their own Islamic banking windows which iclude Bank Mus at s Meetha , Natio al Ba k of O a s - Muzn. Ba k of “oha s - “oha Isla i , Ba kDhofa s Maisa ah, Ahli a k – Hilal Isla i a d O a A a Ba k s Yusr have been announced. A lot has been written on the prospects, potential and promise of Islamic Banking in this GCC Country, with analysts generally optimistic on the overall growth of the industry both in terms absolute Islamic Assets as well as market share. Oman has been classified as an oil-rich economy, heavily dependent on the dwindling oil resources, which sourced around 80% of its revenue in 2012 (S&P, Dec 2013). Thus, aligned with its regional peers Oman's economy and external position stands exposed to commodity prices. However the government has been framing all sorts of initiatives to diversify into non-oil economy (tourism and mining primarily) by means of high investment supported by higher public and private consumption. Oman is a youthful Muslim monarchy with strong faith driven population as benchmarked by World Banks realist index of 97%. The official numbers for the population is 2.78 Mn (World Bank, 2011) Growth Story Intact The “ulta ate fa o a le de og aphi s 6 % of the populatio is et ee the age of 15 to 45 years) coupled with a pro growth and employment backdrop, augur well for the fortunes of the financial sector. The GDP growth during 2000 to 2012 has averaged around 5.6%. Recent government regulations raising minimum wages and expanding employment amongst the masses have also been supportive of o su ptio a d the deposit ase of the atio s a ks. This has also translated positively into a 10% YOY growth in banking Assets to surpass OMR 23 Bn mark. In recent years, a recovery in the prices of crude oil and production coincided to enable supportive government expenditure and an accommodative monetary policy portending well for growth in the country and its banks. Expectations of a continuing expansionary fiscal policy to sustain the current momentum in growth, provide an optimistic outlook for the medium term future. Obvious risks include a 9 substantial fall in oil prices. However, years of fiscal prudence have yielded adequate reserves to ensure continued pro-growth initiatives remain unhampered, even in the event of a mild fiscal deficit. The Eighth Five-Year Development Plan (2011-15) emphasizes a large public investment program. Non-oil activities are expected to grow by an annual rate of 6 percent at constant prices, according to the CBO, and private sector involvement through domestic and foreign private investment is expected to complement government spending. With estimates for the future dwarfing the past activity, USD 50 billion is projected to be spent over the next 10 years, of which USD 28 billion is expected to be awarded between 2013 and 2015 driving growth and the resultant credit off-take in the nation. Oman Banking Sector–Dynamics & Drivers Prima facie, Oman has a thriving, efficient and stable financial intermediation system, with a high Advance to deposit ratio and is deeply rooted into private retail and corporate sector. Around 63% of the deposit is raised from the private sector, which is re-channeled to the private sector to an even higher level of 84% in shape of credit outlay. The illust atio elo des i es the eakup a d dist i utio of the atio s Banking Industry. Structure of Oman Banking Industry – Equity, Leverage, Breakup of Financing and Deposit Activity & Efficiency [Data is sourced fro CBO s A ual ‘eport 2012 and Monthly Report February 2014] The total Banking assets in Oman are around OMR 23.20 Bn with a breakup of an equity of OMR 2.67 and deposits of OMR 16.47 Bn(CBO Annual Report 2012 & Monthly Report February 2014). Total credit of OMR Rs 15.38 Bn turns it into 93% Advance to Deposit Ratio (ADR) banking sector. More encouraging is the fact that OMR 13Bn (out of OMR 15 Bn) is channeled into private sector. Albiet a small population, households (despite being a small population) contribute heavily on both on the deposits and asset side. 10 Box-1 Recent Regulatory Directives – CBO A lot of useful insights can be drawn to identify opportunity pockets, potential challenges and discrepancies by modeling it agai st the e isti g a ki g i dust s o s. Islamic Banking in Oman – Forecasts, Outlook and Realities A lot has been touted and perhaps speculated about the Islamic Banking and markets appetite based on regional market growth stories (e.g. Qatar, KSA, UAE etc). These The central bank has been actively tweaking the reigns of the Banking industry, to ensure stability and efficiency of the financial system. A summary of directives by Central Bank of Oman (CBO) are as follows: Action/Directives Ceiling on Personal Loan Pricing Minimum SME Lending for banks set at Overall Portfolio Capping on Personal Loan Detail Decreased 8.5% to 7% 5% Capping on Housing Portfolio Relaxed Increased to 15% from 10% from Decreased to 35% from 40% projections are broadly, based on cognitive reveries, heuristics and optimism driven by broad generalizations and the growth stories from the past - Without much reference to the dynamics of the local banking industry, regulatory paradigm and balance sheet structures. To quote a few, Mood s epo ts a e opti isti for Islamic Banking in the Oman making a ballpark projection in its ability to grab six to eight per cent share of system assets within the next three to five years. Quantifying this verdict by Mood s, Islamic Banking assets should reach around OMR 3 Bn mark, assuming 10% YOY growth of overall Banking assets, 8% penetration of Islamic Banking in a period of 5 years. Ernst & Young s on the other hand settles-in with a conservative stance, and see it surmounting USD 6.00 Bn (OMR 2.3 Bn) in a matter of few years. Arqaam Capital Research, which is a Dubai based outfit foresee turns out with the most optimistic, professing that by 2017 IBI would generate around 15 per cent of all loans by 2017. Table 1: Projections on the Islamic Banking Industry Size quantified in terms of Assets Research Origin Claimed Estimates – Projection * IB Industry Asset size (Bn OMR) Ernst and Young Islamic Banking to reach USD 6 Bn in next few years. [Assuming 5 years i.e. 2018] 2.3 Moodys IBI to grab six to eight per cent share of system assets within the next three to 3.00 five years i.e 2018. [Assuming 8% share in 5 years] Arqaam Capital Islamic financial institutions as a whole will generate around 15 per cent of all loans IB Credit = 3.35 by 2017. IB Total Assets = 5.05 * The quantification of the broad estimates by various research companies has been based on Oman Banking Industry-wide norms such as Leverage of 8x, ADR of 93%, YOY growth of 10% etc. A careful factual review of the footings and projected growth of Islamic Banking Industry based on ground fact, Industry dynamics and consumer profile appears to be non-existant. This study reviews the present 11 Box-2 Meethaq, the Maverick! Ba k Mus at s i do Meetha ( ith a eage apital of 20.00 Mn) has been very quick to inflate its balance sheet to leverage over 10X against the overall industry norm of 8X leverage. Interestingly, this steep growth is primarily state of Islamic Banks (mostly operational for 1 to 4 quarters), tries to model the growth and progress against the industry benchmarks, with due weightage to the attributed to its inherited musharaka (retail housing) portfolio amounting to OMR 168 Mn which later has grown up to a level of OMR 280.66 Mn as of Dec 2013. The asset side is dominated by long-term musharaka portfolio (referred above), on the other hand the unusual growth in deposit built up on the balance sheet is mainly comprising of deposits from Banks and Financial Institutions which contribute OMR 134 Mn whereas the remaining OMR 66 Mn have been driven from the government sector. With over 7 branches, the bank has not been able to mobilize any significant retail or private sector deposits till Dec 2013. Islamic Banking specifities. This idiosyncratic and perhaps artificial balance sheet structure makes it a difficult situation for the asset-liability maturity profile to manage, wherein 65% of the assets are over 5 years maturity, which is alarmingly funded by a very low maturity deposit. This eventually leads to Asset Liability mismatches, as reported on their balance sheets. and Six Islamic Banking windows has managed to grab a However, given the monopolistic penetration and legacy that its parent bank enjoys with over 38% of the market share, should t e posi g u h of a t ou le to t eak the atte . Moreover, the high yield (6.3%) that this retail musharaka asset, keep its affordable for the bank to manage its liquidity even through interbank markets wherein it can engage relatively low cost liquidity, while keeping its spreads intact. above the overall banking industry average of 93%. The u i ue ess of Meetha does t e ds he e, he the a k being smart enough, recognized the troubles ahead and u eiled it s et a othe out-of-the-box strategy. Instead of going for aggressive deposit mobilization to rationalize its deposit mix, the bank opted for an altogether distinctive route. In an extra-ordinary Board meeting held recently, the board announced the setup of OMR 500 Mn SUKUK program for Meethaq. This can be viewed as an innovative business Model, where the bank instead maintaining saving and term deposit accounts can use a flexible sukuk structure to fund its assets. Islamic Banking in Oman: Start-to-Date Oman Islamic Banking industry, with an initial equity base of OMR 348.5 Bn and a branch network of 32 Branches representing two Independent Islamic Bank noticable 3.24% share of the overall Banking assets. Interestingly, the Islamic Banking industry is operating at an Advance-to-Deposit ration of over 129%, which is well These advances, predominantly are retail and real estate centric, but would hopefully rationalize as the Industry takes on the momentum. The progress should be viewed in the backdrop of the embryonic phase, that Oman Banking industry is going through. The Islamic Asset base of OMR 745 Mn is largely dominated by Meethaq (IBW of Bank Muscat) with 40% share. But this may not come as a surprise as Bank Muscat happens to claim equally dominant share (38%) of the overall banking assets as well. As of December 2014, not much can be seen on the core banking Albeit, all of its break through innovation, the Bank is not losing sight of the core banking business lines. The bank intends to expand its branch network to 15 branches to ensure its outreach to consumer base activities in shape of retail deposits mobilization or private sector lending. Nevertheless, the stage is all set for the get-set-go thrust, with all sorts products launched, branches functioning, IT infrastructure and Human resource in place. The table below , takes a micro view of the bank-wise core activity, by presenting financial statements data on equity, deposits & financing breakup and number of branches as measure of physical outreach. Additionally, this table also 12 elaborate on the deposit profit management practices by presenting profit-sharing ratio, absolute profit rates offered, deposit product weights assigned and most interestingly %age dispersion of the weights across various deposit product. Table 2: Bank-wise details of Assets, Equity, Deposits, Financing, Profitability and Deposit Rates Disclosures NIZWA NATURE ALIZZ Independent MEETHAQ SOHAR MUZN HILAL Al Yusr MAISARAH Bank Muscat Sohar Bank National Bank of Oman Al Ahli Islamic Bank Oman Arab Bank Bank Dhofar Total Window Bank Equity (OMR - Mn) 150 100 26 10 15 25 10 12.5 Initiated on Dec '13 Sept13 Jan '13 Apr '13 Jan '13 Dec 13 Jul '13 March '13 De “ept 3 De “ept 3 “ept 3 1.968 348.5 Deposit Base (OMR in Mn) rounded for whole numbers 3 De 3 De 3 3 3 As of De Current 13 0.5 4.6 3.7 1.4 5.5 NA Savings/Timed 6.9 0.6 Saving: 10.4 15.6 15.1 4.0 NA 8.3 36 0.2 5.1 20.4 30.668 264.6 Term: 212.0 Financing Assets (OMR in Mn) rounded for whole numbers Consumer 12.0 0.5 Commercial 275.61 9.5 3.703 10.092 352.202 29.203 Total Assets (OMR in Mn) rounded for whole number * (assumed as sum of equity and deposits, incase of data unavailibility) 170 100 52 25.1 75.2 10* 14.4* 745 6.2 (0.65) (0.6) (0.3) (0.5) (1.3) (2.787) 298.3 Profits (OMR in Mn) rounded to one decimal place (2.405) (3.232) Profit sharing Ratio Bank:Depositor 50:50 NA 80:20 70:30 NA NA NA NA 7 2 7 3 2 7 2 2 32 Number of Branches Product Participation Weights [1 Month to 12 Month ] a) 1M 45 NA 0.3 0.14 NA NA NA NA NA b) 12M 70 NA 2.0 0.21 NA NA NA NA NA *1M 0.42 NA 0.15 NA NA NA NA NA - 12M 0.95 NA 1 NA NA NA NA NA - NA 567% 50% - - - - - Absolute Rates Offered % Dispersion = (b-a)/a x100 56% *For simplification 1M versus 12M weightages have been taken, ignoring the volume based categorization. Table - 2 13 Reviewing Deposits Side-ProductsMost of the innovation has been seen on the deposit side, and very rightly so as it takes deposits for banks to lend and earn profits. Almost all of the IBBs and windows have well defined call, timed, remunerative and non-remunerative deposit products, bundled with other benefits aligned to the targeted customer base. Box-3 Broadly, deposits are mobilized on the underlying contract Dispersion of Product Weights- Does it matter? of Qardh (for Current Account) and Mudaraba (for savings and terms deposits). Income Determination & Profit Distribution Practices- Market Discipline Meethaq and Nizwa have taken the lead, with well articulated and properly disclosed Profit sharing ratio, product wise weightages and respective yields across various time-volume based slabs. Nizwa Bank and Meethaq presentation and disclosure of profit distribution management has been extremely transparent and regularly updated, with monthly disclosures along with the reporting of profit sharing ratio (PSR). In terms of PSR, Meethaq seeks the highest Muda i s sha e i.e. up to 8 % of the i o e. Commendably, Meethaq took a step further towards the transparency by publishing the participation weightages assigned to the banks equity contributed to the Mudaraba The product- ise eights is a a k s a age e t discretionary tool, and can be craftfully used to tune in the deposit profit rate profile. As a thumb rule higher tenor/volume deposit classes gets the higher weightages, translating in to higher profit rates. In effect, the spread of the weights from the normal saving account vis-à-vis higher term/volume account, can be indicative of the a k s inclination for longer term/higher volume depositor. However, irrationally high dispersion leads to a disadvantaged commoner which is somewhat viewed to be incoherent to the Shariah Ideals. Similar instances of unreasonable weightages have been addressed in Pakistan by the Central Bank di e ti e hi h sa s “The a i u eightage to the Mudaraba based deposit of any nature, tenor and amount shall not exceed 3 times of the 1 eightages assigned to sa ing deposits” . It is worth highlighting here that for Meethaq this spread multiple is as high as 6.7x. The dispersion of weights (as presented in the table above) of 567% against its peers (Sohar Islamic and Nizwa Bank) average of 50%, might cause some concern to the bank and its depositor. This is evident from the uncompetitive profit rate of 0.15% offered by Meethaq being hugely dwarfed by Nizwa Bank in the 1 Month Term Deposit category. Pool along with balances in Profit Equalization Reserves. Except of Nizwa, Meethaq and Sohar, none of the Islamic banking operations have had formal disclosures of deposit products related disclosure on their website, not even the basic profit sharing ratio, despite of the fact that almost all of them have mobilized mudaraba based deposits as reflected on their balance sheets. In contrast to many egio al ju isdi tio s, a d i o plia e ith AAOIFI a d CBO s IB‘F, the I esto s Account Holder Equity has been reported separately between the liabilities and shareholder equity, instead of being reported as a mere liability, considering its Profit Loss sharing of the underlying mudaraba contract. 14 Box-4 Investment Deposits Accounts –Distributing Tieing up with Takaful Services to bundle Bancatakaful Net or Gross Profit? CBO s IB‘F has adapted Gross income method as a standard for income determination and profit distribution to Investment Account holder. However, there is another (AAOIFI defined) income distribution method called Net income method, wherein the net income including the fee based income, adjusted for management overheads is subjected to profit distribution to depositor. This method may have been a viable choice, especially for an emerging market, like that of Oman with scarce liquidity management venues and a developing lending book. Both the methods come with their own inherent trade-offs. Nevertheless, this option might have added to the sustainability and stability of the nascent Islamic Banking Industry in the region. As a trade-off, Displaced commercial risk, could have been a concern, which arises when the bank is t a le to offe a ket competitive returns. Implications Trade-offs of including fee based income versus Management Overheads is a strategic balance to strike, ho e e the ethod of G oss i o e ethod has ee prevalent across all major Islamic Banking Jurisdiction, and rationalizes the choice of CBO. Nevertheless, it is important to note here that the generally inloss Islamic Banks/windows in Oman, with almost no fee based income streams and relatively higher overheads on their Profit and Loss Statement. This situation turns in to a relatively disadvantaged equity shareholder with negative EPS, in comparison to an earning Investment Account Holder. Further, it would be based on a fairness principle on the depositor as well as the Banks. products and provide Takaful coverage for consumer base has also been picking up lately in Oman Islamic Banking scene. Meethaq, being the first Islamic Banking Operation in the sultanate which packaged a Bancatakful product suite on its offerings. Recently, Maisarah has also announced its collaboration with AlMadina Takaful to offer Bancatakaful services. Reviewing the Asset Side Broadly, the asset side products have been design for retail and SME/Corporate clientele, wherein Vehicle Finance, Home Finance, Credit Cards, Personal Finance are offered for the retail segment. Corporate/SME segment on the other hand, comprises of trade, working capital and term/project finance. A deeper analysis of the product offerings reveals that the overall industry seems to have general consensus over the product structures and their respective underlying shariah contract; i.e. Murabaha for Vehicle Finance & Working Capital Finance & Ijarah for term financing to the corporates. Conversely, the case of Home finance is somewhat diversified with Banks employing Murabaha, Ijarah, Diminishing Musharaka, Istisna and even Sale - Lease Back. Interestingly, Personal Financing has only been on the shelves of Nizwa Bank and Alizz Islamic Bank offered on the basis Murabaha and Ijarah. It is only Meethaq and Alizz which are offering Credit Cards, on the basis of Ujrah and Murabaha, claiming it to be interest component, but with not much details of the product processflows. Meethaq Bank retained its eccentricity by offerings Home Financing solution, with an underlying contract based on Diminishing Musharaka, against the 15 Box-5 Maisarah – Breaking the Murabaha Mould Ba k Dhofa s Maisarah, though haven t been on top of it, in terms of numbers with 2 branches and equity of OMR 12.5 Mn, nevertheless have been amongst the few, not only in Oman but across the world, who have been able to break the Murabaha Mould. Maisarah, boasting of its inclination for the ideals of Islamic Finance has launched Mudarabah (equity based profit loss sharing model) based Working capital financing solution for its commercial banking product suite. prevalent norm of employing Ijarah/Forward Ijarah for housing finance as adapted by the rest of the Industry players. The table below would present an overview of retail or corporate financing side products, on the showcase of all the Islamic Banking operations in Oman. Retail Finance Products Car Finance NIZWA SME / Corporate Financing Products Home Finance Personal Financing/ Credit Card Working Capital Financing Infrastru cture Finance Long Term – Project Finance Treasury Ijarah/ Murabaha Ijarah/Muraba ha NO* NO NO NO NO Murabaha ALIZZ Murabaha Ijarah Services Ijaraha/ Murabaha Murabaha Murabaha /IMB IMB/Forw Ijarah Sale & Lease Back /DM WaadForward Contract Meethaq Murabaha Diminishing Musharaka NO Ujrah Murabaha Ijarah DM ND Maisarah NWA*** NWA NWA NWA Musharaka* (Press release) NWA NWA NWA Sohar ND Ijarah/ Murabaha [Press Release] NWA NO NWA NWA NWA NWA Yusr Murabaha/ Ijarah DM NO NO Murabaha Ijarah NO NO Al-Ahli Murabaha Murabaha/I MB/DM/Istis na NO NO ND ND ND ND Muzn Murabaha IMB/ Sale and Lease Back for Conversion NO NO Murabaha IMB / Forward Ijarah/ SaleLeaseback Table 3: Retail or corporate financing side products along with their underlying Islamic Finance Contract *NO - Product Not Offered ** ND - Product offered o the Ba k s We site/press, but underlying Shariah contract Not Disclosed *** NWA - No website available DM- Diminishing Musharaka , IMB – Ijarah Muntahia Bi Tamlik 16 Strategic Dimensions Now, that the stage is all set for the almost all of the eight Islamic Banking players, the next few years are going to be critical in shaping up the industry scene. There are a lot of strategic dimension to it including the legacy of the existing banks (operating through windows), regulatory stance, product innovation, targeting of niche segments, cross selling or Banking the unbanked and most importantly the Shariah governance and assurance. Would it be Windows or the Independent Banks that are going to thrive? Varying opinion prevail on this, with some weighing more to windows having the inherent advantage of infrastructure, penetration and scale efficiencies. Whereas, others perceive it to be a three horse race, with Nizwa, Alizz and Meethaq leading the market share. Is it more than a Three Horse Race? Dubai-based Arqaam Capital Research predicts that Bank Mus at ill ha e 36 pe e t of the ou t s Islamic banking market by 2017, followed by Nizwa with 33 per cent and Alizz with 23 per cent. This is an interesting claim on the face of it, as Meethaq has the lowest equity of OMR 26 Mn against OMR 150 Mn of Nizwa and OMR 100 Mn of Alizz. However the present state of affair, validates the lofty assertions on Meethaq made by the research company. Arqaam further suggested that remaining 8 percent shall be shared by Sohar, Maisarah and Muzn, with no mention of Oma A a Ba k s Yus . It would be premature to drive any generalization about the market shares of the Eight players, given the vigor and enthusiasm that have been exhibited by them. However, in the longer term it would be the shariah compliance, product innovation and the service level that would create the difference. The Sacrosanct Shariah Compliance Islamic Banking is a fresh endeavor in Oman, creating its early impressions on the consumer base. The regulator has taken a stringent, yet principled instance on Shariah Compliance (most prominent being the use of tawaruq and commodity murabaha), and now is the turn of Industry to follow. It would be the first mover, in the right direction that is going to turn the tables. A review of prior research, establishes the fact that Shariah 17 Box-6 Shariah Compliance for Murabaha – Trade Transaction in Letter & Spirit CBO s IB‘F stipulates that the invoice issued by the supplier will be in the name of the Licensee i.e. Islamic Bank, as the commodity would be purchased by an agent on behalf of the Licensee" The compliance of this clause may not be difficult in case house hold financing (car, house etc), however this is going to be a challenge in case of SME and Commercial Lending, wherein mass procurement of raw material is being financed by the bank. As a matter of recurring business practice, invoices are usually raised in the name of the customer (eventual buyer) and are practically not possible to be raised in favor of the bank (The same challenge was faced by Pakistan, while its compliance drive for AAOIFI and has been documented as an exception). Compliance is one of the key purchase reasons of Islamic Banks consumer base. Islamic Banks should ensure a meticulous Shariah governance framework vis-à-vis brand image and ensure income cleansing to charity funds with all its due p ese tatio as stipulated AAOIFI a d CBO s IB‘F. Principled Stand – Islamic Banking Regulatory Framework CBO s IB‘F o e da l is a o p ehe si e a d a p i ipled f a e o k, hi h has i teg ated the est practices and standards from AAOIFI and IFSB etc. A review of the regional regulatory frameworks that ha e ee i the usi ess fo de ades, ould fu the e do se IB‘F s fullness. Paying full heed to Shariah governance, has recently announced formation of National Shariah Board serving as a supervisor and point of reference, to the boards of individual Islamic banks. Despite of all hue and cry and concerted lobbying efforts, the regulator stood firm by its fundamental stance against the alleged use of commodity murabaha and tawaruq for Short Term Liquidity management. However, the Central Bank being cognizant of the dearth of liquidity management venues (except for Interbank Wakalah arrangement) has relaxed ceilings of foreign placements to the Islamic banks. Besides, the Central Bank is also keen to issue Government Sukuks which may also add up to the options for liquidity management for the local Islamic Banks. Islamic Banks and windows have somewhat sorted out the matter of liquidity management by domestic and offshore interbank wakalah arrangements as reflected on the balance sheets as well. Trade Based Products Structures Oman is a thriving trade economy with overall trade accounting for 103% of the GDP. Export account for OMR 20.05 Bn, whereas Imports amounts to OMR 11.01 Bn. It is worth noting here that, around 30% of the total exports comprises of Non-oil (OMR 3.6 Bn) and re-exports (OMR 2.5 Bn). Besides the large Oil portion, Oman exports comprises of Mineral (OMR 422 Mn), Base Metals (OMR 671 Mn) and interestingly Box-7 Non Existent Salam & Istisna Products OMR 175 Mn was from live cattle. In addition to the mainstream Oil based Trade, Islamic Bank can strike in to the Non-oil trade and re-export segment. Islamic Financing contracts inherently are suited to be applied on trade Surprisingly, none of the Islamic Lenders in Oman have offered Corporate Financing products based on Salam or Istisna. It is worth mentioning here that Salam and Istisna Financing is a widely adapted debt based financing contract across various Islamic Banking Jurisdictions, and has been authorized the CBO s IB‘F. 18 transaction. Oman with its huge volumes of documented trade , posses an opportunity for Islamic Banks to structure trade financing transaction on the basis of Murabaha, Salam and Istisna. Re-exports transaction can also be structured either on the basis of Murabaha finance to the trader, or back to back Murabaha for the buy side and salam/Istisna for processing and export transaction. Parallel Salam and Istisna may also be structured where the Islamic Bank can capitalize on its independent role as a buyer and seller. Rather then sticking only to the basic Murabaha, a whole suite of shariah compliant trade financing solutions, to cater the needs of Packing, Pre and Post shipment Export Financing and even bill discounting, can be effectively commissioned - In the most compliant manner, and in complete coherence with the covenants of documentary credits. Further, forward covers to hedge currency risk can also be offered to the customer on Waad contract. Wholesale and Retail Trade segment which contributes around OMR 2.2 Bn or 7.3% of the GDP is another potential sector, that Islamic Banks can delve in to is. With sale based product structures Islamic Banks are fully poised to penetrate in to this segment, by offering supply chain financing solution to this segment. It is worth highlighting here that, majority of the trade is sourced in or destined to the neighbouring countries such as India, China, KSA, UAE, with GCC countries accounting for a major share of the trade. Thus, it can be trade sector which can potentially integrate and magnify O a s Isla i Ba ki g “ e e in to the wider ambit of a Halal Economy. Islamic Banking Windows: Efficiencies or Cannibalization? While, it is generally believed that Islamic windows of existing conve ntional banks will likely be well placed to capture market share, given their ability to leverage much of the existing infrastructure, employees, partly common back office and the brand of the parent franchise – In my personal experience, windows virtually have a limited playfield, with the existing large scale corporates and even the High networth individuals being earmarked as a NO-GO area, if they are already working with their conventional parent bank. Window's endeavors to bid a competitive proposition to penetrate in to the market, is viewed as invasive and tantamounts to cannibalization. There appears to be tacit agreement amongst the C-level management to not to compete from within. For example, one can foresee Bank Muscat's Meetaq experiencing a very limited market, as its parent Bank being the market leader with 38% of the overall market share. It must have been on board with almost all of the large accounts, and might have been graded as a strategic bank by most of the Large scale business enterprises them, owing to its penetration, access, services and scale. This would leave its i do Meethaq with a limited market to dwell-in and may hamper its progress. On the brighter side, it may also turn in to a blessing-in-disguise, with windows pursuing the unbanked and underbanked segments, thus complementing the financial inclusion and broader diversification objectives of the sultanate. 19 The 60-40 Strategy – Islamic Banks to Benchmark the Scales Interestingly, an unweighted mean of the major industry players approximates a 60:40 CASA: Term deposit breakup to be a prevalent norm. Similarly, a 60:40 on the Corporate: Retail Credit portfolio mix has also been observed in the industry. The table below furnishes a sector-wise breakup of asset and deposit in addition to yield and capital adequacy measures. Table 4:A review of convention banks, Segment-wise breakup of asset and deposit, yields and capital adequacy Industry Averages (Unweighted) Deposit Distribution (% of total) Bank Muscat Bank Dhofar Bank Sohar National Bank of Oman Al-Ahli Bank CASA (% of total) 42.0 64 39 38 46 23 Term (% of total) 58.0 36 61 62 54 77 Corporate 58.2 61 59 67 51 53 Retail 41.8 39 41 33 49 47 ROE % 14.5 14.3 13.7 14.7 13.9 15.8 ROA % 1.7 1.8 1.7 1.5 1.5 2.1 Assets:Equity 8.2 7.14 7.3 9.6 9.3 7.7 RWA:Asset % 100.2% 93 101 95 109 103 51.4 59 36 45 72 45 Loan Distribution Returns Fee Income: Net Income % *Stats sourced from Oman Arab Bank Investment Management Group Report as of October 2013. The variables in the table above are highly interdependent; the deposit mix versus the credit mix defines the spread, which subsequently sets the yield. The credit mix along with the overall leverage drives the capital adequacy, which eventually lay down the overall risk appetite of the bank. As apparent in the example of National Bank of Oman (NBO) wherein the Risk Weighted assets (RWA) is significantly higher than the industry averages, probably due to greater share of the retail lending on the asset side. The 60-40 benchmark may enable Islamic Banks to sway their strategic goals, while they follow their respective organic growth. As an indicative yardstick, it can be an overarching frame to avoid any major deviations in shape costly deposit mix or lower-than-the-optimum credit portfolio. Moreover, the overall industry is leveraged around 8 times the equity, which can be used to make a ballpark estimate of the future industry size to be around OMR 2,700 Mn at the present equity levels of OMR 334 Mn. The size of around OMR 3 Bn (or 8% of the Banking Assets share in 5 years) is also coherent ith the ea lie esti ates 20 ade o the asis of Mood s and E&Y expectations. The Big opportunity In the Small Enterprise Segment Around 91,000 SMEs are known to operate in Oman contributing 13.8% to the GDP. The regulator recognizing the significance of has directed to lend to SME for at least 5% of their aggregate Advances. On the conventional banking front, Bank Muscat apparently has the most established, well-staffed and a ded as Al-Wathbah- p odu t suite o offe fo SME including working capital, equipment, Point-ofsale receivables, contract and Trade Financing products. Meethaq, with its legacy of SME/ Transaction banking, and with its fast growing deposit base, it is apparently very well positioned to exploit the SME potential on the Shariah compliant modes as well. For an emergent Islamic Banking, SME segment is especially suitable as it offers smaller per party risk exposures topped by higher yield, and thus furnishes a well diversified and fragmented portfolio. Moreover, Islamic Banking can provide a reasonable thrust to the Cou t s isio to a ds a lo e oil depe de a d di e sifi atio towards non-oil GDP. With Private sector Credit almost half the GDP, 96% Muslim population - Islamic Banking is fully poised to mobilize financial inclusion of the faith driven SME segments, and subsequent growth of the unorthodox and perhaps ignored business sectors such fisheries and agriculture. Box-8 MoCI’s SME Loan Guarantee Program – Does it Work for Islamic Banks? Ministry of Commerce and Industry (MOCI) is operating a Loan-Guarantee program with Oman Arab Bank and Bank Muscat as its channel partners, wherein 50% of loan a ou t is gua a teed a d a k s ea %o the remainder 50% of the loan, turning it in to a 3% subsidized loan to SME obligor. Shariah Compliant products can be structured for such subsidized financing by Islamic Banks in Oman (as has been rolled-out in other jurisdiction, for example Islamic Export Refinance Scheme is offered in Pakistan to extend subsidized funding to preferred Export sector. This is achieved by means of Musharaka Pool between the State Bank of Pakistan and the channel Bank, which subsequently extend the financing to the borrower through Shariah Compliant mode of Murabaha, Istisna or Salam. This would enable Islamic Bank to penetrate swiftly in to a large base of SME segments, by offering partly guaranteed financing on a very attractive pricing. The SME's segment generally is graded as relatively more faith driven and have been considered sizably unbanked in Oman (Bank Muscat, SME Presentation 2012). Furthermore, the purpose driven and asset backed nature of Shariah compliant products, makes it good fit for Islamic Banks to penetrate in to this segment. For the Islamic Lender, the trade based nature of working capital financing, provides an opportunity of referral marketing. The bank through its existing clientele tends to get introduced to either its Supplier (Murabaha) or Buyer (Salam/Istisna). Besides, this segment also offers cross sell opportunities including, payroll accounts, personal financing bundled for the staffing etc. 21 Earnings Dynamics Banking Sector in Oman reportedly enjoy a handsome spread of around 4.2% with weighted average cost of deposits of 1.177 and whereas the corresponding lending yields 5.4%. The higher spread may be attributable of to a lucrative deposit distribution, with one third of zero cost deposit and a similar fraction in low cost saving account. On the asset side, over 45% of the credit flows to the highly rewarding household portfolio. Though the regulator has been careful on rationalizing the household credit portfolio by capping the consumer portfolio overall pricing and diverting the flow to House loan from general personal lending products. It is e ide t that O a s a ki g i dust is hea il elia t o the Box-9 Capital Adequacy Standards: Tailored to Islamic Banks fee based income averaging around 50% of the net income. Despite of all its peculiarities, the existing tried and tested structural norms of the conventional counterpart, offers a lot to learn for the Islamic Banks. In view of the above, Islamic Banks should be targeting fee based income, by pushing cross sell initiatives, customer oriented service levels to route highest ancillary business through its counters. Technology services and conventional commission and processing fee based income as apparently is going to be a critical factor in the overall efficiency of IB industry in Oman. Optimizing the Capital A critical review of the risk weighted assets (RWA) as a percentage of the actual assets reveals that higher credit portfolio outlay to The IBRF underscores the Central Bank's creditable recognition of the unique risk profile of Islamic Bank, and its directives for Capital Adequacy tailored to be consistent with Basel as well as IFSB's guidelines. The IFSB s p ag ati approach to incorporate the Profit loss sharing nature of the Investment account holder funds, with a certain degree of Displaced Commercial Risk (as measured by the variable 'Alpha'), would ease out the capital adequacy requirement (CAR). The 'Alpha' is supposedly set on supervisory discretion and Oman's IBRF has taken a moderate path (as compared to regional jurisdiction) by fixing it to 0.3). It is pertinent to mention here that Alpha oscillate in between 0 to 1 range with Alpha=1 implying an Investment Deposits to behave like a fixed return and capital guaranteed deposit and Alpha=0 refers to a perfect Profit Loss sharing Mudaraba based investment. the retail segment leads to greater RWA and thus pressures the capital adequacy of the Bank. It is the same reason that makes bigger Banks like Bank Muscat and Bank Sohar with retail portfolio in 30 to 40% band enjoy relaxed capital adequacy ratio owing to lesser RWA. On a broad-brush basis, IBs in Oman should be capping retail/house hold lending to 40 to 45% levels to optimize their risk adjusted yield and overall risk appetite. 22 Implications As referred earlier, the easing out of the CAR, would supposedly have direct and positive impact on the overall efficiency of the Islamic Banks, as it enable better allocation of the expensive capital in to profitable venues. Central Banks of Oman (CBO) posed Alpha of 30% optimizes/relaxes its capital adequacy (with a floor requirement of 12% as set out in IBRF), and thus better risk adjusted returns and risk appetite. In the backdrop of such balanced CAR egulatio s, IB s managements are expected to carry out smart and efficient allocation of the capital for an optimum risk adjusted return on the overall portfolio. Conclusion With eight IBIs and their 32 branches, as asset base of OMR 745.00 Mn, Equity of 349.00 Mn, Deposits of 295.00 Mn and Advances of 381.00 Mn in their very first year of operation, it would be safe to claim that Islamic Banking Industry has taken off, and taken off well. The journey from here onwards would surely depend much on IBIs striking the right balance, based on many factors including niche marketing, product innovation, market segment identification, capital and yield optimization, regulatory and Shariah governance. This paper has envisaged a pragmatic and action-oriented outlook of Islamic Banking Industry in Oman, with a solid grounding in facts. An individual as well cross sectional examination of the IBIs is presented, to review its convergence with the overall financial scene, and derive strategic imperatives. This study features the ideas for product innovation for SME and trade segments, trends and gaps in financing products, anomalies in investment deposit profit management, and implications of regulatory directives pertinent to IBIs in Oman. Moreover, prevailing industry norms, products, deposit and financing mix, profitability drivers have also been deliberated. Indeed it is going to be the right move, in the right direction that would certainly take Omani Banking Industry to newer heights. 23 Islamic Banking in Oman Today and the Way Forward A SPECIAL REPORT OMAN Above: Mosaic detailing in the Sultan Qaboos Grand Mosque, Muscat, Oman (Philip Lange). Cover: Entrance to the Sultan Qaboos Grand Mosque (Ivan Pavlov). In this irst of a two-part special, Muhammad Arsalan Aqeeq reviews the progress of Islamic inance in Oman since inception in 2011. I n 2011 a Royal Decree was issued to establish an Islamic inancial system, which paved the way for the promulgation of a regulatory framework, and the subsequent establishment of two independent banks and six window operations in the Sultanate. The Sultanate of Oman is one of the recent entrants into the Islamic banking and inance scene, with a well-established regulatory framework rollout and nascent industry players comprising of two independent Islamic banks and six Islamic banking windows. Since the Royal Decree adjusting the Omani banking law to allow the Shari’ah-compliant format of banking was announced, competition has been seen tough among the local banks. Apart from the two fully integrated Islamic banks – Bank Nizwa and al izz bank – the country’s leading commercial banks have also set up their own Islamic banking windows, including: • alhilal Islamic ahlibank • Maisarah Bank Dhofar • Meethaq Bank Muscat • Muzn National Bank of Oman • Sohar Islamic Bank Sohar • Yusr Oman Arab Bank Much has been written on the prospects, potential and promise of Islamic Banking in this GCC country, with analysts generally optimistic on the prospects for the overall growth of the industry both in terms of absolute Islamic assets as well as market share. cont. overleaf www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 21 OMAN cont. from pg 21 The ledgling yet vibrant Islamic banking industry in Oman has been atracting a lot of atention for its vigorous legislative, regulatory and market developments. Presently, almost all of the eight Islamic banking institutions (IBIs) in Oman have completed a year of operations, and account for a signiicant 3.24 per cent (OMR 745 billion) of the overall banking assets in the country. This two-part research paper takes a descriptive and exploratory approach to encompass the progress of Islamic banking in Oman against the backdrop of the dynamics of the local economy and the overall banking industry. An objective, as well as a strategic review of the banking industry is carried out to identify the opportunities and challenges facing the nascent faith-based format of banking. Oman has been classiied as an oil-rich economy, heavily dependent on dwindling oil resources, which were responsible for around 80 per cent of its revenue in 2012 (S&P, December 2013). Thus, aligned with its regional peers, Oman’s economy and external position are exposed to commodity prices. However, the Government has been framing a variety of initiatives to diversify the non-oil economy (tourism and mining primarily) by means of high investment supported by higher public and private consumption. Oman is a youthful Muslim monarchy with a faith-driven population of some 2.78 million (World Bank, 2011). GROWTH STORY INTACT The Sultanate’s favourable demographics (60 per cent of the population is between the ages of 15 to 45 years) coupled with a pro-growth and employment backdrop, augur well for the fortunes of the inancial sector. Oman’s GDP growth during 2000-2012 averaged around 5.6 per cent. Recent government regulations raising minimum wages and expanding employment have also been supportive of consumption and the deposit base of the nation’s banks. This has also translated positively into a 10 per cent year-on-year growth in banking assets to surpass the OMR 23 billion mark. In recent years, the strength of the crude oil price and rising production have coincided to enable supportive government expenditure and an accommodative monetary policy portending well for growth in the country and of its banks. Expectations of a continuing expansionary iscal policy to sustain the current momentum in growth provide an optimistic outlook for the medium-term future. Obvious risks include a substantial fall in 22 Islamic Business & Finance | ISSUE 85 $50 billion is projected to be spent over the next 10 years, of which $28 billion is expected to be awarded between 2013 and 2015, driving growth and the resultant credit offtake in the nation oil prices. However, years of iscal prudence have yielded adequate reserves to ensure continued progrowth initiatives remain unhampered, even in the event of a mild iscal deicit. The Eighth Five-Year Development Plan (201115) emphasises a large public investment programme. Non-oil activities are expected to grow by an annual rate of six per cent at constant prices, according to the Central Bank of Oman (CBO), and private sector involvement through domestic and foreign private investment is expected to complement government spending. With estimates for the future dwaring past activity, $50 billion is projected to be spent over the next 10 years, of which $28 billion is expected to be awarded between 2013 and 2015, driving growth and the resultant credit off-take in the nation. BANKING SECTOR DYNAMICS & DRIVER Prima facie, Oman has a thriving, eficient and stable inancial intermediation system, with a high advance-to-deposit ratio and is deeply rooted into the private retail and corporate sectors. Around 63 per cent of deposits are raised from the private sector, which is re-channelled to the private sector to an even higher level of 84 per cent in shape of credit outlay. Total banking assets in Oman are around OMR 23.20 billion with a breakup of equity of OMR 2.67 billion and deposits of OMR 16.47 billion. Total credit of OMR 15.38 billion turns it into a 93 per cent advances-to-deposits ratio (ADR) for the banking sector. More encouraging is the fact that OMR 13 billion (out of OMR 15 billion) is channelled into private sector. Albeit a small population, households contribute heavily on both on the deposits and asset side. A number of useful insights may be drawn to identify opportunity pockets, potential challenges and discrepancies by modelling against the existing banking industry’s norms. ISLAMIC BANKING – FORECASTS AND REALITIES A lot has been touted about Islamic banking and the Omani market’s appetite based on growth stories elsewhere in the GCC (e.g. Qatar, KSA, UAE etc.). These projections are, broadly, based on cognitive reveries, heuristics and optimism driven by broad generalisations with but little reference to the dynamics of the local banking industry, regulatory paradigm and balance sheet structures. To quote a few, Moody’s reports are optimistic for Islamic Banking in Oman, making a ballpark www.cpifinancial.net OMAN FIGURE 1: Structure of Oman’s Banking Industry: Equity, Leverage, Financing and Deposit Activity Net earnings OMR 305 m Free Based Income OMR 60 m 20% of Net Earnings Net Spread 4.237% Saving -33% Time -33% Demand -33% Weighted Average Cost of Deposits 1.116% Weighted Average Lending Yield 5.353% Public Sector Enterprise OMR 2.00 bn Deposits - Private Sector 63% Advance: Deposits 93.4% Household 48% Total Credit (TC) OMR 15.38 bn Total Deposits (TD) OMR 16.47 bn Non Financial Corporates 29% Private Sector Credit OMR 13.00 bn Household Credit 45% Total Banking Assets OMR 23.20 bn Deposits - Government & Public Sector - 35.2% Non Financial Corporates 47% Equity Capital OMR 2.67 bn Deposits: Equity 5.7% Total Assets: Equity 7.8% Data Sources: CBO Annual Report 2012, Monthly Report February 2014 projection in its ability to grab six to eight per cent share of system assets within the next three to ive years. Quantifying this verdict by Moody’s, Islamic banking assets should reach around OMR 3 billion, assuming 10 per cent YOY growth of overall banking assets, eight per cent penetration of Islamic banking in a period of ive years. EY (previously Ernst & Young) holds to a more conservative stance, and sees Islamic banking surmounting $6.00 billion (OMR 2.3 billion) in a matter of few years. Arqaam Capital, a Dubai-based investment bank, offers the most optimistic forecast, suggesting that by 2017 Islamic banking in Oman would account for around 15 per cent of all loans by 2017. A careful factual review of the foundation and projected growth of Islamic Banking Industry based on industry dynamics and consumer proiles appears to be non-existent. This study reviews Oman’s Islamic banks (mostly operational for one to four quarters) and endeavours to model growth and progress against established industry benchmarks, with due weighting to the speciics of Islamic banking. RECENT REGULATORY DIRECTIVES The CBO has been actively tweaking the reins of the banking industry to ensure stability and the eiciency of the inancial system. A summary of recent CBO directives shows: Action/Directive Detail Ceiling on Personal Loan Pricing cut from 8.5 per cent to seven per cent Minimum SME lending for banks set at: ive per cent Overall portfolio cap on Personal Loans cut from 40 per cent to 35 per cent Cap on Housing portfolio relaxed increased to 15 per cent from 10 per cent Islamic banking assets should reach around OMR 3 billion, assuming 10 per cent YOY growth of overall banking assets cont. on pg 24 cont. overleaf www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 23 OMAN cont. from pg 23 TABLE 1: Projections on the size of the Omani Islamic banking industry by assets Research Origin Claimed Estimates – Projection * Asset size EY Islamic banking to reach $6 billionin next few years [assuming 5 years i.e. 2018]. OMR 2.3bn Moody’s Islamic banking to grab 6-8 per cent share of system assets within the next three to ive years i.e. 2018 [assuming eight per cent share in 5 years]. OMR 3.00bn Arqaam Capital Islamic inancial institutions as a whole to generate around 15 per cent of all loans by 2017. OMR 5.05bn (of which, credit OMR 3.35bn) *The quantiication of the broad estimates by various research companies has been based on Oman banking Industry-wide norms such as leverage of 8x, ADR of 93 per cent, YOY growth of 10 per cent, etc. MEETHAQ, THE MAVERICK! ISLAMIC BANKING IN OMAN: START-TO-DATE Oman’s Islamic banking industry, with an initial equity base of OMR 348.5 billion and a network of 32 branches representing two independent Islamic banks and six Islamic banking windows has managed to grab a 3.24 per cent share of the overall banking assets. Interestingly, the Islamic banking industry is operating at an advance-todeposit ratio of over 129 per cent, which is well above the overall banking industry average of 93 per cent. These advances, predominantly are retailand real estate-centric, but will, it is to be hoped, rationalise as the industry takes on momentum. Progress should be viewed against the backdrop of the embryonic phase that the Omani Islamic banking industry is going through. The Islamic asset base of OMR 745 million is largely dominated by Meethaq (Bank Muscat’s Islamic banking window) with a 40 per cent share. This may not come as a surprise as Bank Muscat happens to claim an equally dominant share (38 per cent) of overall Omani banking assets as well. As of December 2013, not much can be seen in the core banking activities in the shape of retail deposits’ mobilisation or private sector lending. Nevertheless, the stage is all set for a get-setgo thrust, with all sorts of products launched, branches functioning, IT infrastructure and human 24 Islamic Business & Finance | ISSUE 85 Bank Muscat’s window Meethaq (with a meagre capital of OMR 20 million) has been very quick to inlate its balance sheet to leverage over 10x against the overall industry norm of 8x leverage. Interestingly, this steep growth is primarily atributed to its inherited Musharaka (retail housing) portfolio amounting to OMR 168 million which laterly has grown to a level of OMR 280.66 million as of December 2013. The asset side is dominated by this long-term Musharaka portfolio. On the other hand, the unusual growth in deposits on the balance sheet is mainly comprised of deposits from banks and inancial institutions which contributed OMR 134 million whereas the remaining OMR 66 million have been driven from the Government sector. With over seven branches, the bank has not been able to mobilise any signiicant retail or private sector deposits till Dec 2013. This idiosyncratic balance sheet structure makes it a diicult situation for the asset-liability maturity proile to manage, wherein 65 per cent of the assets are over ive years’ maturity, which is funded by very low maturity deposits. This leads to asset/liability mismatches. However, given the monopolistic penetration and legacy that its parent bank enjoys with over 38 per cent of the market share, it shouldn’t pose much of a problem to ‘tweak’ the mater. Moreover, the high yield (6.3 per cent) of the retail Musharaka assets, keeps it afordable for the bank to manage its liquidity through interbank markets wherein it can engage relatively low cost liquidity, while keeping its spreads intact. The uniqueness of Meethaq doesn’t ends here, when the bank. being smart enough, recognised the troubles ahead it unveiled another out-of-the-box strategy. Instead of going for aggressive deposit mobilisation to rationalise its deposit mix, the bank opted for an altogether distinctive route. In an extraordinary Board meeting in March 2014, the Board announced the setup of an OMR 500 million Sukuk programme for Meethaq. This can be viewed as an innovative business model, where the bank instead maintaining saving and term deposit accounts can use a lexible Sukuk structure to fund its assets. However, Meethaq has not lost sight of its core banking business lines. The bank intends to expand its branch network to 15 branches to ensure its outreach to a broader consumer base. www.cpifinancial.net OMAN TABLE 2: Assets, Equity, Deposits, Financing, Proitability and Deposit Rates Disclosures NIZWA NATURE AL IZZ Independent Parent Bank MEETHAQ SOHAR MUZN ALHILAL AL YUSR MAISARAH Bank Muscat Sohar Bank National Bank of Oman Al Ahli Islamic Bank Oman Arab Bank Bank Dhofar Total Window Equity (OMR million) 150 100 26 10 15 25 10 12.5 Launch date Dec 2013 Sept 2013 Jan 2013 Apr 2013 Jan 2013 Dec 2013 July 2013 March 2013 348.5 Deposit Base (OMR million) As of Dec 2013 Dec 2013 Dec 2013 Dec 2013 Sept 2013 Dec 2013 Sept 2013 Sept 2013 Current 13 0.5 4.6 3.7 1.4 5.5 NA 1.968 Savings/ Timed 6.9 0.6 Saving: 10.4 15.6 15.1 4.0 NA 9.5 8.3 36 0.2 5.1 20.4 30.668 264.6 Term: 212.0 Financing Assets (OMR million) Consumer 12.0 0.5 Commercial 275.61 3.703 10.092 352.202 29.203 Total Assets (OMR million; assumed as sum of equity and deposits, in case of data unavailability) 170 100 298.3 52 25.1 75.2 10 14.4 745 (3.232) 6.2 (0.65) (0.6) (0.3) (0.5) (1.3) (2.787) Profits (OMR million) (2.405) Profit-sharing Ratio (Bank/Depositor) 50:50 NA 80:20 70:30 NA NA NA NA 2 7 3 2 7 2 2 32 Number of Branches 7 Product Participation Weights [1 Month to 12 Month ] a) 1M 45 NA 0.3 0.14 NA NA NA NA NA b) 12M 70 NA 2.0 0.21 NA NA NA NA NA Absolute Rates Offered 1M 0.42 NA 0.15 NA NA NA NA NA - 12M 0.95 NA 1 NA NA NA NA NA - 567% 50% - - - - - % Dispersion = (b-a)/a x100 56% NA cont. overleaf www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 25 OMAN cont. from pg 25 DISPERSION OF PRODUCT WEIGHTS – DOES IT MATTER? Product weighting is a bank’s management discretionary tool, and can be used to tune in the deposit proit rate proile. As a rule of thumb, higher tenor/volume deposit classes get higher weightages, translating in to higher proit rates. In efect, the spread of the weights from the normal saving account vis-à-vis higher term/ volume account, can be indicative of the bank’s inclination for longer term/higher volume depositors. However, irrationally high dispersion leads to disadvantaged customers which may be viewed as somewhat incoherent when compared to Shari’ah ideals. Similar instances of unreasonable weightages have been addressed in Pakistan by the Central Bank, the State Bank of Pakistan, which issued a directive saying, “The maximum weightage to the Mudaraba-based deposit of any nature, tenor and amount shall not exceed three times the weightages assigned to saving deposits.” It is worth highlighting here that for Meethaq this spread multiple is as high as 6.7x. The dispersion of weights (see TABLE 2) of 567 per cent against its peers’ (Sohar Islamic and Nizwa Bank) average of 50 per cent, might cause some concern to the bank and its depositors. This is evident from the uncompetitive proit rate of 0.15 per cent ofered by Meethaq being dwarfed by the 0.42 per cent ofered by Bank Nizwa in the one-month term deposit category. resource in place. TABLE 2 takes a micro view of core activity, presenting inancial statements’ data on equity, deposits and inancing together with number of branches as measure of physical outreach. Additionally, this table also elaborates on the deposit proit management practices by presenting profit-sharing ratio, absolute profit rates offered, deposit product weights assigned and the percentage dispersion of these weights across various deposit products. DEPOSITS Most of the innovation has been seen on the deposit-side, and very rightly so as it takes deposits for banks to lend and earn proits. Almost all of the banks and windows have well-deined call, timed, remunerative and non-remunerative deposit products, bundled with other beneits aligned to the targeted customer base. Broadly, deposits are mobilised on the underlying contract of Qardh (for Current Account) and Mudaraba (for savings and terms deposits). MARKET DISCIPLINE Meethaq and Nizwa have taken the lead, with well-articulated and properly disclosed profitsharing ratios, product weightages and respective yields across various time-volume based slabs. Bank Nizwa’s and Meethaq’s presentation and 26 Islamic Business & Finance | ISSUE 85 disclosure of proit distribution management has been extremely transparent and regularly updated, with monthly disclosures along with the reporting of proit sharing ratio (PSR). In terms of PSR, Meethaq seeks the highest Mudarib’s share i.e. up to 80 per cent of the income. Commendably, Meethaq took a step further towards the transparency by publishing the participation weightages assigned to the bank’s equity contributed to the Mudaraba Pool along with balances in Proit Equalisation Reserves. With the exception of Nizwa, Meethaq and Sohar, none of the Islamic banking operations have had formal deposit products-related disclosure on their website, not even the basic proit sharing ratio, despite the fact that almost all of them have mobilised Mudaraba-based deposits as relected on their balance sheets. In contrast to many regional jurisdictions, and in compliance with AAOIFI and the CBO’s IBRF, the Investors Account Holder Equity has been reported separately between the liabilities and shareholder equity, instead of being reported as a mere liability, considering its proit/loss sharing of the underlying Mudaraba contract. Tying up with Takaful services to bundle BancaTakaful products and provide Takaful coverage for the consumer base has also been picking up lately in Oman. Meethaq was the Almost all of the banks and windows have welldefined call, timed, remunerative and nonremunerative deposit products, bundled with other benefits aligned to the targeted customer base www.cpifinancial.net OMAN irst Islamic banking operation in the Sultanate to package a BancaTakaful product suite in its offerings. More recently, Maisarah announced its collaboration with Al-Madina Takaful to offer BancaTakaful services. ASSETS Broadly speaking, asset-side products have been desigedn for retail and SME/corporate clientele, wherein vehicle inance, home inance, credit cards and personal inance are offered for the retail segment. The corporate/SME segment comprises of trade, working capital and term/ project inance. A deeper analysis of the product offerings reveals that the overall industry seems to have a general consensus over certain product structures and their respective underlying Shari’ah contracts; i.e. Murabaha for vehicle inance and working capital inance, Ijarah for term inancing to the corporates. MAISARAH – BREAKING THE MURABAHA MOULD Bank Dhofar’s Maisarah, with just two branches and equity of OMR 12.5 million, has nevertheless been amongst the few, not only in Oman but across the world, which have been able to break the Murabaha mould. Maisarah, boasting of its commitment to the ideals of Islamic inance, launched a Mudarabah-based (equity-based proit/loss sharing model) working capital inancing solution for its commercial banking product suite. Conversely, home inance is somewhat more diversiied with banks employing Murabaha, Ijarah, Diminishing Musharaka, Istisna and even Sale/ Lease Back. Interestingly, personal inancing is offered by Bank Nizwa and al izz Islamic Bank on the basis of Murabaha and Ijarah. Only Meethaq and al izz offer credit cards, on the basis of Ujrah and Murabaha. Meethaq stands out among those offering home finance, doing so through underlying contract based on Diminishing Musharaka, against the prevalent norm of employing Ijarah/Forward Ijarah for housing inance as adopted by the rest of the Industry players. INVESTMENT DEPOSITS ACCOUNTS – DISTRIBUTING NET OR GROSS PROFIT? The CBO’s Islamic Banking Regulatory Framework (IBRF) has adopted a gross income method as a standard for income determination and proit distribution to Investment Account holders. However, there is another (AAOIFI-deined) income distribution method, the net income method, wherein the net income including the fee-based income, adjusted for management overheads is subjected to proit distribution to depositors. This method may have been a viable choice, especially for an emerging market, like that of Oman with scarce liquidity management venues and a developing lending book. Both methods come with inherent trade-ofs. Nevertheless, this option might have added to the sustainability and stability of the nascent Islamic banking industry in the country. As a trade-of, displaced commercial risk could have been a concern, arising when a bank isn’t able to ofer market competitive returns. IMPLICATIONS Trade-ofs of including fee-based income versus management overheads is a strategic balance to strike, however the gross income method is prevalent across all major Islamic banking jurisdictions, and rationalises the CBO’s choice. Nevertheless, it is important to note here that the generally in-loss Islamic banks/windows in Oman have almost no fee-based income streams and relatively high overheads on their P&L. This situation turns in to a relatively disadvantaged equity shareholder with negative EPS, in comparison to an earning Investment Account Holder. cont. overleaf www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 27 OMAN cont. from pg 27 TABLE 3: Retail & Corporate inancing products and their underlying Islamic inance contract Retail Finance Products SME/Corporate Finance Products Working Capital Financing Infra-structure Finance Long Term/ Project Finance Treasury NO* NO NO NO NO Ijarah/ Murabaha Murabaha Murabaha /IMB IMB/Forward Ijarah SaleLease Back /DM WaadForward Contract Diminishing Musharaka NO Ujrah Murabaha Ijarah DM ND NWA NWA NWA Musharaka* NWA NWA NWA Ijarah/ Murabaha NWA NO NWA NWA NWA NWA Car Finance Home Finance Personal Credit Financing/ Card NIZWA Murabaha Ijarah/ Murabaha Ijarah/ Murabaha AL IZZ Murabaha Ijarah MEETHAQ Murabaha MAISARAH NWA*** SOHAR ND AL YUSR Murabaha/ DM Ijarah NO NO Murabaha Ijarah NO NO ALHILAL Murabaha Murabaha/ IMB/DM/ Istisna NO NO ND ND ND ND MUZN Murabaha IMB/ Sale-Lease Back for Conversion NO NO Murabaha IMB/ Forward Ijarah/ SaleLease back * NO - Product Not Ofered ** ND - Product ofered on the Bank’s Website/press, but underlying Shari’ah contract Not Disclosed *** NWA - No website available DM- Diminishing Musharaka , IMB – Ijarah Muntahia Bi Tamlik ABOUT THE AUTHOR Muhammad Arsalan Aqeeq is a qualiied and experienced Islamic Finance Practitioner and enthusiast, specializing in Shari’ah-compliant product structuring, corporate lending, Credit risk assessment and project inance, having served both conventional and Islamic inancial institutions. He has diversiied experience in managing products, client segments, P & L, sales, marketing, training, and channels. He holds a Bachelor of Engineering degree from NED University, an MBA from Institute of Business Administration, Karachi. He is a qualiied CDIF from CIMA, UK. He has experience of structuring corporate lending products including the Shari’ah-compliant models of Murabaha, Salam, Istisna, Ijarah and Sukuk. Arsalan is a staunch believer in the prospects of Islamic Finance as a viable inancial alternative which, according 28 Islamic Business & Finance | ISSUE 85 to him, solicits a transformation from ‘Shari’ah-compliant’ to ‘Shari’ah based’. He has recently established WAAD Associates, a research and training entity founded by like-minded professionals, engaged in pragmatic, actionoriented research and training endeavours in collaboration with counterparts based in UAE, Qatar and KSA. He has been serving as a faculty and corporate trainer for the Institute of Bankers Pakistan, PAFKIET, SZABIST, Dubai Islamic Bank etc. Arsalan has contributed to numerous international and domestic training programmes and courses on Islamic banking, Islamic accounting standards, credit analysis and corporate inance, etc. He may be reached at arswasti@yahoo.com and at pk.linkedin.com/in/arsalanaqeeq/ www.cpifinancial.net Islamic Banking in Oman Today and the Way Forward A SPECIAL REPORT OMAN Cover: Grand Mosque, Muscat (Philip Lange/Shutterstock); above: Traditional Shipbuilding, Sur, Oman (Wolfgang Zwanzger/Shutterstock). In this concluding instalment of a two-part special, Muhammad Arsalan Aqeeq looks to the future for Islamic inance in Oman 20 Islamic Business & Finance | ISSUE 85 T he stage is now set for the eight Islamic banking players in Oman. The next few years are going to be critical in shaping the industry. There are a lot of strategic dimensions, including the legacy of the existing banks (operating through windows), regulatory stance, product innovation, targeting of niche segments, cross selling, banking the unbanked and, most importantly, Shari’ah governance and assurance. www.cpifinancial.net OMAN Will it be windows or the independent banks that are going to thrive? Opinions differ with some suggesting windows have an inherent advantage of infrastructure, penetration and scale eficiencies. Whereas others perceive it to be a three horse race, with Nizwa, al izz and Meethaq leading market share. MORE THAN A THREE-HORSE RACE? Research by Dubai-based investment bank Arqaam Capital predicts that Bank Muscat will have 36 per cent of the country’s Islamic banking market by 2017, followed by Nizwa with 33 per cent and al izz with 23 per cent. This is an interesting claim on the face of it, as Meethaq has the lowest equity of OMR 26 million against OMR 150 million for Nizwa and OMR 100 million for al izz. However the present state of affairs appears to validate the lofty assertions regarding Meethaq made by Arqaam, which also suggested that the remaining eight per cent will be shared by Sohar, Maisarah and Muzn, with no mention of Oman Arab Bank’s Yusr. It would be premature to drive any generalisation about the market shares of the eight players, given the vigour and enthusiasm that have been exhibited by them. However, in the longer term it will be Shari’ah compliance, product innovation and service levels that will create the difference. SHARI’AH COMPLIANCE FOR MURABAHA IN LETTER & SPIRIT The Central Bank of Oman’s IBRF stipulates that the invoice issued by the supplier will be in the name of the licensee i.e. Islamic bank, as the commodity would be purchased by an agent on behalf of the licensee. Compliance to this clause may not be diicult in the case of household inancing (automobile, housing, etc.). However, this is going to be a challenge in the case of SME and commercial lending, wherein mass procurement of raw materials is being inanced by the bank. As a mater of recurring business practice, invoices are usually raised in the name of the customer (eventual buyer) and are practically not possible to be raised in favour of the bank (The same challenge was faced by Pakistan, in its drive for compliance with AAOIFI standards and has been documented as an exception). SACROSANCT SHARI’AH COMPLIANCE Islamic banking is a fresh endeavour in Oman, creating early impressions on the consumer base. The regulator has taken a stringent, yet principled stance on Shari’ah compliance (most prominent being on the use of Tawarruq and commodity Murabaha), and now it is the turn of the industry to follow. A review of prior research clearly establishes the fact that Shari’ah compliance is one of the key purchase reasons put forward by Islamic banks’ consumer base. Islamic banks should ensure a meticulous Shari’ah governance framework vis-à-vis brand image and ensure income cleansing to charity funds with all due presentation as stipulated by AAOIFI and the Central Bank of Oman’s (CBO) Islamic Banking Regulatory Framework (IBRF). PRINCIPLED STAND The CBO’s IBRF is a commendably comprehensive and principled framework, which has integrated the best practices and standards from AAOIFI and IFSB etc. A review of the regional regulatory frameworks that have been in the business for decades, would further endorse the quality of the IBRF. Paying full heed to Shari’ah governance is the formation of a National Shari’ah Board serving as a supervisor and point of reference, to the boards of individual Islamic banks. Despite concerted lobbying efforts, the regulator stood irm on its fundamental stance against the use of commodity Murabaha and Tawarruq for short-term liquidity management. However, the CBO, being cognisant of the dearth of liquidity management venues (except for interbank Wakalah arrangements), has relaxed ceilings of foreign placements to the Islamic banks. Besides, the CBO is also keen to issue Government Sukuk which may also add to the options for liquidity management for Oman’s Islamic banks. Both the independent banks and the windows have addressed the issue of liquidity management through domestic and offshore interbank Wakalah arrangements as relected in their balance sheets. TRADE-BASED PRODUCT STRUCTURES Oman is a thriving trade economy with overall trade accounting for 103 per cent of Gross Domestic Product (GDP). Exports account for OMR 20.05 billion, whereas imports amount to OMR 11.01 billion. It is worth noting here that around 30 per cont. overleaf www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 21 OMAN cont. from pg 23 NON-EXISTENT SALAM AND ISTINA PRODUCTS Surprisingly, none of the Islamic lenders in Oman have ofered corporate inancing products based on Salam or Istisna. It is worth mentioning that Salam and Istisna inancing is a widely adopted debt-based inancing contract across various Islamic banking jurisdictions, and has been authorised by the CBO’s IBRF. cent of total exports come from non-oil exports (OMR 3.6 billion) and re-exports (OMR 2.5 billion). Oman’s non-oil exports include minerals (OMR 422 million), base metals (OMR 671 million) and interestingly OMR 175 million in live cattle. In addition to mainstream oil-based trade, Islamic banks may target the non-oil trade and re-export segment. Islamic inancing contracts are inherently suited to be applied to trade transactions. Oman with its huge volume of documented trade, offers opportunities for Islamic banks to structure trade inancing transactions on the basis of Murabaha, Salam and Istisna. 22 Islamic Business & Finance | ISSUE 85 Re-exports transactions may also be structured either on the basis of Murabaha inance to the trader, or back-to-back Murabaha for the buy side and Salam/Istisna for processing and export transactions. Parallel Salam and Istisna may also be structured where the Islamic bank can capitalise on its independent role as a buyer and seller. Rather than sticking only to basic Murabaha, a whole suite of Shari’ah-compliant trade inancing solutions to cater the needs of packing, pre and post shipment export inancing and even bill discounting can be effectively commissioned: in the most compliant manner, and in complete coherence with the covenants of documentary credits. Further, forward covers to hedge currency risk may also be offered to the customer via Wa’ad contract. The wholesale and retail trade segment which contributes around OMR 2.2 billion or 7.3 per cent of the GDP is another potential sector that Islamic banks may delve into. With sale-based product structures Islamic banks are fully poised to penetrate in to this segment, by offering supply chain inancing solution. It is worth highlighting here that, the majority of the trade is sourced in or destined to neighbouring www.cpifinancial.net OMAN countries such as India, China, KSA, UAE, with GCC countries accounting for a major share of the trade. Thus, this trade sector can potentially integrate and magnify Oman’s nascent Islamic banking industry in the context of the wider ambit of a Halal economy. ISLAMIC WINDOWS – OFFERING EFFICIENCY OR CANNIBALISATION? It is generally believed that the Islamic windows of existing conventional banks will likely be well placed to capture market share, given their ability to leverage much of the existing infrastructure, employees, partly common back ofice and the brand of the parent franchise. However, in my personal experience, windows virtually have a limited playing ield, with existing large scale corporates and even high net worth individuals being earmarked as NO-GO areas if they are already working with the conventional parent bank. A window’s endeavours to offer a competitive proposition to penetrate into the market, may be viewed as invasive and tantamount to cannibalisation of existing market share. There appears to be tacit agreement amongst C-level management not to compete from within. For example, one may foresee Bank Muscat’s Meethaq experiencing a very limited market, as its parent conventional bank is already the market leader with a 38 per cent share of the overall banking share. It is likely to have existing relationships with almost all the large accountes in the country and be viewed as a strategic bank by most large scale business enterprises, owing to its penetration, access, services and scale. This would leave its window Meethaq with a limited market to dwell in and may hamper its progress. On the brighter side, it may also turn in to a blessing-in-disguise, with windows pursuing the unbanked and underbanked segments, thus complementing the inancial inclusion and broader diversiication objectives of the Sultanate. THE 60-40 STRATEGY – BENCHMARKING THE BANKS Interestingly, an unweighted mean of the major industry players approximates a 60:40 term deposit:current account/savings account (CASA) mix. A similar 60:40 mix between the corporate and retail credit portfolios has also been observed in the industry. The variables in Table 4 are highly interdependent; the deposit mix versus the credit mix deines the spread, which subsequently sets the yield. The credit mix along with overall leverage drives capital adequacy, which eventually affects the overall risk appetite of the bank: apparent in the example of National Bank of Oman (NBO) wherein risk weighted assets (RWA) are signiicantly higher than the industry averages, probably due to greater share of the retail lending on the asset side. The 60-40 benchmark may enable Islamic banks to sway their strategic goals, while they follow their respective organic growth. As an indicative yardstick, it can be an overarching frame The wholesale and retail trade segment which contributes around OMR 2.2 billion or 7.3 per cent of the GDP is another potential sector that Islamic banks may delve into TABLE 4: Review of conventional banks Industry Averages (Unweighted) Deposit Distribution (% of total) Bank Muscat Bank Dhofar Bank Sohar National Bank of Oman Ahli Bank CASA (% of total) 42.0 64.0 39.0 38.0 46.0 23.0 Term (% of total) 58.0 36.0 61.0 62.0 54.0 77.0 Loan Distribution Corporate 58.2 61.0 59.0 67.0 51.0 53.0 Retail 41.8 39.0 41.0 33.0 49.0 47.0 Returns ROE % 14.5 14.3 13.7 14.7 13.9 15.8 1.7 1.8 1.7 1.5 1.5 2.1 Assets: Equity ROA % 8.2 7.14 7.3 9.6 9.3 7.7 RWA: Asset % 100.2 93.0 101.0 95.0 109.0 103.0 51.4 59.0 36.0 45.0 72.0 45.0 Fee Income: Net Income % *Stats sourced from Oman Arab Bank Investment Management Group Report as of October 2013. cont. on pg 26 www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 23 OMAN cont. from pg 25 to avoid any major deviations that could result in a costly deposit mix or lower-than-the-optimum credit portfolio. Moreover, the overall banking industry is leveraged around eight times equity which can be used to make a ballpark estimate of the future industry size at around OMR 2,700 million, at the present equity levels of OMR 334 million. The size of around OMR 3 billion (or an eight per cent share of banking assets in ive years) is also consistent with the earlier estimates made on the basis of Moody’s and EY expectations (see part one, Islamic Business & Finance, #85, p.24). SMALL ENTERPRISE, BIG OPPORTUNITY? Around 91,000 SMEs are known to operate in Oman accounting for 13.8 per cent of GDP. The regulator, recognising the signiicance of the sector, has directed banks to lend to SMEs at least ive per cent of their aggregate advances. On the conventional banking front, Bank Muscat apparently has the most established, well-staffed product suite on offer for SMEs, branded AlWathbah, including working capital, equipment, point-of-sale receivables, contract and trade inancing products. Meethaq, with this legacy of SME/transaction banking and with its fast growing deposit base, is apparently very well positioned to exploit the SME potential in a Shari’ah-compliant mode as well. For an emergent Islamic banking industry the SME segment is especially suitable as it offers smaller per party risk exposures topped by higher yield, and thus furnishes the prospect of a welldiversiied portfolio. Moreover, Islamic banking can provide a reasonable boost to the country’s vision towards lower oil dependency and diversiication towards non-oil GDP growth. With private sector credit almost half of GDP and a 96 per cent Muslim population, Islamic banking is poised to mobilise inancial inclusion of the faith-driven SME segments, and subsequent growth of what have been, perhaps, previously ignored or underserved business sectors such isheries and agriculture. The SME segment generally is graded as relatively more faith-driven and has been considered signiicantly unbanked in Oman (Bank Muscat, SME Presentation 2012). Furthermore, the purpose driven and asset-backed nature of Shari’ah-compliant products, makes Islamic banking solutions a good it to penetrate into this segment. For the Islamic MOCI’S SME LOAN GUARANTEE PROGRAMME – DOES IT WORK FOR ISLAMIC BANKS? Oman’s Ministry of Commerce and Industry (MOCI) is operating a Loan-Guarantee programme with Oman Arab Bank and Bank Muscat as its channel partners, wherein 50 per cent of the loan amount is guaranteed and the banks earn six per cent on the remainder 50 per cent of the loan, turning it in to a three per cent subsidised loan to SME obligor. Shari’ah-compliant products may be structured for such subsidised inancing by Islamic banks in Oman (as has been rolled-out in other jurisdictions, for example the Islamic Export Reinance Scheme is ofered in Pakistan to extend subsidised funding to preferred export sectors. This is achieved by means of a Musharaka pool between the State Bank of Pakistan and the channel bank, which subsequently extend the inancing to the borrower through a Shari’ah-compliant mode of Murabaha, Istisna or Salam. A similar structure in Oman would enable Islamic banks to penetrate switly into the SME segment, ofering partly guaranteed inancing at very atractive pricing. 24 Islamic Business & Finance | ISSUE 85 www.cpifinancial.net OMAN CAPITAL ADEQUACY STANDARDS: TAILORED TO ISLAMIC BANKS The IBRF underscores the CBO’s creditable recognition of the unique risk proile of Islamic banks, and its directives for capital adequacy are tailored to be consistent with Basel as well as IFSB guidelines. The IFSB’s pragmatic approach to incorporate the proit/loss sharing nature of Investment account holder funds with a certain degree of displaced commercial risk (as measured by the variable ‘alpha’), would ease the capital adequacy requirement (CAR). The ‘alpha’ is supposedly set on supervisory discretion and Oman’s IBRF has taken a moderate path (as compared to other regional jurisdictions) by ixing it to 0.3. It is pertinent to mention here that Alpha oscillates in between the 0 to 1 range with Alpha=1 implying an investment deposit to behave like a ixed return and capital guaranteed deposit and Alpha=0 referring to a perfect proit/loss sharing Mudaraba-based investment. IMPLICATIONS The easing out of the CAR, should have a direct and positive impact on the overall eiciency of Islamic banks, enabling beter allocation of expensive capital into proitable venues. Against a backdrop of balanced CAR regulations, the managements of Oman’s Islamic banks have the opportunity to carry out smart and eicient allocation of capital for an optimum risk-adjusted return on the overall portfolio. lender, the trade-based nature of working capital inancing, provides an opportunity for referral marketing. The bank, through its existing clientele, tends to get introduced to both suppliers (Murabaha) and buyers (Salam/Istisna). Besides, this segment also offers cross-selling opportunities including, payroll accounts, personal inancing bundled for staff, etc. EARNINGS DYNAMICS The banking sector in Oman reportedly enjoys a handsome spread of around 4.2 per cent with The banking sector in Oman reportedly enjoys a handsome spread of around 4.2 per cent with weighted average cost of deposits of 1.177 per cent whereas the corresponding lending yields 5.4 per cent weighted average cost of deposits of 1.177 per cent whereas the corresponding lending yields 5.4 per cent. The high spread may be attributable to a lucrative deposit distribution, with one third zero cost deposit and a similar fraction in low cost savings accounts. On the asset side, more than 45 per cent of credit lows to the highly rewarding household portfolio. Though the CBO has been careful in rationalising household credit portfolios by capping consumer portfolio overall pricing and diverting credit low to housing loans and away from general personal lending products. It is evident that Oman’s banking industry is heavily reliant on fee-based income which averages around 50 per cent of net income. Despite peculiarities, the existing tried and tested structural norms of the Sultanate’s conventional banking sector holds many lessons for Islamic inanciers. Islamic banks should be targeting fee-based income, by pushing cross-selling initiatives and customer-oriented service levels to route highest ancillary business through its counters. Technology services and conventional commission and processing fee-based income will also be critical factors in the overall eficiency of Islamic banking in Oman. OPTIMISING CAPITAL A critical review of risk weighted assets (RWA) as a percentage of actual assets reveals that higher credit portfolio outlay to the retail segment leads to greater RWA and thus pressures the capital adequacy of the bank. It is the same reason that makes bigger banks like Bank Muscat and Bank cont. on pg 28 www.cpifinancial.net ISSUE 85 | Islamic Business & Finance 25 OMAN cont. from pg 27 Sohar with retail portfolios in the 30-to-40 per cent band enjoy relaxed capital adequacy ratios owing to lesser RWA. On a broad-brush basis, Islamic banks in Oman should be capping retail/house hold lending to 40-to-45 per cent levels to optimise their risk-adjusted yield and overall risk appetite. CONCLUSION Oman’s eight Islamic banking institutions, with 32 branches, built an asset base of OMR 745 million, equity of OMR 349 million, deposits of OMR 295 million and advances of OMR 381.00 million in their very irst year of operation. It would be safe to claim that the Sultanate’s Islamic banking industry has taken off, and taken off well. The journey from here onwards will surely depend on banks striking the right balance, based on many factors including niche marketing, product innovation, market segment identiication, capital and yield optimisation, regulatory and Shari’ah governance. This paper has envisaged a pragmatic and action-oriented outlook for the Islamic banking industry in Oman through which the right moves may be made in the right direction to grow the industry successfully. ABOUT THE AUTHOR Muhammad Arsalan Aqeeq is a qualiied and experienced banker, Islamic inance practitioner and enthusiast, specialising in Shari’ah-compliant product structuring, corporate lending, credit risk assessment and project inance; having served in both conventional and Islamic inancial institutions. He has diversiied experience in managing products, client segments, P & L, sales, marketing, training, and channels. He holds a Bachelor of Engineering degree from NED University, an MBA from Institute of Business Administration Karachi. He is a qualiied CDIF from CIMA, UK. He brings with him years of experience of structuring corporate credit products including 26 Islamic Business & Finance | ISSUE 85 Shari’ah-compliant modes of Murabaha, Salam, Istisna, Ijarah and Sukuk covering a variety of sectors, including: coal, edible oil, textile, rice, food grain processors, tannery and sugar manufacturers, ethanol, FMCG, pharmaceutical, distributions and automobile assembly. Arsalan is staunch advocate of the prospects of Islamic Finance as an ethicalyet-viable alternate inancial system – which to him solicits a transformation from ‘Shari’ah-compliant’ to ‘Shari’ah-based’. He has recently established WAAD Associates, a research and training entity founded by likeminded professionals, engaged in pragmatic and action-oriented research and training endeavours - in collaboration with counterparts based in the UAE, Qatar and KSA. Recently, he received a Chevening Scholarship from the UK Government to carry out post-graduate research at Durham University, Institute of Islamic Economics and Finance. He has been serving as a Faculty and corporate trainer in the Institute of Bankers Pakistan, PAFKIET, SZABIST and Dubai Islamic Bank, among others. Arsalan has contributed to numerous international and domestic training programs and courses on Islamic banking, Islamic accounting standards, credit analysis and corporate inance etc. He may be reached at arswasti@yahoo. com or pk.linkedin.com/in/arsalanaqeeq/ and tweets @arsalanaqeeq. Oman’s eight Islamic banking institutions, with 32 branches, built an asset base of OMR 745 million, equity of OMR 349 million, deposits of OMR 295 million and advances of OMR 381 million in their very first year of operation www.cpifinancial.net