Focus on banking: Across the GCC, Islamic banks are poised for expansion

With balance sheet growth of 19%, up from 12% the previous year, at the end of 2014 Qatar was home to the fastest-growing Islamic banking segment in the GCC region, according to data released in late 2015 by the international ratings agency Standard & Poor’s (S&P). The country’s four national sharia-compliant lenders – namely Qatar Islamic Bank (QIB), Masraf Al Rayan (MAR), Barwa Bank and Qatar International Islamic Bank (QIIB) – have taken on a growing percentage of overall banking sector market share in recent years. According to the central bank, Islamic banks accounted for 27.3% of total sector assets in February 2016. Despite the declining price of oil and subsequent pressure on the banking sector, most players expect to see continued asset base growth among sharia-compliant lenders in Qatar in 2016-17.

“Everyone is going to pay a little more attention to the liquidity situation in the coming months and years, especially as it relates to the falling oil prices,” Farah Ahmed Hersi, executive manager of economics and research at MAR’s Treasury department, told OBG in late 2015. “But no one in the Islamic segment is worried at all. This sector has performed well in recent years, and I do not foresee this slowing too much in the coming period.”

Taking Off

Indeed, the GCC Islamic banking segment as a whole is seen as relatively well positioned for continued expansion for the foreseeable future, despite the wide range of economic and political challenges currently facing the region. Over the past decade the GCC has become the single most important Islamic banking market in the world. According to the EY 2016 report, as of the end of 2014 the area was home to $606bn – almost 69% – of the global sharia-compliant banking asset base of $882bn. The same year, around 36% of total GCC banking assets were held by Islamic institutions, as compared to 13% in Association of South-East Asian Nations member states and 12% across South Asia as a whole. In Malaysia, a global leader in sharia-compliant financial services, Islamic assets made up 21.3% of total sector assets in 2014. GCC-based Islamic financial institutions posted year-on-year growth of around 18% that year, an increase from 13% in 2013. Between 2010 and 2014 the sector posted a compound annual growth rate (CAGR) of 16.1%.

Economic Headwinds 

Despite the recent positive performance among Islamic banks in Qatar and the GCC region, most local players and international analysts expect to see curtailed growth figures in the coming years. The recent S&P report anticipated that 2016 would be a “crossroads for Islamic finance” around the world, while EY cited “lagging industry infrastructure that could potentially put shareholder value at risk” as a key concern moving forward.

Indeed, the global Islamic financial services (IFS) industry currently faces a variety of challenges. Perhaps most pressing has been the rapid decline in the price of oil over the past 18 months. From a high of around $110 per barrel in June 2014, Brent crude had dropped to around $30 per barrel by early 2016 before recovering slightly to approximately $45 per barrel in mid-2016. Historically most of the Gulf states have relied to a large extent on oil income. In Qatar, for instance, hydrocarbons-related earnings make up around 55% of GDP, according to data from OPEC, as compared to 40% in the UAE and 50% in Saudi Arabia. The impact of this is especially wide ranging as the bulk of economic activity throughout the region relies either directly or indirectly on government spending, which reflects oil revenues.

With crude prices declining by more than 60% between mid-2014 and mid-2016, the Gulf states have begun developing new sources of financing in an effort to shore up national accounts. One of the first places many governments turned for financing was their respective domestic banking systems, where government deposits have historically accounted for a significant percentage of assets. Both 2015 and 2016 were marked by a period of withdrawals from banking systems in the GCC.

“We have seen withdrawals over the course of last year, and we think there will likely be more in 2016,” Sheikh Faisal bin Abdulaziz bin Jassem Al Thani, chairman at Ahlibank, a conventional bank in Qatar, told OBG in late 2015. “This has put pressure on liquidity, though not yet so much that we are particularly worried. Of course what happens in the coming years remains to be seen.”

Preparation Pays Off

In many ways, Qatar and several of its neighbours in the Gulf are particularly well placed to face the current situation. Like many other GCC member states, the government in Doha has spent the past few decades working to develop the non-oil economy in preparation for precisely the current situation. Under Qatar National Vision 2030, the nation’s long-term economic development plan, the state has invested a significant amount of capital and human resources in building up a handful of non-hydrocarbons sectors, including industry, education, health care, tourism and financial services. Indeed, the rapid development and maturation of the country’s banking system, capital markets and insurance sector over the past decade is a direct result of this effort. Furthermore, while national budgets will likely see deficits in the GCC region in 2016-17, most member states boast considerable fiscal reserves in the form of sovereign wealth funds (SWFs). For example, according to the US-based SWF Institute, as of late 2015 Qatar’s SWF, the Qatar Investment Authority (QIA), was the ninth-largest such fund in the world, boasting more than $250bn worth of investments.

Given this situation, the IFS industry, which has long been a key component of Qatar’s non-energy sector, has the potential to become a major economic driver in the coming years. Though the country’s sharia-compliant banks – like their conventional counterparts – have traditionally relied on government deposits, the current situation has the potential to drive a concerted turn toward alternative, perhaps more sustainable, business.

The banking sector, and particularly the Islamic segment, is likely to be a key beneficiary of this trend. According to S&P, in 2016-17 “investor demand for sharia-compliant products and supportive government actions will enable Islamic banks to continue to grow and gradually increase their market share”. In Qatar the Islamic banking segment is widely considered to be better prepared to weather a potential economic slowdown than the conventional segment for a variety of reasons. Due to the restrictions on risk-linked activities (see overview) under sharia law, Islamic banks generally have fewer options for managing liquidity. As such, a large percentage of most sharia-compliant institutions’ balance sheets are held in short-term placements or cash. Consequently, the country’s Islamic banks are generally viewed as more liquid than their conventional counterparts, which gives them extra leeway in terms of issuing credit, for example, according to S&P.

Regional Economic Driver

The situation is similar throughout the GCC, which suggests the regional Islamic banking sector could very well be poised to take on a larger market share in the coming years. This would be, in part, a continuation of recent trends. Over the course of the past decade, sharia-compliant banks have grown much faster than the conventional segment. According to S&P, between 2008 and 2014 GCC Islamic banks posted a CAGR of around 15%, compared to less than 9% among the region’s conventional banks in the same period. In 2014 alone, the regional sharia-compliant banking sector posted asset growth of 12.6%, against 9.6% for conventional lenders. Key drivers of this shift towards Islamic banking include rising demand for sharia-compliant products and services – among both retail and corporate clients – alongside continuous government support for the IFS industry as a whole.

These same drivers have contributed to the GCC’s rising reputation as a global centre for sharia-compliant finance over the past two decades. According to EY, as of late 2015 nine core markets lead the expansion of Islamic finance around the world – namely Qatar, Indonesia, Saudi Arabia, Malaysia, the UAE, Turkey, Kuwait, Bahrain and Pakistan. For its part, Qatar’s sharia-compliant banking sector posted a CAGR of 22% between 2010 and 2014, a figure that makes it the fourth-fastest-growing Islamic banking market in the GCC. According to EY forecasts, from 2015 through to 2020 these nine markets are expected to expand at a CAGR of 14%, with total assets to nearly double, up from $920bn as of late 2015 to $1.8trn by 2020. GCC countries – and particularly Qatar, which has reliably had one of the fastest-growing Islamic banking segments in the region over the past 30 years – are expected to be a driving force of this expansion. Indeed, by 2020 Qatar’s sharia-compliant banking sector is set to have assets of nearly $180bn.