With a stable banking sector, the Sultanate of Oman has good access to capital and a high-quality asset base. Banks’ loan portfolios in particular are considered at minimal risk of default in a global context. In addition to the banks, the country has a vibrant group of non-bank lenders and an Islamic banking segment that is just getting started. Overall, the sector is expected to serve as a key catalyst for an economic shift under way in the sultanate. The government’s long-term vision includes a goal to encourage a more robust and entrepreneurial private sector that will serve as a driver of job growth for Omanis.
Providing access to credit at all levels is seen as an important part of achieving that aim. Banks have had great success lending to the retail sector; however, in 2014 they are expected to increase their focus on the commercial side of loan books. Recently introduced regulations – a series of lending ceilings, floors, and ratios – encourage that process by mandating that further increases in credit to consumers will be paired with a greater number of loans to commercial borrowers as well, preferably small-scale entrepreneurs with the potential to grow.
Consumer Foods
Conditions are ripe and demand remains high on the consumer side, and as a result the sector is expected to attract new capital, recruit new customers from the ranks of the unbanked and feature more robust competition as banks seek to comply with the new regulatory environment. This may, in the short term, put pressure on the profit margins of some lenders and create the overall potential for a small increase in defaults in the future, but is seen as a long-term positive move for the banks and for asset quality (see analysis). Abdul Kader Askalan, the CEO of Oman Arab Bank (OAB), told OBG, “While expansions to the annual national budget continue to positively affect the banking sector, there are some challenges to overcome. The Central Bank of Oman (CBO) has reduced the loan amount banks can provide to clients and increased international competition has put more pressure on local banks and lowered product pricing.”
Competition & Indicators
Sulaiman Al Harthy, the group general manager of Meethaq Islamic Banking, Bank Muscat’s Islamic operation, echoed this sentiment. “At the moment there is an oversupply of banks in the sultanate, which has led to price wars and cut-throat competition,” Al Harthy told OBG. Nevertheless, according to an IMF evaluation at the end of 2012, “The banking system is sound, profitable and well regulated.” The capital-adequacy ratio stood at 16%, above the 12% mandated by the Basel Committee on Banking Supervision as the international standard, according to the fund’s data. Total commercial banking assets rose 13.3% in 2012, to reach OR20.9bn ($54.1bn) at year’s end, up from OR18.4bn ($47.7bn) at the close of 2011. The sector is focused on the tried-and-true practice of lending against the spread, as opposed to securitisation, investment and other complex activities that come with higher risks.
Profits
According to latest full-year data available from the CBO at the time of press, the banking regulator, aggregate net profits (after provisions and taxes) from local banks and foreign branches rose 15.6% in 2012 to OR305.3m ($786.1m), up from OR264m ($683.8m) in 2011. Local banks accounted for 96.1% of the total. Income from interest-bearing products comprised 74.3% of profits. Fee-based income declined slightly, falling from OR60.5m ($156.7m) in 2011 to OR59.5m ($153.9m) in 2012.
While Oman’s petroleum wealth has meant that access to capital is generally not a challenge for the government, banks and large corporations, the sultanate’s leadership is intent on further nurturing its financial services sector, viewing it as a source of stability and economic development. CBO data indicate that banks have deepened their role in the overall economy in recent years: the credit-to-GDP ratio has risen from 39.6% in 2008 to 47.7% in 2012, and the deposits-to-GDP ratio is up from 37.2% to 47.2%.
However, the sector’s progress has not been linear, and both figures fell following the indirect effects of the global financial crisis, which filtered through to Oman. They have since started to rise, but have yet to reach the pre-crisis levels that peaked in 2009.
Sector Organisation
The CBO oversees the seven local universal banks and nine foreign lenders with a domestic presence. The largest bank by a significant margin is Bank Muscat, which had roughly OR8.2bn ($21.3bn) in assets as of July 2013. Two other local banks, Bank Dhofar and Bank Sohar, are planning a merger that would create a combined entity worth roughly OR4.1bn ($10.6bn), still well short of Bank Muscat’s size. As of September 2013, initial merger talks had been completed and the lenders were conducting their own evaluations ahead of negotiating financial terms. In 2012 a merger between HSBC and Oman International Bank took place, creating HSBC Oman. The banking sector is already well represented on the Muscat Securities Market (MSM), accounting for about 40% of its market capitalisation. The last of Oman’s commercial banks not publicly traded is OAB, which has announced plans for a listing and is expected to do so when market conditions are favourable, likely early 2014. OAB’s initial public offering (IPO) is significant for the additional reason that the company was granted a waiver from a capital markets regulation mandating that any listing be worth at least 40% of the value of the company. The bank is instead floating 25% of its value. That rule has also been relaxed for two recent listings in the utilities sector, demonstrating flexibility to the rule, and the possibility of other exceptions (see Capital Markets chapter).
Other Operators
There are two licensed noncommercial banks: the Oman Housing Bank and the Oman Development Bank. Also prominent in the sector is a group of six non-bank financial services providers, commonly referred to as leasing companies. They are also licensed and regulated by the CBO. Their core business is financing the purchase of vehicles and other assets, primarily by small and medium-sized enterprises (SMEs), but retail consumers and larger corporate customers as well. The leasing companies offer working capital and time deposits to corporate customers, but otherwise do not take deposits. Minimum paid-up capital for a non-banking licence is OR25m ($64.75m), whereas for banks it is OR100m ($259m). As a group, the leasing companies have about $2bn in assets on their collective balance sheet – about a third of the total of banks. Al Omaniya Financial Services is the dominant actor, with roughly $700m in assets.
Leasing companies generally have a higher risk profile and charge higher rates. Their cost of funds is also greater – they can be publicly traded and seek other sources of finance, but also typically rely on borrowing from the banks for capital. Financial services providers of all types are subject to rules on the number of expatriates they can employ, as the government has set minimum levels for local employment across all economic sectors. Bank staff must be 90% local, whereas the “Omanisation” rate for the leasing companies is 80%. Finding qualified Omanis and training willing ones can be difficult, due to the traditional preference among the local workforce for a government job. Costs are also higher, as locals tend to draw a higher salary than expatriates in the same role, in particular at the lower and middle segments of corporate wage scales. “We have an open-door policy here,” said Aftab Patel, CEO of financial services firm Al Omaniya. “Any Omani who wants to come in for a job interview can do so, and if they do well enough they’re hired the next day.”
Islamic Finance
The newest entrants into the banking sector are two Islamic institutions, whose licences were granted after the 2011 decision to allow sharia-compliant financial institutions to operate in the sultanate. Bank Nizwa began operations at the end of 2012, and Al Izz Islamic Bank commenced operations at the end of September 2013. Existing conventional banks were offered the option of opening Islamic branches backed by a separate capital base, and all local banks, save for HSBC Oman have done so. The Islamic Banking Regulatory Framework (IBRF) calls these separate branches “windows”, a label Oman uses fairly uniquely in the world of sharia compliance. In most countries in which Islamic banking exists alongside conventional finance, the term implies separate counters in conventional bank branches for sharia-compliant options.
International Involvement
Foreign investment laws mandate that foreign companies can take no more than a 70% stake in a locally incorporated firm. Local operation through 100 percent foreign branches is also permitted in many sectors including. Further, foreign branches are not subject to this restriction. Though licence applications to the CBO are evaluated on their own merits, in the future they are also likely to be made conditional on the applicant agreeing to sell shares on the MSM in an IPO. The government has in recent years been supporting the country’s equities market by stipulating IPOs as part of licence agreements.
Still, some feel that more needs to be done. Abdul Aziz Al Balushi, the CEO of Ahli Bank, told OBG, “To attract more foreign investment into Oman we need to improve overall efficiency; transparency, ease and cost of doing business are fundamental.”
Loan Rates
The Omani rial is pegged to the dollar, and therefore the CBO mimics American monetary policy. Loan rates are below 10% for almost all borrowers in Oman. According to IMF data the spread between average deposit rates and average lending rates in local currency at the end of 2012 was 4.3%, compared with 4.8% at the end of 2011. Credit growth reached 14% over the course of 2012, and with total outstanding loans in default at year’s end at 2.1% of the total. For the banks, the lending focus has been Omani consumers, and in particular public-sector workers. These retail customers enjoy a high degree of job security and income stability. Many also own stakes in SMEs in which ownership is shared with expatriates who retain operational control and are the main beneficiaries. These foreign investor-local partner arrangements provide thousands of Omanis with an additional source of steady income, which makes them even better candidates for bank loans. Rates are capped at 6% for personal loans, having been reduced from 7% in October 2013. The market was expecting the cap to be lowered again, but details on timing and amount were not clear at the time of writing. The ceiling has been lowered in the past several decades – the maximum as of 1999 was 13%, for example. The average lending rate at the end of 2012, calculated as a weighted average based on different types of loans and their share of the total, was 5.2%, down from 5.52% a year earlier. Credit to non-residents fell 21.4%, from OR221.7m ($576.42m)to OR174.3m ($451.44m), in 2012. The catalyst was a regulatory change: a reduction in the maximum exposure to foreigners from 5% of that borrower’s local net worth to 2.5%. The CBO also introduced a $5m limit on exposure to non-resident borrowers unless through a syndicated loan.
The ratio of non-performing loans has fallen from 2.5% in 2011 to 2.2% at the end of 2012, according to the latest full-year CBO data available. If the central bank’s plan to shift the lending focus from consumers to SMEs is successful, however, margins may expand. As SMEs are accustomed to borrowing at higher rates due to their perceived greater risk, a rise in their share of overall lending would have the effect of boosting the net interest margin.
As of the end of the first half of 2013, according to CBO data, total deposits had reached OR14.94bn ($38.8bn), of which 28.6% came from government, 6.1% from other public enterprises, 62.9% from the private sector, and 2.4% from non-residents.
New Regulations
CBO oversight of the leasing companies is more relaxed, as they are not subject to micro-regulations such as caps on fees or retail interest rates, or to the lending rules recently put in place by the CBO to increase credit to SMEs. The main change to accomplish that was a requirement that banks have at least 5% of their total loans outstanding to the SME segment by December 2014. For the CBO, the desire is to help the sultanate’s long-term economic vision by steering capital toward investments that create jobs, providing a multiplier effect that filters throughout the economy.
The CBO also wants to reduce consumption of imported goods to some extent, in order to keep Omani wealth stimulating the local economy. “Consumer lending is higher than what is desired,” said Al Omaniya’s Patel. “There is a consistent effort to ensure that loans are for productive purposes.”
Though banks are being steered toward other areas of the economy, consumer demand is likely to rise significantly in 2014. There have been two large hikes of minimum wage in 2011 and 2013 that have more than doubled the salary floor, and the government has increased hiring in recent years as well. This means there are tens of thousands of newly bankable Omanis, and tens of thousands who are no longer affected by the debt-to-burden ratio regulation. Demand for imports is likely to remain high, however, in particular for cars. The minimum wage increase in 2011 was followed in 2012 by a historic high in new car sales – edging above 200,000 on the year for the first time ever – and the same is forecast to happen again in 2014 (see Insurance chapter). The by-product of the CBO’s regulations could be a change in the balance between banks and leasing companies, which are not subject to them (see analysis).
Open For Business
Alongside the mandated rise in access to capital for SMEs, the development of Islamic finance is expected to be a main storyline in the Omani banking sector in 2014. In addition to the Islamic banks and windows now open for business, Oman Development Bank announced in August 2013 that it is considering opening an Islamic window to provide a sharia-compliant version of its soft loans.
Oman has not yet invited the leasing companies to participate in Islamic finance, although within that segment of the market several of the companies have expressed an interest. Al Omaniya, the largest of the group, said in a local banking survey in June 2013 that it has put aside OR10m ($25.9m) in capital to establish an Islamic window. The firm’s asset-backed lending model is an easy fit with sharia-compliant finance because of the physical asset at the core of the transaction needed in Islamic finance. The CBO informed OBG it is taking a wait-and-see approach, watching how Islamic finance develops among banks before bringing in more types of providers. Among the reasons for introducing Islamic finance in Oman in 2011 was that some Omanis had been taking their capital to banks in other countries to access sharia-compliant instruments.
It was expected that the availability of Islamic products at home would result in a swift repatriation of capital and that Islamic assets would quickly comprise a significant amount of the total in the banking system – as much as 6.5% by the end of 2013, according to research from QNB published early in that year. However, as of mid-year that expected inflow had not yet materialised. The process may end up being slower than anticipated, in part because the sector is so new in Oman and products currently available are basic, and also perhaps because investments abroad could not be quickly liquidated and transferred.
Compliance Focussed
One of the features of the new Islamic banking system that stands out in a global context is regulation. Regulators typically decide to take a proactive approach to ensuring sharia compliance in Islamic financial services or a more hands-off strategy. The CBO has opted for the more hands-on approach. One example of this is the decision that conventional banks’ Islamic windows must be in separate buildings and not within existing branches.
Regulations also do not permit Islamic banks to take part in the most common form of interbank financing, commodity murabaha, a type of sale that is compliant with sharia restrictions. The murabaha structure typically accounts for almost two-thirds of Islamic banking assets worldwide at any given time because it is a useful way to structure shorter-term products for customers and for banks to manage their balance sheets. The practice involves a financial intermediary buying a commodity traded on an international exchange and selling it on that day to another intermediary at a higher price, but with payment deferred for an agreed-upon period. That gives the buyer the short-term cash it needs, and the seller a profit from helping to provide it. Commodity murabaha is commonly used in Islamic finance because it fulfils the sharia requirement that any banking product be based on a physical asset. Islamic banks typically use this product to meet that requirement, instead of insisting on using an underlying asset that is actually exchanged by the two parties as part of the transaction. The CBO’s regulations allow an exception to the commodity murabaha ban in those cases in which the bank’s existence is threatened.
Scholars
Oman’s regulations on sharia scholars are also notable. Islamic banks typically establish a panel of sharia scholars to provide them with an ultimate authority on whether the products they are offering are compliant with Islamic practices. These experts are typically paid and meet regularly; however, they do not work for the bank on a full-time basis. In the past two decades Islamic finance has grown faster than the supply of able scholars, so the existing ones are often in high demand and sit on the sharia boards of multiple Islamic financial institutions. In some countries with Islamic banking regulations, central banks or regulators maintain their own sharia boards. Regulatory frameworks often require banks to have sharia boards, but sometimes consider them optional. In Oman, requirements for sharia scholars mandate that individuals cannot serve on more than one bank’s sharia board. The CBO has articulated three additional roles within company structures that require a person with a scholar’s expertise on a full-time basis: a sharia advisor, a sharia auditor and a sharia compliance officer. This level of sharia oversight should help to make Islamic banking in the sultanate an appealing option for potential customers.
For the institutions, however, the requirements add greater costs than seen in a global context. Islamic financial products worldwide are typically more expensive than conventional equivalents, because they are designed to meet the same consumer need and often to compete with non-Islamic products, but have the added cost of ensuring sharia compliance. Banks may choose to insulate customers from this added cost by absorbing it themselves, which often means a smaller profit margin on these services.
Consumer Preferences
Trends in Islamic finance worldwide indicate that many Muslims want financial options in line with their faith but ultimately consider cost as well. The sector in the sultanate is too young to draw any conclusions about what Omanis want. One concern among sector players is that some consumers equate Islamic finance with interest-free loans, as opposed to loans for which the cost of finance is still present but structured differently. One positive indicator for the future of Islamic finance in Oman is the money that had flowed out of the country in search of sharia-compliant products abroad in previous years – repatriated or not, that represents a confirmation of the significant local demand.
Another question for those evaluating the future prospects of the sector is the degree of support coming from government agencies. One way in which Islamic banks can thrive – and indeed price their products competitively with conventional ones – is if they can achieve a lower cost of funds. In some countries government deposits are placed with banks with expectations of a very low rate of return or none at all, essentially providing the bank with free or almost free money. Government deposits account for about 29% of the banking system’s deposit base, and there have been no indications as to whether the government is likely to shift some to sharia-compliant banks or accept a lower rate of return.
While these questions of profitability may answer themselves over time, the new Islamic banks and windows also face some short-term challenges that pose small risks until the sharia-compliant sector matures. Islamic banking has preceded other developments such as the availability of sukuk – sharia-compliant alternatives to conventional bonds – and a suitable interbank lending market. Both would be welcome tools for banks and windows to manage their balance sheets. Banks also await the development of Islamic insurance, called takaful. Sharia-compliant life insurance products would be bundled in with loans to insure against repayment risks.
The introduction of these products may be controlled to a certain extent by the pace of reforms to Oman’s legal environment. Several private sector companies have approached the capital markets regulator, the Capital Markets Authority, with the desire to issue sukuk, and in November 2013 Al Madina Investments issued the first corporate sukuk for OR50m ($129.5m) for Tilal Development Company (see Capital Markets chapter). However, it appears likely that in many cases laws will need to be passed or adjusted to support Islamic products.
Outlook
The CBO’s new regulations on consumer lending present multiple scenarios. Banks may raise more capital and lend more to continue growth on the retail side, where they perceive the lowest risks and highest margins. Islamic banks may step in and seize the opportunity. Leasing firms may see their bank loans coming at higher costs because the banks are now incentivised to chase that market segment. Consumers may need to accept a higher cost of finance if they decide to make use of a leasing company, rather than a bank. Or, the financial services sector could end up inviting unbanked Omanis into the formal system, achieving one of the CBO’s goals at the same time. However, while the consequences of these changes may result in a redistribution of the market share and increases in non-performing loans among banks, the sector appears likely to remain profitable.
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