After a sluggish end to 2014, much was expected of the Islamic finance sector in Oman in 2015. There were initial teething problems such as trying to complete staff training at participating banks and achieving customer awareness of Islamic finance products available. However, at the same time, the installation of a central Islamic finance supervisory board by the Central Bank of Oman and Oman’s Capital Market Authority was largely addressed by the new year.
Oman’s first sovereign Sukuk issue – anticipated since as early as the second quarter of 2014 – was regarded as imminent, and likely to lead to the wider use in the Sultanate of this most broadly-used Islamic finance instrument globally, and this added to the general sense of expectation.
Review of 2015
To a great extent, that expectation has been met; Islamic finance has had a good year. Islamic bank assets have increased by some 53% to September year-on-year, to almost OMR2 billion (US$5.18 billion) and some 6.5% of total bank assets. A good proportion of this growth has been provided in the retail credit sector, with strong demand for Islamic finance home mortgages, vehicle financing, credit cards, bank accounts and loans (amid the government’s concern of excessive ‘consumerism’, that is to say, aggregate individual consumer indebtedness levels).
The OMR200 million (US$517.61 million) debut sovereign Sukuk was finally underway at the end of October and was very well received – it was increased by 25% to part-satisfy a total orderbook of around OMR350 million (US$905.82 million), reflective of the high level of Islamic finance asset liquidity among the banks and financial institutions joining in the private placement; conventional banks also participated, mainly to diversify investment portfolios.
Additionally, there is clear evidence of Islamic finance structures being used increasingly in development projects, following the Kempinski hotel construction at The Wave complex last year: Bank Dhofar, through its Islamic finance window Maisarah, is financing the completion of the new Copthorne Millennium Hotel at Muscat’s Grand Mall scheduled for soft completion in December. It is believed that this funding will be provided on the same basis as for the Kempinski – an Istisnah with deferred Ijarah structure. Four other luxury hotels across the country are also slated to use Islamic funding.
The International Medical City project at Salalah scheduled for completion in two phases through 2016/20 will also use Islamic finance for the debt component (US$1 billion). The exact structure to be adopted is as yet unknown.
Preview of 2016
While the aforementioned events justify a degree of optimism for the continued development of the Islamic finance sector, there are issues that will need to be addressed to ensure the 2015 momentum is sustained.
First, there is the persistently low level of the price of crude oil. Oman’s credit rating has been downgraded twice in the last six months, due to an increasing public budget deficit. The pricing of future sovereign Sukuk will therefore necessarily rise, removing one of the leading attractions to the government of issuing this kind of debt. Were the government to determine instead to raise its ongoing borrowing requirement by other means, this would deny the excess Islamic finance liquidity in Oman a domestic home, with implications for the whole sector.
Next, despite the prodigious increase in Islamic finance bank assets from 2015 as noted previously, the eight banks participating in the sector still struggle to make significant profits from the Islamic finance products on offer; there is a need to be competitive with conventional equivalent instruments to attract custom volume but besides this, the sharing of risk between customers and the bank inherent in all Islamic finance products means that the risk to be apportioned to the bank makes the cost of funds somewhat higher than in conventional banking. These factors combined spell trouble for profitability.
Further, the two Islamic banks participating in the Islamic finance sector (Alizz Bank and Bank Nizwa) complain that the six other participants (with dedicated Islamic finance windows) enjoy a cost advantage compared to them since the conventional bank operation can serve directly as a sharer of costs and resources and that all such windows should be incorporated as subsidiaries to level the playing field. If the government follows this line of thinking, this would place further pressure on the sector’s overall profitability.
Lastly, it is widely expected that 2016 will see further moves toward consolidation among participating banks due not only to the economies of scale but also (as in the Omani banking sector as a whole) to the quite apparent presence of oversupply.
Conclusion
There are important challenges to be addressed in the coming year. A sustained low crude oil price will increase the government’s need to borrow and make it more expensive for it to do so. Key fundamentals that two years ago made it compelling to utilize Sukuk as a means to balance the public budget have altered significantly.
On the plus side, it is evident that there is significant public demand for Islamic finance products, although a major priority for participating banks is to convert that demand into a sustainable profit. At the same time, the increasing use of Islamic finance structures in major development projects is very good news for the sector and should help the sector to sustain the momentum seen in 2015.
Anthony Coleby heads the Corporate Commercial Department of Said Al Shahry Law Office (SASLO). He can be contacted at [email protected].