Oman’s Islamic Banking Growth to Continue Despite Pandemic

Fitch Ratings-Dubai/London-23 March 2021: Oman’s Islamic banking sector growth is likely to continue apace in 2021-2022 following strong momentum in 2020 despite the pandemic and lower oil prices, Fitch Ratings says. Islamic financing in Oman grew by 9.5% in 2020, compared with the conventional banks’ loan growth of 2.1%. This was driven by demand for Islamic products, support from conventional banks offering Islamic products through their Islamic windows, and regulations supportive of Islamic finance.

The market share of Islamic banking and Islamic windows increased to 14.3% at end-2020 (end-2019: 13.6%), with total assets of OMR5.1 billion (USD13.5 billion). This is high considering that Oman was the last Gulf Cooperation Council (GCC) country to introduce Islamic banking in 2013. In contrast, Islamic banking has been present in Indonesia and Turkey for more than two decades but market shares there are below 8%.

Omani Islamic banks are adequately capitalised with reasonable profitability and asset quality indicators, reflecting conservative regulation and relatively low-risk business models. Payment holidays and flexibility allowing banks not to classify financing as impaired when payments are deferred mask underlying asset quality. We expect the weakening operating environment to pressure profitability and asset quality in 2021-2022, particularly in the real estate, construction and manufacturing sectors.

However, the sector’s growth potential is high given Oman’s Muslim-majority demographics and low banking penetration. Only 56% of the adult population had a bank account in 2016, with 14% of adults citing religious reasons for not having an account, according to the World Bank. Islamic banking penetration is likely to increase through training and awareness campaigns, new products and the greater use of fintech to target customers.

Challenges for the sector include limited short-term sharia-compliant investment options to place excess liquidity, a relatively low capital base and low customer awareness of Islamic products. Short-term sharia-compliant investment options are limited due to regulations preventing Islamic banks and Islamic windows from placing funds with conventional banks or parent banks, and the regulatory ban on ‘tawarruq’ products, which in other Islamic finance jurisdictions are typically used for interbank funding and personal financing.

These factors constrain profitability. Islamic banks can, however, receive money from conventional banks and parent banks, provided the underlying contract is sharia-compliant. There are no Islamic repo facilities with the central bank, which is problematic during tight liquidity conditions, but Islamic windows have the benefit of largely fungible capital and liquidity from their conventional parent banks.

The Central Bank of Oman (CBO) is working on offering Islamic liquidity management through remunerative deposit accounts and a standing liquidity facility, and by acting as lender of last resort. It is also working to expand domestic-currency sukuk issuance, which should increase sharia-complaint options for Islamic banks and help them to manage their liquidity. Sukuk issuance currently represents about 22% of total listed bond and sukuk issuance in Oman.

Omani Islamic banks have smaller capital bases than their conventional peers, hindering their ability to participate in large government financing projects. Government and public enterprise projects represented only 4.6% of the financing mix of Islamic banks and windows at end-2020, compared with 15% for conventional banks. Sector consolidation would therefore be credit-positive. A notable development in 2020 was the takeover of Alizz Islamic Bank by Oman Arab Bank.

Under Oman’s Islamic Banking Regulatory Framework, any losses on ‘mudaraba’- and ‘musharaka’-based profit-sharing investment accounts (PSIAs) are borne by the account holders, although we have not seen cases of PSIAs bearing losses in practice. In future, PSIA losses will be covered by a sharia-compliant version of the Bank Deposits Insurance Scheme, currently under development.

Bashar Al Natoor
Senior Director, Global Head of Islamic Finance
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