International credit rating agency Fitch says the Islamic banking sector in the Sultanate of Oman is likely to sustain its positive trajectory in the short-to-medium term despite a number of structural challenges.
Supportive government regulations, strong retail demand for Islamic products and a strong push from the Islamic windows of conventional banks all contribute to the growth of the sector. Growth in both Islamic and conventional banking is also driven by expected positive real GDP growth, higher oil prices, improving operating environment, the easing of the coronavirus restrictions and the rise in interest or profit rates.
In 2021, the Islamic banking sector’s financing growth topped 11.6 per cent y-o-y, in contrast to the conventional banking sector’s 3.1 per cent, with a compounded annual growth rate of 9 per cent in 2017-2021. Surging public demand and low-base effect propelled the growth. As a result, the market share of Islamic banking and Islamic windows increased to 15.2 per cent at end-2021 (end-2020: 14.3 per cent), with total assets of RO 5.9 billion ($15.3 billion).
Fitch says key structural challenges persist mainly due to the sector’s recent inception in Oman (around 10 years ago). These include gaps in the distribution channels, limited product offerings, a still-developing regulatory framework, a small capital base, limited sukuk investment options and insufficient Islamic liquidity management products.
Fitch says, “We continue to see consolidation. In January 2022, Bank Nizwa and Sohar International Bank received Central Bank of Oman (CBO) approval to start due diligence for a potential merger. The proposed structure of the merged entity is still unknown. This follows the takeover of Alizz Islamic Bank by Oman Arab Bank in 2020. Consolidation could be a credit-positive as it generates cost-efficiencies, deepen distribution channels and strengthen capitalisation levels. Consolidation could also support faster growth in the Islamic subsidiary or window through the larger conventional banks’ capitalisation and liquidity profiles.”
“We expect mild asset quality deterioration following the end of payment holidays and flexibility as banks will not have to classify financing as impaired when payments are deferred. This is likely to arise in the more vulnerable sectors, particularly in real estate, construction, tourism and manufacturing. We expect profitability to improve with rising rates and lower impairment charges, but a return to pre-pandemic levels is unlikely before 2023-2024'', the ratings agency added.
Omani Islamic banks have in the past been adequately capitalised, but at lower levels than conventional banks. Oman’s Islamic banking regulatory framework allows Islamic banks to use a 30 per cent alpha factor which can uplift capital ratios, unlike conventional banks. However, Islamic banks continue to apply their undiscounted risk-weighted assets and do not benefit from discounted risk-weights for assets financed by profit-sharing investment accounts.
The capital bases of Islamic banks are also smaller than those of conventional peers, which may limit the scale of participation in large government financing projects. However, amid rising core capital and reserves at Islamic banks and windows, Islamic banks are increasingly financing government and public enterprise projects, with their share of total financing jumping to 10.4 per cent at end-2021 (end-2020: 4.6 per cent). It was lower than that of conventional banks whose share was 16.1 per cent at end-2021.
The CBO is developing a medium-term strategy for the Islamic banking sector, including a lender of last resort facility for Islamic banking entities, with a sharia-compliant deposit insurance scheme. In 2021, the Omani Capital Market Authority released draft rules for sukuk and bonds, including for ESG-linked instruments. Sukuk issuance represents about 19 per cent of total listed government bond and sukuk in Oman in March 2022.
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