Islamic banking in Oman is growing at a faster rate than conventional banking, with Islamic banking credit up by 25 per cent YoY at the end of December 2017, according to the Central Bank of Oman (CBO), pointing to a wider acceptability of products.
Total credit of Islamic banks and the Islamic banking windows of conventional lenders in December 2017 amounted to RO 3.03bn, compared to RO 2.43bn in FY 2016, taking Islamic banking’s market share of total credit within the country to 12.9 per cent in 2017, from 11 per cent in 2016. We believe that Islamic banking will continue to grow at a strong rate in the coming years; however, growth momentum is expected to slow down as the sector matures.
Rising yields on assets expected to offset rising cost of funding
The cost of funding has increased, and this has squeezed banks’ financing margins in 2016 and 2017. Although the pressure eased a bit after Oman’s Government issued international bonds and unlocked payments to contractors, we think the cost of funding will remain inflated in 2018-2019.
Any subsequent US Federal Reserve (Fed)’s rate hikes, which effectively feed into Oman’s economy though the $-RO peg, could result in Islamic deposits shifting to profit-sharing investment accounts from unremunerated current accounts. If this happens, it would raise the cost of funding even further.
However, we have seen improvement in Finance Income yield (profit rate on Financing Assets) also and that has helped to partially offset the higher cost of funding. Net interest margins are expected to have bottomed out and will begin to pick up from hereon, albeit slowly.
Cost of risk has declined; Expected to marginally rise from hereon
Cost of risk has been on a decline for both Bank Nizwa and Alizz Islamic Bank. However, we foresee slightly higher credit losses in the coming years, due to rising cost of funding. Exposure to subcontractors, SMEs, and retail customers (especially expatriates) will likely fuel the upward trend for credit losses.
Deferred tax amortisation to have an uncertain effect on earnings
Both Bank Nizwa and Alizz Islamic Bank have taxable losses available for offset against future taxable profits, which can be utilised prior to their expiry. The banks must utilise the deferred tax asset within five years of creation of that asset. For BKNZ, a total of RO 2.68m while for BKIZ, RO 3.57m of deferred tax asset is available for amortisation as at the end of FY18. In our model-building process, we have assumed a 50 per cent amortisation per annum of the asset sequentially until it is fully exhausted.
Sector dynamics and Outlook
We believe that the key growth drivers for Islamic Banking, like their conventional counterparts, are: (1) Economic sectors to be promoted under the Government-backed $20bn Tanfeedh Programme that is to be funded through Public-Private Partnership initiatives (2) Government spending on mega projects such as the Sohar Refinery and Duqm Airport; (3) Favourable demographics of Oman (~43 per cent working age population-aged 25 to 54 years) as a key driver for growth in the consumer lending segment and higher disposable incomes of the youth population.
Oman’s macroeconomic outlook is encouraging on the back of planned non-oil GDP growth triggers
Oman’s economic growth is set to recover modestly over the medium term, as forecasted by the IMF & World Bank. A boost in the hydrocarbon sector is expected in 2018, mainly on end of “Opec plus” restrictions on oil supply coupled with the Khazzan gas project’s increased production capacity.
As the gradual recovery of oil prices improves confidence and encourages private sector investment, overall GDP growth is projected to rebound to 2.9 per cent by 2019. As has been the case for many years now, the government is focused on economic diversification.
Over the longer term, pro-business reforms such as the foreign ownership law and the FDI law, and the lifting of sanctions on Iran are expected to increase trade and investment opportunities.
We expect credit growth in Oman to soften to an average of 6 per cent between 2019-2022, with Islamic Banking consistently increasing its market share albeit slowly as compared to previous years. Overall, the banking system is well-positioned for sustained growth in the future and will benefit from the Sultanate’s systematic shift towards a more diversified economy.
[Courtesy: U Capital]
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