Oman’s Islamic Banking Industry Growing

The Islamic banking sector in Oman is likely to sustain its positive trajectory in the short-to-medium term despite a number of structural challenges, Fitch Ratings says. Growth will be driven by growing awareness, strong retail demand for Islamic products, supportive regulations, and a strong push from the Islamic windows of conventional banks. An improving operating environment, expected positive real GDP growth, higher oil prices, the easing of coronavirus restrictions, and the rise in interest or profit rates will also support growth in both Islamic and conventional banking.

The Islamic banking sector’s financing growth topped 11.6% YoY in 2021, in contrast to the conventional banking sector’s 3.1%, with a compounded annual growth rate of 9% 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% at end-2021 (end-2020: 14.3%), with total assets of OMR5.9 billion (USD15.3 billion).

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.

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 capitalization levels. Consolidation could also support faster growth in the Islamic subsidiary or window through the larger conventional banks’ capitalization 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.

Omani Islamic banks have in the past been adequately capitalized, but at lower levels than conventional banks. Oman’s Islamic banking regulatory framework allows Islamic banks to use a 30% 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% at end-2021 (end-2020: 4.6%). It was lower than that of conventional banks whose share was 16.1% at the 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% of the total listed government bond and Sukuk in Oman in March 2022.

Oman’s share of global Islamic banking assets is growing but was small at 0.7% at end-3Q20, according to the Islamic Financial Services Board. The long-term growth potential remains positive given Oman’s Muslim-majority, with a sizeable sharia-sensitive and unbanked population.

Originally published on www.fitchratings.com