New vistas of growth

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The Sultanate is all set to embrace Islamic finance as the Central Bank of Oman is expected to issue a full-fledged Islamic Banking Regulatory Framework (IBRF) very soon. Khalid Yousaf, Director, Islamic Finance Advisory Services, KPMG Oman, observes that by the end of 2015 Islamic finance assets will achieve roughly 20 per cent of the total banking and insurance assets in the country. He urges Islamic finance practitioners and scholars to invest more in research and innovation to satisfy the increasing market appetite. Excerpts from an interview with Muhammed Nafie.

How do you see Islamic finance/ Islamic banking shape up in Oman in the coming years?
The landscape for Islamic finance has been carefully and methodically planned in the Sultanate. Whereas a robust legal environment exists already, a comprehensive Islamic Banking Regulatory Framework (IBRF) has been designed by the Central Bank of Oman (CBO) to address the regulatory requirements of full-fledged Islamic banks and Islamic windows; another set of regulatory requirements address Takaful and Sukuk by Capital Markets Authority (CMA); and changes to tax regime to ensure that Islamic banking products and services are not treated less favourably have been undertaken by the Secretary General of Taxation (SGT). This architecture of strong pillars gives the Islamic finance industry an enduring foundation which will ensure that the industry will build and flourish in a disciplined manner. The industry however, is not likely to follow the “big bang” explosive growth model. Instead it is anticipated that a steady and moderate growth will be the hallmark of Islamic finance industry in Oman. In my opinion, the Islamic finance assets will achieve roughly 20 per cent of total banking and Takaful assets by the end of 2015 in the country. The turning point will be when the current conventional banks and insurance companies will start converting into full-fledged Islamic banks and Takaful companies to meet market demand. Subsequently, Islamic assets will take the dominant share in both banking and insurance sectors.

What will be Islamic banks’ potential for contributing to Oman’s economic development in the long run? What kind of business opportunity will it convert into?
Islamic banks are likely to attract a huge deposit base from retail, SME, corporate and public sectors, giving them sufficient liquidity to finance the “capital-hungry” projects and sectors. Thus Islamic banks will bridge the gap and provide capital flows necessary for steady growth of Oman’s economy. Oman’s economy with GDP already approaching $70bn has commitments to major infrastructure projects like the new Muscat International Airport, Gas-fired power generation and road network projects costing over $30bn. These projects will require financing and Islamic banks can take the lead in private-public-partnership (PPP) initiatives to fund asset-backed transactions. Further, the markets and public at-large are displaying signs of preference for Islamic products and services and Islamic banks will offer retail, corporate and treasury products to their customer base. Although some of the customers may just be converting from conventional to Islamic, it is likely that a large segment of retail, SME and corporate customer base which has henceforth shunned conventional banking for lack of availability of Islamic products and services will take the role of new contributors to the banking sector. Their addition will provide a significant boost to Oman’s economy through the growth of banking assets, which in turn will boost the money supply through M1 and M2 factors.

The CBO is expected to announce soon a full-fledged regulatory framework for Islamic banks in the Sultanate. Since there are different methodologies to follow, according to you what will be the best regulatory regime for Oman?
There are currently three regulatory regime models practiced in countries offering Islamic finance products and services. The first being the “purist” model practiced by Sudan and Iran which has no room for conventional banking and the banking laws and regulations address exclusively the regulatory requirements for Islamic banks and insurance companies only. The second model offers the “parallel” laws and regulations for both conventional and Islamic banking to co-exist, practiced by Malaysia, Indonesia, Pakistan, UAE and now Oman. The third model which is most prevalent across the globe follows the principle of “financial equivalency” whereby Islamic banking products and services are measured on the same legal and regulatory scale as their conventional counterpart. The Western world, Australia, Singapore, Hong Kong, South Korea, most other Islamic or secular countries with majority Muslim population practice this model.

Draft Islamic Banking Regulatory Framework (IBRF) is a comprehensive set of rules and regulations for Islamic banks and windows in Oman. Being the latest addition to the list of countries offering Islamic banking, Oman has the advantage of evaluating and comparing similar regulations around the world and cherry-pick the best-practices. The draft IBRF which may still be subject to modification, comprehensively covers the licensing requirements; general obligations & governance; accounting standards & audit reports; supervisory powers & control; capital adequacy; credit risk; market risk; operational risk; liquidity risk and other pertinent operational requirements. Although these rules and regulations still form part of the overall banking laws in Oman, they are unique to Islamic banks and window operations. Their robust and comprehensive structure will not only give a powerful supervisory and monitoring tool in the hands of CBO but also give confidence and trust in the minds of general public.

Islamic banks have bucked the global financial meltdown to a large extent as it did not have as much exposure to collateral debt obligations and real estate as conventional banks. Is this a major plus for it?
It is true that post global financial meltdown, Islamic banks did not feel the same pain as the major conventional financial institutions around the world. This is largely attributable to the relatively small size of Islamic banks on the global scale as well as the fact that unlike conventional banks which were highly-leveraged (some had assets in excess of 100 times their equity capital), Islamic banks either had zero or very low leverage. As a result, the loan/deposit ratios in Islamic banks were very low compared to conventional banks. Global financial meltdown created severe liquidity problems for conventional banks because their assets lost value suddenly while creditors/depositors demanded payments upon maturity. Consequently, their respective governments had to bail them out financially. Islamic Banks also suffered some pain as their real estate portfolios lost value, but having little or no leverage saved them from the scale of liquidity crunch which crushed their counterparts.

Two full-fledged Islamic banks and the Islamic windows of a number of conventional banks are about to start operation in Oman. Will it be difficult for them to find enough experts at their Sharia boards?
This is the crux of problems facing Islamic Finance industry across the world, but even more so in Oman. CBO’s draft IBRF requires every full-fledged Islamic bank or Islamic window of a conventional bank to have a Sharia’ supervisory board consisting of a minimum of three Sharia’ scholars. The “Fit & Proper” criteria lay down strict qualifications and experience requirements; each Sharia’ scholar can have a maximum tenor of three years initially with a maximum of two consecutive terms. Also, a Sharia’ scholar cannot be a member of more than two Islamic banks or a maximum of four Islamic financial institutions like Takaful, asset manager or fund manager. Islamic finance industry has traditionally faced a paucity of qualified Sharia’ scholars, hence most noted Sharia’ scholars internationally sit on the Sharia’ supervisory boards of dozens of Islamic financial institutions. Islamic finance is new to Oman and the shortage of Sharia’ scholars will be felt even more acutely here than elsewhere. The solution lies not only in easing the regulatory requirements, but also making efforts at national level to train and develop Sharia’ scholars to meet the burgeoning demand of Islamic finance industry.

How feasible will it be for conventional banks to offer Islamic banking services?
Conventional banks have been quick in announcing the launch of Islamic window operations both for aggressive and defensive reasons. Given the robust demand for Islamic banking products and services, conventional banks want to gain their share in this new market as quickly as possible. At the same time, there are concerns that if conventional banks do not take immediate steps, they may start losing their customers to Islamic banks and windows. The conventional banks, therefore, wish to maintain their overall market share or improve on it. Through the opening of Islamic windows they hope not only to retain their loyal customers, but also attract customers from other banks. It is foreseen that in the early stages of development, competition between Islamic banks and windows will be quite intense and some banks or windows may even become “loss leaders” to capture the target market share.

Since conventional banks are likely to lose some customers, if they do not offer Islamic banking services through window operations, their positioning through Islamic window is to counter the threat of losing customers to other competitors. Opening an Islamic window operation therefore is not only a “defensive” strategy but also an economic one because it requires less capital while sharing a common cost base with additional business. This strategy, therefore, compares favourably against establishing a full-fledged Islamic banking subsidiary. Given these cost advantages, conventional banks will have the capacity to offer their products and services at lower prices than full-fledged Islamic banks. They are also expected to leverage their existing brand image in the market to address new target Islamic banking customers.

What are the major challenges faced by Islamic banks all over the world?
Islamic finance is a baby when compared to conventional financial system. Whereas the conventional financial system has been in existence for 300+ years, Islamic finance in its present form has been in existence for just over 30 years. A lack of understanding of its underlying Sharia’ principles by governments, regulators, industry and public at large are the biggest problems facing the industry today.

There are also skeptics who question the strict compliance with Sharia’ principles and consider Islamic finance as a wrap around the conventional financial products. The fact remains that being fledgling, the industry has successfully made the existing financial products and services “Sharia’-compliant” but will take some more time to develop and introduce exclusively “Sharia’-based” products and services. Hence, Islamic finance is currently a part of the whole financial system, rather than being a parallel financial system. The challenge for both Islamic finance practitioners and Sharia’ scholars is to continue to invest in research and innovation to satisfy increasing market appetite.

How will Islamic banking be appealing to non-Muslims in Oman?
Islamic banking products and services are not targeted at Muslims only. They offer all features of “ethical” banking plus more. Whereas “ethical” banking shuns alcohol, adult entertainment, gambling, environment pollution and weapons of mass destruction, Islamic banking goes a step further in shunning conventional “riba-based” banking and financial services as well. Non-Muslims seeking ethical banking products are therefore attracted to Islamic banking products and services. In Malaysia for instance, 35 per cent end-users of Islamic banking products and services are non-Muslim Chinese population seeking ethical products which meet its financial criteria. Also, due to the nature of Sharia’ technique applied in house, car or other loans, the terms and conditions may be more acceptable to non-Muslims seeking those peculiar terms.

In your capacity as the director of Islamic finance advisory services at KPMG, how are you looking to contribute to Islamic banking in Oman during its gestation period?
KPMG wants to have a sustainable presence in Oman by being recognized as a quality service provider in the field of Islamic finance. We wish to demonstrate our continuing commitment to the country. This is why resources have been allocated and an Oman-based director has been appointed.

Our mission going forward will be to promote the growth of Islamic finance through education, training & development, raising public and industry awareness, providing advisory services to clients in establishing new Islamic banks, Islamic windows, Takaful companies, asset management or Islamic funds in the country. We also aim to assist the government and regulators in bringing changes to legislation and regulations to ensure that Islamic finance products and services are not treated less favourably by the financial system.


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