Oman's Tremendous Growth In Islamic Finance

Head of products and segments at Muzn Islamic Banking, Suleman Muhammad Ali, wrote about the Islamic finance development in Oman for Katılım Finans.

Islamic Finance In Oman

Sultanate of Oman is a country strategically located in the southeastern part of the Arabian Peninsula. With an extensive coastline of 3,165 km facing the Arabian sea, Sea of Oman and Straits of Hormuz in the north, the country has been a part of major shipping routes since historical times connecting West Asia, Levant, and Africa with South Asia, Far East and Oceania. Oman has a total population of around 5.2 million. Compared to other countries in the region and the GCC, Oman was the last country to introduce Islamic finance (IF) back in early 2013 to launch the country's first Islamic banking window. However, the sector has seen unprecedented growth since then with Islamic banking reaching a share of 14.3% of the banking industry in terms of assets size at the end of 2020. This is a tremendous growth over an 8-year period, especially if we compare the share of Islamic banking in other countries that have had Islamic banking for a considerable number of years.

Regulatory Framework And Market Dynamics 

The Islamic Banking industry in Oman is governed by the Islamic Banking Regulatory Framework (IBRF) issued by the Central Bank of Oman (CBO) in December 2012. It is a comprehensive regulatory framework covering licensing requirements, Shariah governance framework, capital adequacy measures, risk management and other regulatory requirements. In terms of organizational structure for engaging in Islamic banking business, the IBRF allows the setting up of full-fledged Islamic banks and Islamic banking windows of conventional banks. Currently, the industry is characterized by two full-fledged Islamic banks and five Islamic banking windows of conven tional banks. The two Islamic banks are Bank Nizwa and Bank Alizz. Meethaq Islamic Banking is the window of Bank Muscat, the largest bank in the Sultanate. Other four windows include Muzn Islamic Banking, Maisarah Islamic Banking services, Sohar Islamic and Ahli Islamic.

Complying with the Shariah requirements as laid down by IBRF, Islamic banking window operations are being run independently from their conventional parent organizations with their separate balance sheets, dedicated branches, front office personnel, core banking systems and marketing activities. This is in stark contrast to the Islamic window operations in some countries where joint marketing, selling and Islamic desk operations within conventional bank branches are tolerated. However, Islamic banking windows in Oman benefit from established procedures and administrative back-end support from their conventional parent organizations.

The Islamic Financial landscape in Oman is also characterized by two full-fledged Takaful operators, namely Takaful Oman and Al Madina Takaful. The Islamic banking industry is the main driver for the demand for Takaful products in the country. The takaful sector is regulated by the Capital Markets Authority (CMA) of Oman.

Shariah Governance 

Shariah compliance is the defining factor of the Islamic banking industry. In this regard, Oman follows a robust Shariah governance mechanism, with the sector being overseen by the Higher Shariah Supervisory Authority of CBO. In addition to this, Islamic banks and windows must have their own Shariah Supervisory board (SSB) comprised of at least three qualified Shariah scholars with expertise in Fiqh al Muamalat. To assist the SSB in fulfilling its function of ensuring Shariah compliance in day to day matters Islamic banks operate a well-structured Shariah compliance department headed by an Internal Shariah reviewer (ISR) who has a two-pronged responsibility of ensuring operational Shariah compliance as well as conduct quarterly Shariah audits. The ISR directly reports to the SSB.

Product Landscape 

The transactions of tawarruq or commodity murabaha, though widely used by Islamic banks globally, are not allowed to be used as per regulation for any form of financing by Islamic banks in Oman. This has led Islamic banks and windows to improvise innovative structures to develop products and financing solutions that cater to the market's needs. The Islamic banking industry uses the products listed in the table and modes to provide Shariah-compliant financing solutions to Oman's corporate and retail markets.

Issues And Challenges

Managing short-term liquidity is a universal problem faced by most Islamic banks; the Islamic banking sector in Oman is no different. Factors such as restrictions on tawarruq exacerbate this problem since Islamic banks cannot deploy their short-term excess liquidity with conventional banks. Moreover, with Islamic banks and windows being only in their first decade since inception, they have not been able to build a low-cost, well diversified retail funding base compared to much larger conventional banks and hence have to rely on the wholesale funding sources from large corporates and entities. This impacts the profit margins negatively as well as increases the concentration risk on the deposit side.

The non-availability of short term sukuk and liquidity management instruments limits the ability of Islamic banks to manage their asset liability mismatches efficiently. The scarcity of sukuk instruments has also led to a very limited secondary market activity, with most institutions preferring to buy and hold the limited sukuk available for investment. There is an urgent need for industry participants to structure and introduce more shorter tenor instruments to resolve this issue.

With a young and growing population, the housing finance sector is set to see more demand over time. However, with the Islamic banking sector reaching the housing finance asset ratio limits the market opportunity and the available liquidity will be limited going forward. A viable solution for this can be Islamic secondary mortgage market securitization. This will enable the issuance of sukuk of various tenors, thereby also helping the industry manage the short-term liquidity requirements.

Turkish Participation Banking Sector 

Global credit rating agency Moody's recent report rated Turkey and Oman as the fastest-growing IF markets. The share of the Turkish participation banking sector at year-end 2020 stood at 7.2% of the total banking sector assets. With a large Muslim population, interest from the government and other stakeholders and advancements in fintech, there is a vast potential for the rapid growth of participation banking sector in Turkey. Some estimates expect it to double by 2025. However, the following factors will be very crucial in achieving this potential:

Awareness about Islamic Finance: doubts, questions, and non-clarity regarding IF among the customer base have always been a major impediment for the industry's growth in every Muslim majority country. These can be dispelled by having widespread awareness efforts in the form of workshops, seminars, etc., involving Shariah scholars and local imams in different country regions and economic centres.

Islamic Finance Education: no industry can grow without the availability of an adequate level of qualified personnel. In the case of Islamic banks, it can be a major roadblock in expanding their branch network and developing effective products to cater to the market needs. Hence education regarding Islamic finance at high school and university levels is a necessity

Developing market competitive products: while ensuring Shariah compliance, Islamic banks also need to develop products that are also market competitive and fulfil the diverse needs of the customers. Developing shariah-compliant, competitive products will ensure that Islamic banks develop a full suite of products and do not lose their customers to conventional banks.

Targeting MSME segment: Turkish economy is characterized by many medium and small scale industrial, business and agricultural units. These have been recognized as crucial growth engines for the future by all countries. Secondly, these entities tend to be more Shariah concerned, and their operations provide an opportunity for developing more easily customized Islamic products.

Islamic Fintech: evolving nature of technology has made concepts like crowdfunding, P2P finance, etc. an affordable and efficient way to access funding. At the same time, fintech applications provide an opportunity for the participation banking sector to reach out and rapidly expand their customer base without the cost of heavy investments in traditional brick and mortar branches.