QR50bn: Qatar Islamic Bank’s total assets at June 2011
70 per cent: Qatar National Bank’s estimated market share of the corporate banking business
At the beginning of 2011, Qatar’s Central Bank shocked the banking system by announcing that by the end of the year all conventional banks had to close their Islamic banking operations.
The ruling, affecting what are generally known as Islamic windows, was a serious blow to conventional banks that had invested heavily in building a network of Islamic branches to capture religious customers. Many banks worried that they would end up losing a large proportion of business as a result of the central bank’s decision and be forced to sell their Islamic branches.
As 2011 comes to a close, the ruling looks far less dramatic in its impact than first assumed. Just one sale of an Islamic banking operation has occurred: International Bank of Qatar’s (IBQ) sell-off of its Al-Yusr Islamic banking operation to the local Barwa Bank in mid-August.
Other banks in Qatar are instead in the process of simply converting their branches to conventional ones and running down their Islamic banking assets. By mid-December, there were few signs that a rebranding of Islamic banking windows run by conventional banks was taking place. Most branches still had their Islamic branding over the doors, but a swift change has to occur by 31 December.
Rebranding branches is not what bankers in Qatar are worried about though. “The whole rebranding exercise can be done very quickly, the more difficult challenge will be what to do with assets in the Islamic businesses,” says one banking executive in Doha.
Further sales could still occur. Sources in Qatar say several banks are in talks with local Islamic banks interested in buying their assets. With no chance of being able to grow their Islamic business, banks are expected to decide that it is easier to just sell them off than maintain them until they mature.
“It becomes uneconomic to just run down a business that you cannot grow because, even when the assets are declining, you have a fixed infrastructure and people you need to look after that business,” says George Nasra, managing director of IBQ.
Selling off Islamic operations is complicated by the fact that conventional banks often did not house their Islamic banking operations in separate legal subsidiaries that can be easily hived off and sold. The added degree of complexity has made it difficult for banks to simply part with their Islamic businesses.
With the Qatari financial sector split between 17 banks and government-owned Qatar National Bank (QNB) taking up more than 50 per cent of the banking industry, it is also difficult for Islamic banks to buy the entire sharia-compliant businesses of their rivals. QNB’s Islamic window, QNB Al-Islami, had assets of QR32.2bn ($8.8bn) at the end of 2010. By comparison, Qatar Islamic Bank (QIB), the largest Islamic bank in Qatar, had total assets of about QR50bn by June 2011. As one insider at QNB puts it: “There is no one in the market big enough to buy QNB Al-Islami.”
There are rumours that it was the size of QNB Al-Islami that prompted the central bank’s announcement, worried that it would soon grow larger than QIB, whose chairman is the prime minister’s son.
“QNB has been successful at getting its Islamic corporate customers to stay with it and go back to conventional banking”
Banker in Doha
The central bank says the move is about maintaining the purity of the Islamic finance sector by ensuring that Islamic deposits do not get mixed up with conventional deposits behind the facade of an Islamic branch. It also makes regulating the Islamic banking sector easier if different capital ratios are to be applied to them to account for their different business models. QIB and other Islamic banks have said they see the directive as an opportunity for them. They will have to do a lot of work to capitalise on it.
Whatever the rationale for the ruling, bankers have now got over the initial shock of the move and have accepted it. In some cases, they are now far less worried about the move than they were when it was first announced.
Analysts so far seem unconcerned about the effect the change will have on QNB, despite the fact that QNB Al-Islami made a profit of more than QR900m in 2010, up by more than 100 per cent since 2009.
“QNB has been very successful at getting its Islamic corporate customers to stay with it and go back to conventional banking,” says one banker in Doha.
Other bankers in Qatar also believe that the majority of corporate customers are prepared to switch from Islamic finance to conventional. They also dismiss the notion that the government could use its large stable of state-owned firms with financing needs to stimulate the domestic Islamic finance sector, as government-owned corporates in the UAE and Saudi Arabia have done.
That could mean that growth in the overall pool of Islamic corporate assets in Qatar slows in the short term, given QNB’s stranglehold on the corporate banking market.
“People don’t deal with us so much because we are the government bank, but because we have the largest market share, can offer investment banking services, treasury services and have a large capacity to fund,” says a source at the bank.
Even rivals admit that the Qatar banking sector is “QNB with some second-tier banks fighting over what’s left.”
QNB is estimated to have a market share of about 70 per cent of the corporate banking business in Qatar. Despite not being able to book any new sharia-compliant business during the whole of 2011, this is expected to increase to about 80 per cent by the end of the year.
In the retail banking sector, Islamic customers are expected to be more loyal, choosing to stay with Islamic banks for religious reasons. Nasra says that around the region the proportion of customers who want to only use Islamic finance is growing and that this is also true of Qatari customers.
After IBQ sold its Islamic business, customers were given the opportunity to switch to conventional IBQ accounts or maintain the accounts that were being taken over by Barwa Bank. When deals are structured like this, most customers are expected to take the easiest choice.
“Ultimately, the end of Islamic banking windows is unlikely to be the doomsday scenario many feared”
Because IBQ sold off its Islamic customer accounts to another bank, they effectively had to opt out of the change that was occurring in their accounts. Other bankers think that as Islamic banking windows are absorbed into conventional branches, forcing customers to change banks if they want to keep their finances sharia-compliant, many will simply take the easiest option and become conventional banking customers.
Ultimately, the end of Islamic banking windows is unlikely to be the doomsday scenario many feared it would be when the news was broken earlier this year. Most analysts continue to forecast healthy growth levels for Qatari banks, especially QNB and Commercial Bank of Qatar. Islamic banks may have to wait until late 2012 before they start to see any noticeable upside from having the sharia-compliant space to themselves. Once that starts to occur, they will undoubtedly capitalise on the strong growth rates in the Islamic finance sector.
The challenge for them will be dealing with the influx of customers in their existing networks. Most of the current Islamic finance branches look likely to be conventional bank branches by 1 January 2012, taking a significant part of the sharia-banking infrastructure out of the market.
In the meantime, conventional banks could be better placed to grow their businesses with all the infrastructure investment the government has planned. This is mainly because the largest banks are conventional ones and they will not have the capacity issues testing their resources that Islamic banks will have over the next year or so.
More broadly, Qatar could have made the domestic financing market more complex for its firms and the private sector. Previously companies could raise money through an Islamic deal and invite all banks to participate, as most had Islamic windows that could be used to book the asset. Now, any deal of significant size in Qatar will have to feature both an Islamic tranche and a conventional tranche in order to attract liquidity from a wide range of Qatari banks.
With all the investment planned in Qatar by both public and private entities, the work of structuring the financing has now expanded massively, says an investment banker at one local bank. For example, the financing of the QR6bn Doha Festival City retail development, which is expected to be completed by early 2012, will include both a conventional and an Islamic tranche.
With a newfound sense of pride in its Islamic finance sector and civil unrest sapping confidence in Bahrain (the region’s current hub for Islamic finance), Qatar could become an increasingly important centre of expertise in sharia-compliant finance.
The problem will be that a lack of dollar liquidity in all Qatari banks will limit the opportunity for Qatari Islamic banks to play any significant role outside their domestic markets. Coupled with that, the conventional banks are not letting go of their customers easily and finding that many of the largest ones value the relationship above the type of account they hold.
By wiping out a huge swathe of competition through closing the window on Islamic banking, the government has tried to provide a lift to the market. Instead, it may find that it has convinced the largest Islamic banking customers to give up on the market.