Islamic banks in Qatar received a shot in the arm last year, when the central bank issued a ruling banning Islamic windows in the onshore banking system, in effect requiring conventional banks to shut down or divest their sharia-compliant businesses.

The Central Bank of Qatar (QCB)’s February 2011 directive to conventional banks ordered them to halt offering Islamic products and close their Islamic windows with effect from the end of 2011.

This attempt to forge a level playing field between Islamic and conventional lenders may be reinforced with proposals currently under consideration that would ensure that conventional Qatari banks would not be able to circumvent the ban via the Qatar Financial Centre.

The rationale for the scrapping of Islamic windows is straightforward. Conventional banks, being able to raise funds at lower rates than their Islamic counterparts, are able to capture a large share of sharia banks’ business segment. QCB’s move was designed to redress the structural imbalance.

Bank reforms

Besides levelling the playing field, another motivation was to reduce complexity, noted the Washington-headquartered IMF in an assessment of Qatar’s bank reforms issued earlier this year. The overlapping nature of non-Islamic and Islamic activities made risk management and compliance with prudential requirements more difficult.

Since the directive, conventional banks have ceased undertaking new financing activities and taking sharia-compliant funding.

“We didn’t expect a massive transfer of assets … into Islamic banks and we have been proven right”

Mahin Dissanayake, Fitch Ratings

But the jury is still out as to whether the ruling really stands to deliver a substantial boost to the country’s Islamic banks. Before the ban, Islamic banking assets accounted for 31 percent of total banking sector assets, according to the IMF. Total assets of Islamic windows in the conventional banks engaged in this activity reached 12 per cent of the balance sheet of conventional banks at end of 2010, accounting for a similar share of profits. The assets of standalone Islamic banks constituted 21 per cent of total assets in the Qatari banking sector. According to the Institute for International Finance, the sector is worth $35bn, accounting for an estimated 19.3 per cent of the country’s total banking assets.

At the time of the announcement of the closure of Islamic windows, ratings agency Moody’s Investors Service said Islamic banks would benefit from access to a larger pool of customers and would improve their profit margins. Conventional banks would lose between 8 and 16 per cent of their deposit bases, assets and profits, forecast Moody’s.

However, there has not yet been a significant transfer of assets from the conventional to the Islamic in the nearly two years since the QCB directive. Indeed, Qatar National Bank (QNB), considered the bank most exposed to the negative impact of the ruling, actually saw its assets rise by 35 per cent in 2011.

Analysts do not expect that a major migration in assets will be under way anytime soon. “When the new ruling came out we came out publicly and said we don’t expect a massive transfer of assets from conventional banks into Islamic banks and we have been proven right; it hasn’t happened,” says Mahin Dissanayake, senior bank analyst at Fitch Ratings.

The only significant sale of an Islamic window to date was the divestment in August 2011 by International Bank of Qatar (IBQ) of its Al-Yusr Islamic banking business to Barwa Bank, a sharia-compliant Qatari lender.

Profits for some

On the other hand, some Islamic lenders do seem to be benefiting from the move. “We are already seeing the impact of the closing of the Islamic windows,” says Raja Ghoussoub, vice-president of research at Kuwait’s NBK Capital. “For example, Qatar Islamic Bank (QIB) witnessed rapid growth in its financing book, which expanded 29 per cent between December 2011 and September 2012.”

Total assets at the bank rose 26.7 per cent by end-September 2012, compared with the year earlier, standing at QR66.8bn ($18.3bn). Asset growth has been supported by rising financing activities, which reached QR38.1bn.

QIB’s lending has grown more ambitious in the past year. Its latest major loan agreement saw the bank, Qatar’s largest Islamic lender, extend $500m to telecoms giant Qtel in September 2012, the first ever sharia-compliant loan taken on by the company.

QIB is also looking to deepen its debt capital market issuance, establishing a $1.5bn sukuk (Islamic bond) programme.

Barwa Bank, the newest Islamic lender in Qatar, has also shown a substantial increase in loans and assets. In 2011, total assets increased by 143 per cent to reach QR19bn, after the financing portfolio rose from QR2bn to QR9bn, with customer deposits trebling from QR3bn to QR9bn.

The bank was among the first to benefit from the QCB ruling regarding the closure of the Islamic windows of conventional banks, having picked up IBQ’s Islamic retail banking operations last year, a move that expanded the bank’s customer base and branch network. It ended the year with six branches as opposed to the single one it started out with.

Mixed picture

If QIB and Barwa Bank can attribute at least a portion of their balance sheet growth to the positive impact of the QCB ruling, for other Islamic banks it is more of a mixed picture. Qatar International Islamic Bank’s (QIIB’s) total financing portfolio grew by only QR2bn to end September 2012 at QR12.6bn.

For conventional banks, the pain of losing Islamic franchise business has been ameliorated by the otherwise benign economic conditions in the emirate. “Although the closing of Islamic banking windows was a negative development for conventional banks as it prevents their involvement in a high-growth industry, this impact is overshadowed by the growth in the domestic market and the strong demand for traditional banking products,” says Elena Panayioutou, Moody’s Qatar bank analyst.

In other words, the rude health of the sector overall has insulated the conventional banks from erosion of market share.

The dominant Islamic window was QNB’s – by far the largest bank in Qatar, which held QR30.2bn in Islamic assets at the end of 2010 – followed by Commercial Bank of Qatar and Doha Bank.

“With a regulatory tailwind behind them, sharia-compliant banks have plenty to look forwards to”

Among the standalone Islamic lenders, after QIB, the two biggest institutions are Masraf al-Rayan (whose assets stood at QR60.5bn at mid-2012) and QIIB, which held QR25.5bn in assets at the end of the third quarter of 2012. QIB is also the third-largest bank in Qatar by assets, accounting for 8.5 per cent of total banking assets and 36 per cent of Islamic banking assets at mid-2012. The bank’s robust market position is bolstered by its close links to the government, with the Qatar Investment Authority (QIA) the largest shareholder with a 16.7 per cent interest. In a sign of Islamic banks’ growing maturity, QIB has participated in some major project-related activity, announcing in April the signing of a deal with the Middle East Dredging Company (Medco) to finance the company’s channel dredging work at the New Doha port project.

The QR4.5bn financing will enable Medco to buy the required machinery, equipment, labour and other necessary works needed to execute the contract. The port project forms part of the Qatar National Vision 2030 plan.

If Islamic banks such as QIB can build up their project loan banks in this way, they should be well placed to compete with the likes of QNB in the burgeoning Qatari project market.

“Some of the Qatari projects have an Islamic tranche attached to them and if you look at aircraft financing deals, these are typically asset- backed finance structures, where Islamic banks have the skills set,” says Dissanayake.

“This is generally the type of business that they can take on, so they can finance the purchase of jets and ships.”

Debt capital markets will prove another key growth area for Qatar’s Islamic banks. The government is pushing an ambitious sovereign sukuk programme and has started to build a yield curve for both conventional and Islamic securities. In May 2012, the government mandated five banks to help arrange a new sovereign Islamic bond.

Sukuk issuance, however, is not going to be restricted to standalone Islamic banks, and there are likely to be tie-ups between conventional and Islamic players in the issuance of Islamic debt securities.

“The QCB ruling does not explicitly prevent conventional banks from issuing sukuk. What we will likely see is a tendency whereby there will be at least one Islamic lead manager in order to issue sukuk,” says one Doha-based banker.

A new sukuk from QIIB has seen a mix of conventional and Islamic players participating. In October, QIIB brought in the UK’s HSBC bank and Standard Chartered alongside QNB Capital as mandated banks to arrange the investor meetings in the Middle East, Asia and Europe.

Sukuk plans

The $700m five-year sukuk is in line with the bank’s strategic plans to actively participate in financing large projects, particularly on the infrastructure side, and megaprojects. At the time of its launch in mid-October, subscriptions for the sukuk exceeded $5bn.

QIB is also planning a dollar-denominated sukuk under its recently approved $1.5bn sukuk programme.

Qatar’s Islamic banks are also winning mandates for international sovereign sukuk issuance. In September 2012, Barwa Bank was appointed co-lead manager for Turkey’s debut sukuk worth $1.5bn, having previously established its credentials as co-lead manager role on Dubai’s $1.25bn sukuk issuance.

Mimicking their conventional counterparts, Qatar’s Islamic banks are looking to become more acquisitive. Masraf al-Rayan, for example, is bidding to buy a 70 per cent stake in the UK-based Islamic Bank of Britain, its first big overseas foray.

With a regulatory tailwind behind them, Qatar’s sharia-compliant banks have little to fear and plenty to look forwards to.

The share of the country’s Islamic banking sector by total assets, at 19 per cent, makes it the second largest sector in the GCC, behind Kuwait. That proportion is only likely to grow, as Islamic lenders compete on a level playing field for a robust pipeline of lending activity.

Qatar Islamic banking in numbers

29 per cent: Rise in Qatar Islamic Bank’s loans between December 2011 and December 2012

26.7 per cent: Rise in assets of QIB as of September 2012 compared with a year earlier

Source: MEED