QR40bn: Islamic assets held by conventional banks
QR8.8bn: The profit those assets generated in 2010
At the start of 2011, if you lived in Qatar and wanted a sharia-compliant bank account, you could have turned to any of 12 different institutions. These days, your choice is down to just four.
The change comes as a result of a surprise decision by the Qatar Central Bank in early February to force conventional banks to shut their Islamic divisions. They have until the end of the year to wind down existing sharia-compliant assets and liabilities, or place them into a special portfolio until they reach maturity. In the meantime, they are barred from opening any new Islamic branches or accepting any new Islamic deposits at their existing offices.
Competitive landscape for Qatar banking sector
Qatar’s banks are still coming to terms with the implications of the decision. It promises to significantly change the competitive landscape in the financial services sector.
The clear winners will be the country’s four wholly Islamic banks: Qatar Islamic Bank (QIB), Masraf al-Rayan, Qatar International Islamic Bank and Barwa Bank. They have the opportunity to target more than QR40bn ($11bn) of Islamic assets held by conventional banks, which now need to be transferred. They can also go after the QR8.8bn in annual profits that those assets helped to generate during 2010.
Any bank that gets concentrations in its loan book makes itself vulnerable to problems
Islamic banking industry analyst
“The segregation of the Islamic business from the conventional banks will provide room for growth for the Islamic banks, which operate in a highly competitive market,” says Elena Panayiotou, lead analyst for Qatari banks at Moody’s Investors Service, a ratings agency.
“[It] will provide access to a larger pool of customers, strengthen their franchise dynamics as fewer institutions will be competing for the same business and potentially provide greater bargaining power with customers, resulting in better profit margins.”
The question for sharia-compliant institutions now is whether they can take full advantage of the opportunity that lies in front of them. Some caution is justified on this as Qatar’s Islamic banks have not always performed well compared with their peers in other countries.
The rise in political instability in the region is largely negative for Islamic banks
Anouar Hassoune, Moody’s Investors Service
They were far more exposed to the real estate and construction sector during the boom. In 2008, 38 per cent of all loans from Qatar’s Islamic banks were directed to the property market, according to statistics from the International Monetary Fund. The same year, 26 per cent of the credit provided by the UAE’s Islamic banks was directed towards real estate and construction – even though the UAE is generally seen to have had the most egregious property market bubble in the region.
The figure for Saudi Arabia’s Islamic banks was just 5.5 per cent, which made them the most conservative in the Gulf in that respect.
The Qatari banks’ overexposure to a single part of the economy meant that, while their assets, credit and profitability all grew strongly in 2007, those figures dropped sharply in 2008 when the global economic downturn struck. Having largely outperformed conventional banks in 2007, they lost ground to them the following year.
“Any bank that gets concentrations in its loan book or funding base makes itself vulnerable to problems,” says one industry analyst. “It all comes back to the basics of banking. What your deposit base is, what your capital position is, how profitable you are and what your asset quality is like.”
The banks have since recovered, but the four remaining players in the country’s Islamic market will need to be careful to avoid such overexposure in the future.
While they try to work out how best to take advantage of a market that has become far more attractive overnight, the position of the eight conventional banks with Islamic windows is somewhat different. Instead of preparing for growth, they are left wondering how to adjust to their exclusion from what has become the most dynamic part of the market.
“Fundamentally, this will be healthy for the Islamic banks,” says a source in a local conventional bank. “They’re the direct beneficiaries of such a move because the market share taken by the bigger banks was considerable. What this means for us is no new Islamic business. We need to wind down our operations, but still need to manage existing deposits until their maturity is reached, which could take years.”
The situation lacks transparency. The three largest conventional banks in the country, Qatar National Bank (QNB), Commercial Bank and Doha Bank, all saw their Islamic divisions grow more quickly than their conventional business last year. Profits at QNB, for example, rose by 136 per cent overall between 2009 and 2010, but by 249 per cent in its Islamic division.
Their ejection from the Islamic market means they are all likely to see profit and asset growth slow in the coming years. In the shorter term, they also need to decide what to do with their existing Islamic branches and assets. The main choices are to simply shut down their Islamic branches, convert them into conventional bank branches, or to sell that part of their business.
It may also be possible for them to set up an Islamic banking subsidiary with a separate licence from the central bank, or to take stakes in wholly Islamic institutions. Kuwait, which also insists on a distinct separation of Islamic and conventional banks, allows this. National Bank of Kuwait, for example, holds 46 per cent of Boubyan Bank, but it is not yet clear if the Doha authorities will also allow such a practice.
Decision time for banks in Qatar
Conventional banks have until the end of the year to decide what to do and most are still trying to work out how best to proceed. “We are currently considering our options,” says a spokesman for HSBC Amanah, the sharia-compliant arm of the UK banking giant.
Similarly, a spokesman for Commercial Bank, which has one of the largest Islamic windows in the country with assets of QR4.4bn and eight branches, says: “We are still seeking further clarification from the central bank. We are looking for additional clarity before we can make any important business decisions.”
For investors, February’s abrupt policy change led to a more straightforward calculation. The fear of falling profits at conventional banks, with the hope of rising income at Islamic banks, prompted them to take action. That day, in heavy trading on the Qatar Exchange, the share prices of the three listed Islamic banks, QIB, Masraf al-Rayan and Qatar International Islamic Bank, rose by about 10 per cent.
The impact on the commercial banks was generally more muted, but QNB, the most heavily exposed to the Islamic banking sector, saw its value drop by 5 per cent. By the end of the week, Al-Ahli Bank, which also has a relatively large Islamic banking operation, had lost a similar amount of its value and Doha Bank was forced to deny speculation that it might transform itself into a fully Islamic bank.
By 10 February, the central bank had issued its statement confirming and explaining the decision to segregate the market. In its announcement, it raised some legitimate concerns over the potential confusion in having Islamic and conventional assets controlled by the same institution. In particular, it pointed to the problems it raises for risk management and regulatory oversight.
There are different international standards for reporting the financial results of Islamic and conventional banks, for example. The central bank says it is preparing new capital adequacy ratios for Islamic banks that will differ substantially from those given to conventional banks.
The central bank also insisted that the country’s existing Islamic bank network is extensive enough to meet demand. However, further growth of branch networks is now likely, whether from organic expansion by the Islamic banks or via the takeover of sharia-compliant branches currently operated by conventional banking rivals.
Qatar’s Islamic banks are still relatively small in regional terms. The assets of QIB, the country’s largest, are equivalent to just 29 per cent of Saudi Arabia’s Al-Rajhi Bank and 30 per cent of Kuwait Finance House, the two largest Islamic institutions in the Gulf. It is possible the recent decision by the central bank could, in the longer term, allow QIB to offer a challenge to the market leaders.
At the same time, events outside the country offer further opportunities for growth. The violent crackdown on pro-democracy protests this year in Bahrain, which has historically had one of the most active Islamic banking markets in the world, is likely to undermine its attractiveness for many businesses. Qatar offers a stable alternative base in the region, although it will have to compete with the far larger banking market in Dubai for that business.
“The rise in political instability in the region is largely negative for Islamic banks,” says Anouar Hassoune, senior credit officer at ratings agency Moody’s Investors Service. “The centre of gravity of Middle Eastern Islamic finance is moving. Bahrain now offers a more fragile operating environment for Islamic financial institutions.”
Rapid expansion in Qatar
Another factor in favour of Qatar in the coming years is the anticipated growth in its economy. Substantial receipts from its gas exports and the need for significant amounts of infrastructure investment in preparation for the football World Cup in 2022, is fuelling the state’s rapid economic expansion.
This combination of strong domestic economic factors and political strife in rival financial centres means there would be a clear opportunity for Qatar’s Islamic banks to grow. With the regulatory change announced in February added into the mix as well, the future looks even brighter for them.
Regulatory standards in Qatar’s banking sector
The move to stop conventional institutions offering Islamic banking could be seen as the first step by the Qatari authorities towards a complete overhaul of the Gulf state’s banking sector.
With the banking community in a period of recovery and consolidation, Qatari regulators have taken a proactive approach in seeking to clarify the structure of the industry.
The Qatar Central Bank points out that Qatar already had an established Islamic banking sector that caters adequately for local demand for sharia-compliant services. With conventional banks moving into this area, the regulator says the overlapping nature of their Islamic and non-Islamic activities hampers the process of risk control.
It is easy to see why conventional institutions wanted to get into the Islamic field: across the Gulf region this has been a growing market, particularly for retail banking. This is a strong attraction for conventional banks whose business is heavily oriented towards the corporate market.
However, in terms of fast-tracking and merging the regulatory standards, there has been no sign of an early decision. “We do not expect major changes to the regulatory framework in Qatar following the recent separation of conventional and sharia-compliant banking,” says Panayiotou.
“Although there are still plans to establish a single banking regulator under the Qatar Financial Centre and the central bank, no details have been disclosed of when such a merger will happen. For now, both conventional and Islamic banks continue to fall under the central bank’s supervision.”
The domestic banks could be the ones to suffer. The central bank has shown – both throughout the global financial crisis and in its recent action on the Islamic finance issue – that it is a decisive and strong regulator and due to its preventative measures, the Gulf state maintains a strong economic position.
The case for change in the regulation of the country’s financial sector remains in place, but it may have been weakened by the Qatari authorities decisive and effective strategies over the past few years.