In January 2013, Bank Nizwa became Oman’s first Islamic bank to open for business, following a royal decree in May 2011 allowing sharia banking in the sultanate.

The decree permitted the establishment of both dedicated Islamic banks and sharia-compliant windows by conventional banks, making the sultanate the last GCC country to embrace the industry.

Alizz Islamic Bank has also been granted an Islamic banking licence and is expected to launch in September. Conventional banks too have started testing appetite for sharia products, converting existing branches to offer Islamic banking services. It marks the start of a new financial services industry in Oman.

Credit growth

The two new Islamic lenders will be looking to tap into growing demand for credit in the sultanate, which is being driven by increased government spending and the expansion of the private sector. Between 2006 and 2011, banking credit grew at an average of 21.6 per cent, more than 1.5 times the rate of expansion in gross domestic product (GDP). From 2013 to 2017, growth is expected to average 12.2 per cent.

Recent experience from Qatar suggests customers in Oman will opt to get sharia services from established banks

Bank Nizwa started operations in January, following a RO681m ($1.7bn) initial public offering (IPO), which was 17.1 times oversubscribed, reflecting the strength of interest in the emerging sector. The lender started off with a presence in Muscat, Nizwa and Sohar, and is in the process of opening four additional branches in Ibraa, Salalah, Al-Khoudh and Ghubra.

Bank Nizwa’s range of sharia-compliant products includes raising debt – it obtained an Islamic investment banking licence in July. As Oman’s money markets remain undeveloped, sukuk [Islamic bond] issuance could help firms in the country tap into financing.

Current projections state the bank could turn a profit of RO29.2m by 2017. Initial infrastructure and asset investments resulted in a loss of about RO11m in the first half of 2013, but this is broadly in line with expectations.

Upon the launch of the brand in May 2012, Ahmed al-Rawahi, chairman of Bank Nizwa’s founding committee, said the feasibility study for establishing the bank showed there is substantial unmet demand for sharia finance products in the sultanate, with at least 20 per cent of Omanis saying they would prefer a sharia-compliant bank.

“This, together with the attractive economic fundamentals of Oman and the growth in the Omani banking market, highlights the growth opportunity for Bank Nizwa,” he said.

A 2011 study by the UK-based Islamic Finance Advisory & Assurance Services indicates support for the sector is certainly present. According to the report, 85 per cent of retail consumers in Oman expressed an interest in Islamic finance products. More than half were said to be “bothered” by using riba (interest)-based products.

Alizz Islamic Bank, meanwhile, plans to launch its operations in September, having completed a $102m IPO in November 2012. “I believe in the long run Islamic banks and windows will start eating up market share from conventional banks,” says Jamal Darwiche, acting CEO at the lender.

“What will be critical to further support the sector is the development of Takaful [Islamic insurance], an equity index and the issuance of sukuk. Liquidity in Oman is strong, so banks will want to create more products in order to diversify their source of funding.

“Sukuk in particular could be used as an alternative for leveraging. An [added] advantage is that the central bank allows lenders to invest 75 per cent of their net worth in foreign currency-denominated assets in their first six months of operation, and 50 per cent in the following six months.”

Untapped potential

Darwiche says nearly three-quarters of the sultanate’s predominantly Muslim population is ‘bankable’ as the market is currently underpenetrated, compared with the rest of the region. Oman’s banking assets currently account for only about 70 per cent of GDP, compared with a GCC average of 114 per cent. Alizz Islamic Bank estimates sharia assets in Oman will exceed RO2bn by 2015, representing 10 per cent of total banking assets.

I believe in the long run Islamic banks and windows will start to eat up market share from conventional banks”

Jamal Darwiche, Alizz Islamic Bank

Trading in Islamic bonds is set to take off in the near future as well. In early June, the Muscat Securities Market (MSM) announced that it would soon launch the MSM Sharia Index, which will operate under standards issued by the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions.

A planned RO50m sukuk issue by the local Tilal Development Company – to repay debt and expand its Muscat Grand Mall development – is raising expectations that more companies will follow suit as the Islamic finance industry expands.

Over the past year, Oman has been developing its Islamic banking law, expanding the legislation to include detailed regulation regarding the types of transactions that are permitted, taxation, exceptions to land law constraints and the provisions of other areas of substantive law if Islamic banking is involved, as well as an outline of levels for sharia supervisory boards.

Strict regulations

Introduced in December 2012 to provide direction and support the industry, the Islamic Banking Regulatory Framework is expected to be reviewed periodically. It does not put in place a centralised body to supervise and vet Islamic products, allowing the banks to have their own sharia board to oversee product development. Strict rules have been established to ensure Islamic windows operate separately from their conventional parents.

Conventional branches of the parent bank are not allowed to offer Islamic banking products. Instead, they must open separate branches for the two different products and make clear the sources of their funds and what they are used for. Dedicated Islamic banking representatives are required to run back office operations and business for the Islamic windows.

Most conventional banks have already opened windows, including Bank Muscat (Meethaq), Bank Dhofar (Maisarah), Al-Ahli Bank (Al-Hilal Bank) and Sohar Bank (Sohar Islamic). They need a minimum paid-up capital of RO10m, compared with RO100m for pure Islamic banks, though many windows operate on significantly larger amounts than required.

Oman Islamic banking sector 
Pure Islamic banks Islamic window Launch date Number of branches/windows
Bank Nizwa — Jan-13 3
Alizz Islamic Bank — Sep 2013 (expected) na
Conventional banks with Islamic windows
Bank Muscat Meethaq Jan-13 1
National Bank of Oman Muzn Islamic Banking Jan-13 1
Bank Dhofar Maisarah Islamic Banking Mar-13 4
Sohar Bank Sohar Islamic Jul-13 2
Al-Ahli Bank Al-Hilal Bank Jan-13 6
Oman Arab Bank  Al-Yusr Islamic Banking Jan-13 1
Standard Chartered Bank Saadiq Expected soon na
Oman Development Bank na Expected soon na
National Bank of Abu Dhabi Abu Dhabi National Islamic Finance Expected soon na
na=Not applicable. Source: MEED

The first steps towards creating an Islamic interbank market have been also taken in recent months. Bank Nizwa has signed wakala [agency contract] agreements with various Islamic windows in a move towards greater cooperation among Islamic lenders.

“A lot of conventional banks opened their windows more as a defensive strategy to avoid losing clients,” says Laila Sadek, a London-based analyst at the US’ Fitch Ratings. “They have the advantage of being able to cater to either type of client. They are doing well, but not that well.”

Competition to win customers between the windows and the dedicated Islamic banks is expected to be fierce. Based on discussions with conventional banks, Sadek believes pure Islamic banks will require more aggressive strategies to win market share. “A lot will be [dependent on] terms, pricing, and levels of service, though there is certainly room for growth,” she says.

The combination of a well-known brand, an established network, service quality and cost-efficiency savings will give the incumbents a significant advantage, said Fitch Ratings in a November assessment of Oman’s emerging Islamic finance industry. The agency believes there will be opportunities for cost savings at the operational level over pure Islamic lenders, despite the need to keep existing and sharia operations separate at the point of contact with customers.

“While there is demand for Islamic banking, and its growth across the Gulf region is likely to outpace that of conventional banking, recent experience from Qatar suggests customers in Oman will opt to get these services from established banks,” the assessment said.

On the other hand, conventional banks are close to regulatory caps. The new Islamic banks are also likely to have funding cost advantages as they raise low-cost deposits.

Sadek says conventional banks’ Islamic windows currently account for 1-3.5 per cent of total lending activities.

Cautious approach

Oman has adopted a cautious approach to establishing an Islamic banking sector, waiting to see how the industry developed elsewhere in the region before introducing its own legislation. And it is still treading carefully.

For the time being, it looks like Bank Nizwa and Alizz Islamic Bank will be the sultanate’s sole dedicated institutions – the central bank has indicated it will not be issuing more Islamic banking licences while it monitors the market’s reaction to new lenders.

Dubai’s Arqaam Capital predicts that the two banks will take 34 per cent and 18 per cent respectively of the Islamic finance market by 2015, representing 4 per cent and 2 per cent of the overall national banking market. It expects Islamic finance to generate 15 per cent of outstanding loans in Oman in the next five years.

For consumers, meanwhile, the introduction of Islamic banking represents an opportunity for attractive deals as banks compete for business.

Key fact

About 85 per cent of retail consumers in Oman have expressed an interest in Islamic finance products

Source: Islamic Finance Advisory & Assurance Services report