Oman’s new Islamic banking department established by the Central Bank is reflective of the commitment to Islamic banking. It also shows how regulation can be supportive of the growth potential for Islamic banking. While Oman’s Islamic banking has stayed in the spotlight, takaful is on the sidelines waiting for a takaful law and seeing its growth eclipsed by Islamic banks. According to central bank data as of Q1-2015, Islamic banking assets account for 5.5% of all banking assets in Oman and 6.5% of all financing. Takaful accounted for about 6.5% of all gross written premiums.
The growth of Islamic banking assets was aided by a comprehensive Islamic banking regulatory framework (IBRF) which was released in December 2012. The initial asset base was composed of Bank Muscat’s portfolio of Islamic banking assets it built prior to the official start of Islamic banking as well as the proceeds from the IPO of Alizz Islamic Bank and Bank Nizwa, the two standalone Islamic banks, earlier in 2012. These three banks continue to represent about 60% of Oman’s Islamic banking assets.
Asset growth for the sector as a whole—from RO 429.5 million ($1.1 billion) in Q1 2013 to RO 1.5 billion ($4.0 billion) in Q1 2015 represents an annualized growth rate of 106%. A growth rate this rapid is a testament to both high consumer awareness of Islamic banking and demand for it. Oman ranked third in the ICD Thomson Reuters Islamic Finance Development Indicator, behind only Malaysia and Bahrain and ahead of much larger markets for Islamic finance.
This growth has somewhat missed the takaful sector which awaits a takaful law “soon” according to reports in local media. The ongoing rules which are set to continue under the final takaful law include a requirement for an IPO and a ban on takaful windows. To date, only one insurer (Al Madina Takaful) has converted to takaful and another, Takaful Oman, was set up de novo. Both commenced takaful operations at the beginning of 2014. Compared to the Islamic banking market, supported by the IBRF and CBO’s attention, takaful has somewhat languished with market share only rising from 5.8% to 6.5% through the first quarter of 2015.
The slower growth is due in part to the limitation in the market to publically traded, standalone takaful operators only but 2016 could be a good year for takaful in Oman. A first step in accelerating takaful’s expansion into is the plan by Al Madina to acquire Vision Insurance, which had premiums of RO 16.8 million in 2014 (up over 30% year on year compared with 2013). The combined entity would control nearly all of the takaful in Oman and represent over 10% of all written insurance premiums in Oman. This would represent significant growth potential for takaful and establishment of an equally rigorous regulatory system to the country’s Islamic banks is key to growing the market further.
Indonesia’s new repo facility for Islamic banks will help to reduce their liquidity risk by providing ready access to repo transactions collateralized by government sukuk. However, in the absence of Shariah compliant deposit insurance, Basel III liquidity coverage ratio (LCR) rules could apply higher run-off factors on deposits at Islamic banks than conventional banks, offsetting the benefit of having an Islamic repo.
One of the objectives of the Basel III rules is to provide a liquidity management framework that attempts to insulate banks from liquidity risk by requiring higher short-term liquidity coverage to act as a short-term (30 day) buffer against potential liquidity disruptions. While it can help reduce vulnerability to liquidity crises, it will disadvantage Islamic banks if they are effectively forced to carry higher liquidity because equivalent repo products, something that has eluded the industry for many years, are not available or not recognized on par with their conventional alternatives.
Even where Islamic repo products are made available, their usage is limited because most Islamic banks have short-term excess liquidity making it difficult to find another Islamic bank that needs cash and can pay a competitive return to justify the risk. In many markets, low global interest rates mean there is not as stiff a penalty for banks that hold cash instead of low yielding assets. However, in countries like Indonesia where interest rates (overnight rate is 7.5%) and inflation (currently at 7.3%) are higher, there is a bigger opportunity cost.
The head of the Indonesian Islamic Global Market Association is of the view that the newly launched repo rate is likely to be above the FASBIS (the overnight facility with the central bank) but below the interbank financial market price since the repos will be collateralized with government sukuk. Higher rates than the central bank rate will help increase its appeal, as will the safety provided by collateralization. However, it is imperative that a suitable Shariah compliant deposit insurance program is set up to equalize the LCR treatment for banks using the Islamic repo product to ensure that it doesn’t disproportionately affect Islamic banks.