Riding on Fundamentals

Loan-to-deposit ratios will likely remain steady in 2013, according to Fitch Ratings, as Omani banks are already well capitalized. An expected increase in customer deposits will likely grow but will be offset by limited access to international wholesale funding, partly due to the modest rating of Omani banks compared with others in the GCC.

Aggregate deposits held with commercial banks increased from OMR12.57 billion ($32.68 billion) in 2011 to OMR14.17 billion ($36.84 billion) at the end of 2012. Private sector deposits, accounting for 64% of the total base, rose by 12.3% in 2012. Hamood Sangour Al Zadjali, Executive President of the Central Bank of Oman (CBO), expects continued broad-based growth in private sector deposits. “With government expenditure playing a significant role in overall GDP growth, the deposit growth in the banking sector is expected to remain buoyant,” Al Zadjali told TBY in an interview.

New regulations on retail lending—a cautionary move aimed at ensuring loan quality and healthy consumer habits—are squeezing margins, with slightly lower net earnings expected for 2013. However, demand for credit from the corporate sector is expected to keep credit growth at approximately 10%-12%, according to Fitch. At the same time, emphasis on credit quality is bearing fruit. Provisions at the end of 2013 stood at 2.4%, while non-performing loans (NPLs) at the end of 2012 formed just 2.2% of total loans, according to the CBO.

LANDSCAPE

Oman’s six listed commercial banks represent 90% of total credit as of end-2012. They raised an estimated $1 billion in equity and subordinated debt issuances over the year and reported total profits of approximately $691 million, implying a return on equity (ROE) of 13.4% and growth of 25% over 2011.

The largest bank in Oman is Bank Muscat, with $21.37 billion in assets, $3.25 billion in market capitalization, and a market share of 38.5% as of April 2013. It also has the largest branch network, with 136 domestic branches.

National Bank of Oman is the second largest with $7.10 billion in assets followed by HSBC Bank Middle East Limited, Oman ($6.65 billion), Bank Dhofar ($6.09 billion), Bank Sohar ($4.65 billion), Oman Arab Bank ($3.40 billion), and Ahli Bank ($3.18 billion).

Bank Dhofar took the top spot in terms of profitability in 2012 with $83 million in net profits. Bank Muscat recorded net profits of $65 million followed by National Bank Oman on $22 million. Bank Sohar, Oman Arab Bank, and Ahli Bank all recorded $16 million, with HSBC Bank Middle East Limited, Oman rounding out the group with $15 million in net profits for the year.

Increased competition has already pushed some degree of consolidation in the market. HSBC merged its Omani assets with Oman International Bank in April 2013, creating the second-biggest network in the Sultanate under the name HSBC Bank Middle East Limited, Oman. Bank Dhofar has also opened merger talks with Bank Sohar, potentially creating a new second-biggest bank, with a prospective combined $10 billion in total assets.

REGULATORY CHANGES

Relatively high interest margins for personal loans have been a significant revenue generator for Oman’s banking sector in recent years. At the end of 2012, the sector-wide loan portfolio stood at OMR14.4 billion, of which 40% were personal loans. However, in a cautionary move aimed at ensuring sustainable personal debt levels among individuals as well as banks, a regulatory change by the CBO may push down that figure. A 2012 law stipulated that commercial banks cannot deduct more than 50% of a borrower’s salary as an equated monthly installment (EMI) for personal loans and 60% for housing loans. In order to lower the repayment burden, the loan repayment tenure was also capped at 10 years. A further tightening is planned for June 2014, when the upper ceiling of the commercial banks’ personal loan portfolios lowers from 40% to 35% of a bank’s total credit.

Downward regulatory pressure on retail lending is coupled, however, with a move to raise the housing loan limit from 10% to 15%. Ultimately, this regulatory shift is meant to implement discipline in the broader economy by reducing debt for depreciating assets, while at the same time freeing up financing for sounder investments such as houses. Although the change will have an immediate impact on overall revenue since the mortgage market has lower margins than the personal loan segment, the increase in mortgage finance is expected to improve banks’ loan quality and by extension drive the real estate sector and provide a more solid footing for the overall growth of the real economy.

These regulatory shifts are happening against the backdrop of Oman’s broader movement toward Basel III compliance. The CBO is currently implementing a roadmap on capital adequacy, stress testing, and market liquidity in accordance with the newest global regulatory standards. Omani banks are ahead of the game in many respects, including an overall capital adequacy ration (CAR) of between 16% and 20%, well beyond the Basel committee criteria of 8%.

ISLAMIC BANKING

The most conspicuous change to Oman’s banking landscape is the introduction of Islamic banking by Royal Decree in 2012. The law allows purely Islamic banks to operate or existing banks to establish completely independent Islamic finance windows. Ratings agency Moody’s believes the Islamic banking sector is likely to take a 6%-8% share of the market over the next three to five years.

According to Sulaiman bin Hamed Al Harthy, Group General Manager of Bank Muscat’s Islamic banking division, there is potential for broad market capture. In an interview with TBY, Al Harthy stated that he believes there is a small segment of the population that will bank strictly Islamic and a small segment that will bank strictly conventional, but that the largest segment—possibly 40%—simply prefers Islamic banking, but only if it offers competitive value and enough incentives to change accounts. “This is why innovation will be crucial to the future growth of Islamic Banking in Oman,” he explained to TBY.

Banks face significant costs to establish new franchises, while the lack of domestic Islamic instruments, such as sukuk, make liquidity a challenge. However, in the medium term, the Sultanate is eying the demand for Islamic banking demonstrated in the other GCC countries, where Islamic assets currently account for between 15% and 50% of total banking system assets.

The benefit of Oman’s late entry into Islamic finance has been its ability to observe the strengths and challenges of neighboring regulatory frameworks. Oman’s own laws have been praised by industry insiders as precise and concrete. One differentiator from other GCC practices is that in Oman, people who sit on a bank’s sharia governance board can only have one board position at a time. Their term is four years, with a two-term limit followed by a cooling off period before another membership is possible. Also unlike several of its neighboring jurisdictions, Oman has established both a Sharia Monitor Unit as well as a Sharia Audit Unit.

The CBO shares this view. “It is expected that Islamic banks will complement the current conventional banking in promoting growth in the economy, diversifying banking services, and augmenting financial inclusion,” CBO Governor Al Zadjali told TBY.