That Oman’s banking sector emerged from the global financial crisis relatively unscathed is hardly surprising. In the years leading up to the crash, the country's banks trod a careful path to sustainable growth, limiting their exposure to the kind of risk that undermined some of their Gulf Co-operation Council (GCC) counterparts.
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Under the guidance of the country’s central bank, most lenders concentrated on the domestic market, a strategy that has generated a resilient and stable banking system. This approach has produced a notable, if unspectacular, upward trajectory for the country's banks. Today, Oman’s lenders have quietly emerged as one of the more impressive growth stories in the Middle East and north Africa (MENA) region.
Impressive growth
According to The Banker Database, the average return on assets for Omani lenders to year-end 2013 was 1.85%, compared with a MENA average of 1.73%. Similarly, the aggregate capital adequacy ratio for Omani lenders hit 11.61%, compared with a regional figure of 10.66%. Much of this success has been driven by the strength of the country's economy, which has recorded a compound annual gross domestic product growth rate of 4.7% over the past five years, according to think tank the Heritage Foundation.
It is also a product of the oversight of the Central Bank of Oman (CBO), which has been mindful of generating a responsible banking model. “The CBO has to be commended for the way in which it has minimised the risks to Oman’s financial sector. It has always acted quickly in terms of implementing regulation, and has saved a number of Omani lenders from ill-advised business ventures,” says Mohammed Al Ardhi, chairman of the National Bank of Oman, the country’s second largest lender by total assets.
This prudent approach to oversight has been accompanied by a progressive approach to regulation, in which the CBO has emerged as one of the region’s more pioneering regulators. As in many economies in the region, Oman’s small and medium-sized enterprises (SMEs) have traditionally been starved of credit. To address this, the central bank boldly implemented minimum SME lending requirements, amounting to 5% of the banks’ total credit portfolio in 2013.
While Oman was the last Gulf state to authorise Islamic banking, in 2012, it became the first to introduce a centralised sharia-board in late 2014. This centralised structure, which draws on the experience of jurisdictions such as Malaysia, is expected to improve the standards and consistency of Islamic finance in the country. In a nod to the efficacy of this approach, the central banks of the United Arab Emirates and Bahrain are expected to follow Oman by enacting centralised systems in the coming months, according to local press reports.
Clouds on the horizon?
For Oman’s lenders, these developments, coupled with the country's strong economy and extensive government infrastructure plans, led to a successful 2014. Yet, the longer term picture is less clear. The country’s economic growth may be hit over the medium term if energy prices remain depressed. Moreover, the regulatory environment which has served Oman’s banks so well in recent years has the potential to stifle longer term growth in a highly competitive market by limiting the prospects for expansion.
"The year 2015 will be a period of increasing competition for the banking sector in Oman with the launch of competitive channels and new products to cater to new and growing [business] sectors," says AbdulRazak Ali Issa, chief executive of Bank Muscat, Oman's largest lender by both Tier 1 capital and total assets.
For now, most indicators remain positive and industry insiders remain optimistic about their near-term prospects. These views were vindicated by the performance of Oman’s largest banks over the past 12 months. Bank Muscat saw net profit for the year ending on December 31, 2014 increase by 7.3% from OR152.19m ($395.27m) to OR163.23m while net loans and advances grew by 8.4%. "The banking and financial sector witnessed healthy performance in 2014 in tandem with the economic growth led by sustained consumer demand and public sector activities. Banking credit growth stood at over 10% by the end of November 2014 to reach OR16.8bn compared to OR15.2bn during the same period in 2013," says Mr Ali Issa.
Meanwhile, BankDhofar, the country's number one lender in terms of return on assets and return on capital, maintained its impressive growth momentum, registering net profit growth of 14.23% year on year, excluding a one-off legal case recovery, in 2013. “The result has been very satisfactory for 2014. We are reaping the rewards of our five-year strategy, initiated in 2012, which emphasises investments in technology and enhancing the efficiency of our operations,” says Abdul Hakeem Omar Al Ojaili, acting CEO of BankDhofar.
Yet, it was the National Bank of Oman which posted the most striking figures from 2014. Net profits increased by 21%, reaching OR50.3m in 2014, up from OR41.4m the previous year. This success was accompanied by modest total asset growth, which saw a 3% rise to hit OR2976.1m by year-end 2014. “We have worked hard to develop our team, attract new talent and become more efficient. There is great potential for growth across Oman’s financial sector and we believe our performance speaks to the strength of the Omani economy,” says Mr Al Ardhi.
Oil worries
Nevertheless, despite the bullish outlook shared by most of the country's lenders, the depressed oil price environment will offer longer term challenges. While continued government spending and ongoing infrastructure development will diminish the short-term impact of this price environment, most observers concede that 2016 will be a more difficult year for Oman's banking sector.
In a December 2014 report from Moody’s, the agency noted that Oman will be more adversely affected by lower oil prices due to its higher fiscal break-even oil price and lower reserve buffers relative to its GCC peers. "We think that reviewing and reducing non-strategic projects, such as cancelling prestige capital projects and delaying non-essential infrastructure upgrades, will be a starting point, following the experience in the previous oil price downturn," said the report.
In January, the Omani government passed a 2015 budget which increased spending by about 4.5% from the previous year. Assuming an oil price of $65 for 2015 to 2017, this will see the country's fiscal balance shift to negative territory, hitting -15.2% during this period, according to projections from the World Bank. While the government may intervene either through spending cuts or tax increases, sovereign debt issuance will likely finance this deficit expansion.
In this respect, the government’s ambitions have been a source of confidence for most lenders, as few predict a fall off in activity from the country’s larger corporates over the short term. “Lower oil prices will definitely make the corporate sector more cautious and they will try to rationalise their costs. Nevertheless, 2015 won’t throw up too many difficulties because most projects are already under way. Beyond that, we will need to see,” says Mr Al Ojaili from BankDhofar.
A steady course
With the government expected to issue about OR500m in conventional and Islamic bonds in the first half of 2015, there is clearly little appetite to alter the country's course of economic development. "The banking sector is poised to continue its strong performance owing to the government’s ongoing focus on economic diversification and infrastructure development across the sultanate," says Mr Ali Issa from Bank Muscat.
For now, the priority is to diversify a hydrocarbons-dependent economy and to achieve this by allowing SMEs to flourish. Here, the banking sector is playing a sizeable role, following the introduction of minimum SME lending requirements by the central bank in 2013.
"This has had a huge impact on Oman’s banking sector. Five percent of the banks' total loan portfolios will eventually be targeted towards SMEs, which is significant. It has put banks under pressure but I think it’s a good pressure. You have to be more flexible as a lender and you have to be aware of the challenges facing SMEs," says Mr Al Ardhi from the National Bank of Oman.
Though Omani lenders have been granted an extension to meet these requirements up to December 2015, most are now moving swiftly to engage with the country’s SMEs. New staff, services, products and branches are being rolled out across the country to tap into the potential offered by this largely under-served market.
"As part of its commitment to encouraging entrepreneurial initiatives, Bank Muscat recently launched the Najahi suite of products and services [targeting] and benefiting micro and small businesses. Similarly, an initiative offering non-collateral finance will be a major boost for start-ups and small businesses in Oman," says Mr Ali Issa.
For most, the challenge now is finding an effective approach to handling thinner credit files, assessing more opaque business practices and developing product and service solutions to meet the needs of small businesses across the country.
“When dealing with SMEs, you need significant in-house expertise to understand their exact financing requirements. In response, we have expanded our teams and developed business centres staffed with specialists. We have 68 branches that we would like to use as windows in order to sell our services in the SME space. In the past our branches were more focused on the retail side; now it’s a combination of retail and SME services,” says Mr Al Ojaili.
Islamic finance shines
Beyond SMEs, the Islamic finance sector is the brightest long-term prospect for most Omani lenders. Since the central bank authorised sharia-compliant financial services in late 2013, the industry has enjoyed stellar growth. With two fully fledged sharia-compliant lenders in the country, Alizz Islamic Bank and Bank Nizwa, coupled with five windows, most banks have been quick to capitalise on the opportunity. Islamic banking assets now account for 5% of the Omani system’s total.
That Oman’s Islamic banking sector has achieved this in a little over two years of being fully operational is remarkable. To put this development into context, it has taken Indonesia, which permitted the creation of sharia-compliant financial institutions in the early 1990s, more than two decades to achieve the same result. “When the sector was launched here, nobody expected that kind of growth in the first couple of years. The expectations were very low,” says Sohail Niazi, chief Islamic banking officer of Maisarah, the sharia-compliant window of Bank Dhofar.
Today, both the windows and fully fledged sharia-compliant institutions are flourishing. "Meethaq, under the umbrella of Bank Muscat, is the centre for Islamic financial services in Oman. Meethaq accounts for approximately a 50% share in financing of the total Islamic banking market in [the country]. With a paid-up capital of OR150m, Meethaq Islamic Banking is focused on developing as a benchmark Islamic financial institution on both the local and regional level," says Mr Ali Issa from Bank Muscat.
Encouragingly, much of this growth is emerging from new business as well as from conversions from conventional banking. The strength of the country's economy is one reason for the impressive numbers behind the growth of Islamic banks. Yet, according to Mr Niazi, it is also a product of Oman’s favourable demographics. “Just over 40% of the population is below the age of 34. That means there is a growing supply of new graduates coming to the job market and they are looking for financial services options. Younger demographics are very open to Islamic banking in Oman and we see this as an opportunity for continued growth.”
Alizz Islamic Bank, established in November 2012 as a fully sharia-compliant lender, has similarly benefited from the surging interesting in sharia-compliant finance. Despite the challenges of operating as a start-up entity, figures from September 2014 show the bank’s financing portfolio reached OR49.2m, while total assets hit OR104.23m. Aggressive network expansion saw Alizz extend its network to Salalah at the end of January, giving the bank a total of five branches including its headquarters.
“The two fully fledged Islamic banks launched simultaneously with the conventional bank Islamic windows are creating an exciting yet challenging market platform,” says Salaam Said Al Shaksy, chief executive of Alizz Islamic Bank. “As a new market entrant we want to differentiate ourselves through the efficiency of our services and our approach to the customer experience. We also have a big emphasis on alternative banking channels, including mobile and internet banking.”
The introduction of a centralised sharia board in late 2014, under the auspices of the Central Bank of Oman, will go some way to supporting the industry’s growth over the long term. In particular, it will act as a point of reference and help to harmonise industry standards in the country, as well as assuming an arbitration role in the case of any sharia-compliant disputes. Moreover, it has the potential to catalyse the development of in-country expertise in Islamic finance, ensuring that Oman becomes globally significant in terms of its human capital contribution to the industry both regionally and internationally.
Where now?
There is little doubt that the short-term picture for Oman’s lenders is promising. But real questions remain over how the banking sector can develop from this juncture. While the system as a whole is stable, it is also highly competitive. The financial sector, in conjunction with the oil and gas industry, is mature and dominates the country's business landscape.
This means that the potential for significant expansion, in a country of just over 4 million people, remains limited. Meanwhile, the Central Bank of Oman’s regulatory oversight, while a guarantor of stability, has also put pressure on the market by limiting the scope of banks’ lending activities and keeping the banks domestically focused.
“I strongly believe that the next phase for banking in Oman is not in Oman. The next phase is outside of the sultanate. We have reached a level of maturity and competitiveness where organic growth is not the long-term answer for the sector. As an industry, we need to have a conversation about where we go from here,” says Mr Al Shaksy.
In research published in June 2014, Moody’s noted that most of the country's mid-sized lenders are battling both intense competition and regulation in their pursuit of enhanced performance. According to the report, net interest margins for National Bank of Oman, Bank Dhofar, HSBC Bank Oman and Oman Arab Bank all declined by 100 basis points between 2009 and 2013.
“We have some serious challenges, including a young population which has growing needs, and government resources are limited. The private sector has to grow to become independent and strong enough to contribute to national growth by providing genuine and sustainable opportunities for employment. To achieve all of this by remaining within the country is going to be extremely challenging,” says Mr Al Shaksy.
With a strong and well-regulated banking sector, which continues to perform above regional standards, Oman is now looking to the future. How the country, and its banks, choose to progress from here will have implications not only for the country but for the region as a whole.
