When the Qatar Central Bank (QCB) instructed conventional commercial banks operating within the country's financial jurisdiction to close their Islamic finance operations, the country’s banking community was taken aback. For one thing, very few observers had seen this directive coming. More importantly though, the QCB's reasoning for this decision - that it saw higher risks from conventional lenders operating Islamic units - appears to undermine arguments about how Islamic finance can bring greater stability to financial activity compared with conventional financial practices.
The QCB issued specific directives to each of the country’s conventional banks that have Islamic branches. It told them “to stop opening new Islamic branches, accepting Islamic deposits and dispensing new Islamic finance operations”. Out of seven registered conventional Qatari banks, six have Islamic banking windows. As part of the directive, those six as well as two foreign banks (HSBC and Arab Bank) will have to comply by December 31, 2011.
QCB restrictions
The QCB's latest order was not completely without portent. In 2010, the QCB told conventional banks with Islamic operations to restrict their lending. That instruction had been preceded by another order, namely that Islamic branches of conventional banks operate within separate buildings from sharia-compliant activity.
The order for conventional banks to close their Islamic operations is of a different magnitude altogether. According to international law firm Eversheds, which advises many banks within the Gulf Co-operation Council (GCC), many observers have expressed concern that such a “significant decision seems to have been made without a proper consultation process with some of the key stakeholders”.
The consensus among commentators is that not enough time has been given to the banks to comply fully with these new regulations. Furthermore, not all the exact details have been fully clarified, adding to the confusion within Qatar’s financial community. HSBC Amanah, HSBC’s Islamic banking subsidiary, says it is communicating with the QCB “to seek clarification”.
Scholastic controversy
One source close to the QCB says the decision has been taken because of the ongoing confusion between Islamic and conventional banking, as it becomes more difficult to distinguish between the two activities.
Yet Islamic scholars who gathered in Doha to comment on the decision expressed their surprise at the directive. While most understood the need to clearly distinguish between conventional and sharia-compliant banking, many agree with the view taken by Dr Ali Al Qaradagi, a leading authority on sharia finance and founding member of the International Union for Muslim Scholars. He says the directive has been implemented in haste and that its effect on the industry and Qatar’s financial services had not been properly taken into account.
Deposit losses
Conventional banks are expected to lose between 8% to16% of their deposit base, total assets and profits as a result of this directive. The biggest impact will be on Qatar National Bank (QNB), according to a report published by Moody’s Qatar analyst Elena Panayiotou. A spokesperson for QNB would only say that it would fully comply with the directive, without adding any further comment.
QNB is the largest commercial bank in Qatar, with a 39% share in the total banking system assets and a 20% market share in Islamic banking assets. Islamic banking earnings comprised about 15% of QNB’s net income in 2010, which stood at QR1.7bn ($467m) in 2010.
The Commercial Bank of Qatar and Doha Bank are the second and third largest conventional Qatari banks. Islamic assets and deposits make up 7% to 10% of their balance sheets, respectively. According to Doha Bank’s September 2010 financial report, 9% of its net operating income comes from sharia-compliant investments.
Conventional banks still dominate the financial landscape in Qatar, holding a 75% market share, compared with the 17% held by Qatar’s four Islamic banks: Qatar Islamic Bank, Qatar International Islamic Bank, Masraf Al Bayan and Barw Bank.
Competitive advantage
Of course, the directive is not bad news for everyone. It was no surprise that Qatar’s bourse witnessed a surge in demand for stocks of Islamic banks in the aftermath of QCB’s announcement. While conventional banks took a beating on the trading floors of the Doha exchange, all four Islamic banks gained 10% in their share prices and continue to trade at a premium.
Despite Islamic banks' immediate gains many key industry players say the directive will negatively affect international participation in the Islamic banking industry of Qatar. They expect it to damage confidence in the country's industry and hamper innovation in what remains a relatively new sector of finance.
There is no doubt, though, that Islamic banks will benefit from the directive. The splitting up of Islamic and conventional banking will provide Qatar's four Islamic banks access to a much larger pool of customers. This should allow them to strengthen their franchise dynamics in the country because fewer institutions will be competing for the same business. This will provide them with greater bargaining power over customers and should result in wider profit margins.
The ban prohibits all Qatari commercial banks from extending new Islamic loans and insists all loans are paid back by December 2011. Given that most of the loans are short term, meeting this deadline should not cause many problems. Although Qatari banks may be in a position to convert part of their Islamic deposits into conventional deposits, repayment of the Islamic deposits will have a negative impact on their liquidity over the short term, which “nonetheless should remain at adequate levels”, according to Moody’s Ms Panayiotou.
The liquidity of Qatari banks is supported by their solid funding profile and by the sizeable portion of government-related deposits on their balance sheets, which stands at 25% to total banking system deposits. However, it remains unclear what the banks will do with some of their longer-term Islamic assets because the QCB’s directive does not indicate whether the conventional banks will have the option to apply for a separate banking licence to be able transfer their Islamic business to a separate subsidiary.
Regulatory disputes
The Qatar Financial Centre Authority (QFCA) played no part in this decision and local bankers have pointed to rifts between the management of the QFCA and the QCB. Observers say that over the past few months tensions had risen between the two bodies over who had the remit to regulate over specific parts of Qatar’s financial services industry.
This claim is denied by Shashank Srivasta, the chief executive officer of QFCA, who says there are clear provisions for each of the regulatory bodies and no clashes have occurred. “We deal with our prerogatives and stick to our [respective] areas of expertise,” he says.
Although the QFCA claims to regulate and supervise the full spectrum of financial services activities - which include banking, insurance, asset management and Islamic finance - it was excluded from the consultation process that led to this decision by the QCB. Following the announcement concerning the termination of Islamic finance services offered by conventional banks, the QFCA said in a statement that this was a matter for the Qatar Central Bank. “The QFCA is not in a position to comment as to how this might impact QCB-regulated entities,” the statement concluded.
Gulf turmoil
This decision has no doubt left the Gulf financial community in turmoil and many questioning the reasoning behind such a move. Bankers from the United Arab Emirates remain concerned as to whether this move will set a precedent that could spread to other Gulf countries. They also point to investments made by Qatar’s commercial banks to develop Islamic operations in the UAE, which will now become redundant as a result of the decision made in Qatar.
Bankers are also likely to be confused as to how to interpret the official signals they receive in the Gulf from now on. For example, bankers say the inauguration of HSBC’s Islamic operation in Qatar by the central bank’s governor Sheikh Abdullah Bin Saud Al Thani, in July last year, was widely interpreted at the time as an encouragement to banks to set up more Islamic operations.
All in all, this ban has been regarded as a curious decision at a time when the Middle East is gradually emerging from a global financial crisis that, to some extent, encouraged conventional banks to develop Islamic finance windows because of the perceived stability they offer. The after-effects of the QCB's decision will be keenly watched by both bankers and regulators in Islamic finance markets alike.
