Why do you think Oman decided to go ahead with Islamic banking after all these years of not allowing it?

The Islamic finance industry is growing at a remarkable rate and Oman’s large Muslim population means that the Islamic banking opportunity for the country could be substantial. According to Ernst & Young’s estimates, assets in Oman’s Islamic banks could rise to as much as US$6bn over the next few years if the country rolls out a successful Shari’a-compliant banking system.

The decision to open the industry to Islamic finance is likely to draw foreign investment into Oman. In addition, the decision will also cater to the growing consumer appetite for Shari’a-compliant financial products, facilitating Oman’s efforts to retain investments of Shari’a-sensitive Omani high net worth individuals (HNWIs).

How long do you think it would be before banks here can roll out Islamic finance products?

It generally takes anywhere between six months to one year to launch Islamic banking operations. The time frame will depend on a number of factors, including the level of support from the central bank, the proactive response of board and management and the availability of technical expertise.

A number of banks have started their feasibility analysis and brainstorming, but it may be at least 4-6 months before they can finalise their business plans, obtain the required regulatory approvals, establish the necessary infrastructure and then rollout their products. At least one bank has already obtained an Islamic banking license and is currently in the process of developing its Shari’a-compliant product suite. 

What are the main concerns banks here need to address before they get into Islamic finance?

There are a number of challenges that Oman’s Islamic finance industry will need to successfully address in order to grow. They are:

Awareness about the Islamic Banking System: For most Omanis, it will be their first introduction to Islamic finance. Education and positioning Islamic finance as a genuine, Shari’a compliant, ethical and comparable alternative to conventional finance, will be a key challenge.

Need for professional Islamic bankers: Having no prior experience in Islamic finance, the Omani banking industry will face a significant challenge in attracting and recruiting experienced Islamic finance professionals. It will take time to train current industry professionals on the concepts and structures of Islamic finance and for the interim period, the industry will have to depend on human resource availability in the neighbouring Islamic finance hubs.

Competition: New entrants will need to differentiate based on the strength of their Sharia offering as well as service quality model. In the medium term, banks with robust customer acquisition plans, innovative product programmes, and scalable technology and risk infrastructure will succeed.
When it comes to consumer loans or home loans, is there any advantage for consumers if they go in for Islamic finance? If there were no advantage, why would non-Muslims opt for it?

There are a number of technical differences between Islamic and conventional financing products. Some of these products may have monetary advantages for consumers of the Islamic banks. An example would be in the case of houses financed using ijarah (Islamic lease). If the house is damaged for reasons beyond the control of the customer, then the bank will bear the loss (if there is any due to the difference in the bank’s exposure and the takaful coverage).

However, the key attraction will be the ethical business model that forms the basis for Islamic finance. Islamic finance advocates prudent practices and disallows speculative and high risk commercial activities. All investments and operations have to be morally acceptable. Risks and rewards are shared between customers and their financial institutions, allowing for a win-win situation for all stakeholders

What are the potential pitfalls for Omani banks if they choose to open Islamic windows?

The main concern regarding Islamic windows is that the customers may not perceive the window as independent from the conventional side of the bank. Therefore, customers may not perceive it as fully Shari’a compliant. Also, effective governance becomes a challenge in running Islamic window operations for a conventional bank, which includes the problem of commingling of funds. Hence Islamic windows must ensure a robust customer acquisition strategy, effective governance framework including separation of conventional and Islamic funds and a unique work culture that differentiates their Islamic offering.

How do Islamic banks and IBS products reward their depositors since payment of interest is not allowed?

Interest-based contracts are not allowed in Islam and therefore Islamic banks use a wide variety of Islamic contracts in structuring different products. Deposits are usually structured using the contract of mudaraba which is a type of equity finance contract where one party (rab al maal) provides the capital and the other party (mudarib) administers, operates and manages the venture.

Depositors are usually regarded as rab al maal and their reward comes from the profit of the Shari’a-compliant investment and financing activities undertaken by the bank. The profit sharing ratio between the mudarib and rab al maal is determined and agreed upon at the time of signing the contract.

Under mudaraba, what happens if a person has taken a loan from an Islamic bank for starting a business but his business fails. Who bears the loss – the bank or the entrepreneur?

According to mudaraba rules, profit is to be divided as per agreement and loss is solely to be borne by the capital provider (rab al maal) unless where the mudarib is negligent. In other words, if the business operations fail due to the entrepreneur’s wrong doing, the loss would be borne by the entrepreneur but if the business operations fail in spite of the entrepreneur’s hard work and best efforts, then the loss would be borne by the bank (as rab al maal)

Have there been instances where depositors have lost money in an Islamic bank because of the fundamental principle of profit and loss sharing?

There were no reported cases of a loss in any Islamic bank so far, one reason being the maintenance of reserves such as Profit Equalisation Reserve (PER) and Investment Risk Reserve (IRR) by the Islamic banks to cover for periods of low profitability.

PER is a type of reserve that is used to smooth the income of depositors and is built up from an amount deducted from the income attributable to shareholders before distribution. In addition, IRR is used to mitigate the effects of future losses and is built up from amounts deducted from the income attributable to only investment accounts holder.

What per cent of global market does Islamic finance account for now? What is the future outlook?

Islamic finance accounts for a very small percentage of the global markets (about one per cent).The future outlook of Islamic finance is promising – the market has grown rapidly over the past decade. Global Shari’a-compliant assets are estimated to have crossed US$1tn in 2010. The industry is growing at a sustainable 15-20 per cent per annum and has certainly gained recognition within mainstream global finance.

Muslims across the world have shown increasing propensity to adopt Islamic finance, reinforcing greater adherence to Shari’a in their economic matters. At the same time, non Muslims are also finding Islamic financing to be more sustainable and ethical. This is clearly evident in the more developed Islamic finance markets like Malaysia. At the current pace, Islamic assets are expected to quadruple to US$4tn by 2020.

Can differences of interpretation between Sharia scholars about what is permissible and what is not create problems? How can uniformity be achieved?

Differences in interpretations of certain Shari’a instructions are expected and these are limited to only 5-10 per cent of the products/ principles governing the industry. However, the setting up of international standards setting organisations such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) which is based in Bahrain and the Islamic Financial Service Board (IFSB) which is based in Malaysia, has really helped in narrowing down these differences.

Both these organisations are working hard to narrow these differences to the minimum through continuous discussions. The AAOIFI develops accounting, auditing, governance, Shari’a and ethical standards relating to the activities of Islamic financial institutions and IFSB sets standards for regulatory and supervisory agencies to ensure soundness and stability of Islamic financial institutions.

In Oman, who will ensure Sharia compliance of the Islamic finance products that would be launched?

Shari’a governance is one of the most critical aspects of Islamic banks and this system shall ensure the compliance of Islamic finance products to Shari’a principles and guidelines. The most important components of a Shari’a governance framework will comprise:

An independent Shari’a supervisory board reporting directly to the board of directors, which comprises Shari’a scholars who give their opinion regarding the permissibility of products and services offered by the bank.

An internal Shari’a supervision/ control department, which assists the Shari’a supervisory board in ensuring that the Islamic financial institution is adhering to the Shari’a guidelines and fatwas issued by the Shari’a supervisory board and the relevant rules prescribed by the regulatory bodies (e.g., AAOIFI or IFSB, if applicable).

An independent Shari’a audit undertaken annually which is a check to see if the bank has correctly implemented the Shari’a guidelines provided by the Shari’a supervisory board. This is an important measure to ensure loose controls and measures are picked up for consumer protection and rights. It is in the bank’s interests to ensure things are being done correctly as otherwise, they will lose any profit they make from non-compliant transactions and more importantly, they will dilute the reputation of the Islamic banking industry.