Savings and shari’ah in Qatar

by  — 3 March 2014

Globally, Islamic financial institutions are managing far more assets compared to the mid-1970s, yet in traditional Islamic markets, the growth of shari’ah-complaint banks is less spectacular. Against increasing global opportunities and competition in the sector, Simon Watkins and The Edge’s Aparajita Mukherjee analyse the international status quo of Islamic banking and investigate why Qatar, which has ambitions to be a centre of Islamic banking and hosts a large Muslim population, seems to have relatively better penetration in conventional banking.

In a financial sector dominated by Southeast Asian states such as Malaysia, Arab and particularly Gulf states such as Qatar are rapidly rising to prominence in global Islamic banking and finance. (Image Corbis)

The global Islamic finance industry as a whole has grown in size from around USD10 billion (QAR36.4 billion) of total invested assets in 1975 to just more than USD2.2 trillion (QAR8 trillion) in 2013, according to figures from 1st Ethical Trust in London. Indeed, Standard & Poor’s (S&P) forecast that shari’ah-compliant assets worldwide will sustain double-digit growth in the coming two to three years and most industry analysts project that the sector is growing twice as fast as conventional banking. 

Yet, it also remains the case that the actual pace of expansion of Islamic banking compared to its conventional counterpart appears to be slowing in the Middle East. Looking forward, then, is this trend likely to continue, and if it does, will it be compensated for by growth in other geographic areas?

Slow growth in Islamic states

Within the key countries of the Middle East, where Islamic banking would be expected to be substantially solidifying its position – Kuwait, the Kingdom of Saudi Arabia (KSA), and the United Arab Emirates (UAE) for example – growth is in fact levelling off. Part of the sector’s stasis can be attributed to already high levels of penetration, highlights AT Kearney’s Cyril Garbois, head of Middle East financial institutions practice, in Dubai.

Nevertheless, Garbois adds, there is no clear attempt by any Islamic banking providers in the region to differentiate themselves in this space by offering a global pure-play Islamic banking leader with a broad or specialised business model.

“Islamic banks are considerably smaller than their conventional competitors in their domestic markets.” – Cyril Garbois , AT Kearney Middle East.

“There remains no Islamic Citibank or Islamic Goldman Sachs,” Garbois tells The Edge, “meaning that the Islamic banks in the region are considerably smaller than their conventional competitors in their domestic markets, and even the biggest Islamic banks are typically small compared to international conventional competitors.” 

To Middle Eastern investors, then, the overall banking offering from these smaller institutions clearly lacks scope, especially as many of the world’s biggest conventional banks continue to launch Islamic windows, with HSBC a leading example across the region. “As a result, merely being shari’ah-compliant is not a major differentiator,” Garbois underlines.

According to the Qatar Financial Centre (QFC), Qatar is taking a prominent role in promoting the growth of Islamic finance. The QFC is contributing, for example, by making special provisions for Islamic finance within an attractive low tax regime to ensure that its principled approach to interest is not disadvantaged. In a 2013 study, the QFC Authority released in partnership with the International Tax and Investment Center, based in Washington DC, Turkey and the QFC were found to have the most Islamic finance-friendly tax systems out of eight MENA countries.

Suliman Al Salhi, chief business officer at Qatar First Bank (QFB) says that Islamic finance is still a niche market and a number of issues such as the risk culture, regulation and development of innovative retail products have to be addressed to allow its evolution into a profitable service-oriented industry competing with conventional banking.

The QFC also supports the development of (re-) takaful products and the issuance of sukuk as an asset class in response to increasing investor demand. The QFC’s plans include developing a framework for shari’ah-compliant asset management.  Leading shari’ah-compliant firms such as Qatar First Bank and Abu Dhabi Islamic Bank have QFC licences. However, Nicolas Mackel, chief executive officer (CEO) Luxembourg for Finance (LFF), says that though Qatar has the assets, the expertise and the will to become a major Islamic financial centre, local investors are inhibited by the lack of a domestic investment fund market. He adds, “Qatar has one of the highest savings rates in the world, at 49 percent of GDP, but most private wealth is held abroad or invested in real estate.”

Mixed regional offerings

While Qatar prohibited conventional banks from offering Islamic windows through a Qatar Central Bank (QCB) directive in February 2011, rating agency Fitch highlights the mix of two categories of banking in other countries in the region. The combination of a well-known brand, an established network, service quality, and cost-efficiency savings will give incumbent conventional and mixed-offering banks a significant advantage over new Islamic banks, according to Fitch.

Indeed, further referencing Fitch, although there is demand for Islamic banking, and its growth across the Gulf region is likely to outpace that of conventional banking, recent market behaviour suggests that customers in Oman, for example, will opt to get these services from established banks, which offer a mix of conventional and shari’ah-compliant products. 

These include, of course, Bank Muscat, and HSBC Bank Oman, which are both in the process of setting up Islamic banking arms in preparation for the upcoming rule changes. Indeed, a recent Fitch report highlights that while the established banks will need to keep their existing and Islamic operations separate at the point of contact with the customer, there will be “plenty of opportunities for cost savings at the operational level”. 

This general notion of the lack of interest from customers in the type of wholly Islamic banking currently available in the Middle East (via small, non-global product architecture) was seen recently in Qatar. When the QCB directive came into effect, Qatari Islamic banks had expected an influx of customers as those with shari’ah-compliant accounts switched banks. 

However, in practice it seems many customers decided to switch back to conventional accounts with their existing banks instead. However, at present the situation appears to be changing, thinks Timucin Engin, associate director of S&P in Dubai, thanks to in part, for example, the high degree of support from the Qatari government, as a function of its core strategy of growing Qatar as a global Islamic banking centre. 

Overall Islamic banking now accounts for around 25 percent of the country’s entire banking system in terms of assets, up from 13 percent in 2006, and S&P anticipates that Qatar’s Islamic banks’ assets will reach USD100 billion (QAR364 billion) on the balance sheet by 2017, up from USD54 billion (QAR196.6 billion) at year-end in 2012. 

The Qatar Economic Insight 2013, cites that conventional banks account for the largest share of banking assets (72 percent). Mackel of LFF interprets this relative slow growth of Islamic banking in Qatar and cites three reasons. First, he says, Islamic banking is a relatively recent phenomenon: Qatari institutional investors and entrepreneurs have operated for decades in the conventional sphere. Second, Islamic banking contracts remain complex and unfamiliar to the international community. Third, until and unless there is a competitive shari’ah-compliant equivalent for all the products and services required by a company operating in a global economy, the conventional banking system will continue to be the principal method.

“When the QCB directive came into effect, Qatari Islamic banks had expected an influx of customers but many customers decided to switch back to conventional accounts with their existing banks instead.”

Suliman Al Salhi, chief business officer at Qatar First Bank (QFB) says that Islamic finance is still a niche market and a number of issues such as the risk culture, regulation and development of innovative retail products have to be addressed to allow its evolution into a profitable service-oriented industry. Al Salhi adds, “Qatar has taken major steps to grow its Islamic finance sector, facilitating the establishment of new banks such as Barwa Bank and Qatar First Bank. Qatar has one of the fastest growing Islamic banking sectors driven mainly by the huge demand for local credit to fund the government spending required for large-scale infrastructure projects. Islamic banks in Qatar continue to grow by developing new products, diversifying their funding resources and geographically expanding.” 

Asian and European growth

Globally, given that it rarely exceeds a third of total market share, several potential markets with large Muslim populations remain largely untapped, such as Malaysia, Indonesia, and India. Even better prospects, perhaps, are the extremely sizeable Muslim populations in the eurozone region, and in the United Kingdom, in which the overall Islamic banking penetration rate remains virtually non-existent.

For Asia as a whole, one problem in terms of shari’ah finance in general is the difference of interpretation of the Islam part of Islamic finance. While, for example, Saudi Arabia follows the stricter Hanbali school of Islamic thought, Malaysia adheres to the less conservative al-Shafi school of Sunni Islam (and consequently benefits from being home to the largest Islamic bond market in the world). Much of the remaining GCC steers more of a middle course, with its following of the Maliki school of Islam. However, Gregory Man, senior lawyer specialising in Islamic Finance for Clifford Chance in Hong Kong, highlights as an increasing number of such deals go through the market, the likelihood is that there will be more of a convergence over what is deemed acceptable for trading purposes for Islamic finance products, resulting in the expansion of the market for Islamic banking, albeit one with an overall conventional banking architecture. 

The European Union (EU) area as well offers a large untapped customer base, with more than 20 million Muslims in the area under supplied with Islamic finance offerings, despite strong support from various European governments and regulatory authorities for the Islamic finance model, and the unification of the regulatory framework within the European Union, highlights Marco Lichtfous, partner specialising in Islamic finance in Deloitte, Luxembourg. To redress this situation, he adds, comes the recent announcement of an agreement to set up the first Islamic bank in the Eurozone – Eurisbank. 

With a start-up capital of EUR60 million (QAR297 million) Eurisbank intends to offer precisely that entire spectrum of financial services in retail, corporate, and private banking, all within the Islamic finance structure that has been lacking in such operations within the Middle East, according to Ammar Dabbour, managing partner in Excellencia Investment Management.

Such a move, and others perhaps in the pipeline, should find their momentum driven further as the pool of shari’ah-compliant assets in the region develops towards a critical mass, and the Islamic capital markets base in the area broadens and deepens. There have been a number of extremely significant developments in this regard recently. 

One such step was the recent launch by the London Stock Exchange of the ‘FTSE Shariah Developed Minimum Variance Index’ series. This is founded on a business screening process whereby companies involved in ineligible activities are excluded, with the risk curve within these parameters delineated by overweighting stocks that reduce index volatility and underweighting stocks that increase index volatility.

Underlying the entire index in keeping with shari’ah principles is that it has been created in partnership with Yassar Limited, an independent consultancy and leading authority on shari’ah, and has been certified as shari’ah-compliant through the issue of a fatwa by Yassar’s principals. “This reflects the growing demand from investors for best-in-class benchmarking tools that adopt a conservative approach to shari’ah-compliance,” says Kevin Bourne, managing director of the FTSE’s environmental service group, in London. 

Increasing competition

With Asia and Europe opening up to Islamic banking, analysts foresee competition between Qatari and GCC Islamic banks and their Malaysian and Indonesian peers in capturing these markets. 

Machel of LFF explains that the Malaysian market has succeeded in cross-selling retail savings products to the non-Muslim market in Asia, which may give them a competitive edge in Europe, where the Muslim population is diffused and can only be reached by broad retail distribution. “The strength of Qatar, by contrast,” he counters, “lies in its capacity to buy financial institutions in strategic markets, thus bypassing the need to work through partnerships.”

However, from a Qatari perspective, Suliman of QFB feels that the way forward is to establish partnerships with Asian peers to share expertise and optimise opportunities and talent and establish an industry standard for Islamic Finance. 

In turn, Engin of Standard & Poor’s cites Qatar Central Bank data showing Islamic banking’s  expanding market share. In 2006, he tells The Edge, the first year when the QCB began to provide separate statistics on conventional banks versus Islamic banks, the market share of Islamic banks was around 13 percent, which has now expanded to 24 percent in September 2013. Together with this, Qatari Islamic banking players are adding more financial instruments to their offerings. “Traditionally,” Engin continues, “Qatari Islamic banks have not been very active in the sukuk market in terms of issuance, however we expect to see them tapping the sukuk space more often over the next few years, as we expect their credit growth to remain strong.”

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