Interview: AbdulRazak Ali Issa,  Amin Al Husseini, Lloyd Maddock

What do you see as the most significant impact over the coming years of the introduction of Basel III regulations in Oman?

LLOYD MADDOCK: Basel III is largely concerned with the amount of capital that banks are required to maintain in supporting their operations. All banks in Oman currently hold in excess of the Basel III required capital. However, as a bank grows and expands, it will need to raise additional capital to maintain its capital adequacy ratio. Banks can raise capital using a number of different methods in Oman. For example, banks are able to retain profits, depending upon that bank’s profitability as well as its annual dividend payout.

Other options can include issuing debt instruments, such as qualifying Tier-1 “perpetual bonds” or qualifying Tier-2 “subordinated debt issuance”, which essentially acts as a long-term deposit provided to the bank by an investor.

Under Basel III banks are already required to adhere to certain financial ratios, such as the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR), which are reported to the regulator on a monthly basis. Basel III is not unique to Oman, so banks will tend to prefer to increase the amount of capital-efficient assets held, whether in the form of loans or investments. As a result, I do not foresee Basel III having any unique or drastic impacts on Oman’s banking sector.

In addition to Basel III, the international accounting board standards are being revised. Of particular interest is the international financial reporting standard (IFRS) 9 that is expected to be introduced in January 2018. This outlines how banks should account for future expected credit losses (which in turn has implications for return on capital) and how banks account for their investments, for example in bonds and equities. Indeed, the fundamental impact on the sector of IFRS 9 will be material. Therefore, banks are currently studying what revisions to policy might be required.

AMIN AL HUSSEINI: The largest impact of the introduction of Basel III regulations is the higher capital requirement. Conditions relating to the eligibility of the financial instruments for inclusion in Tier-1 or Tier-2 capital have made it a challenge to raise additional capital in addition to increasing the cost of capital. The Central Bank of Oman (CBO) has opted for the phased increase of the capital conservation buffer between 2014 and 2018 and is deciding on the counter-cyclical buffer, which will further increase the capital requirement.

Once both the capital buffers are completely in force, the minimum required capital might increase to 17% from the 12% minimum required capital prior to the implementation of the Basel III regulations. This in turn will encourage the banks to either reduce their risk-weighted assets by reducing their exposures or else to grow selectively based on the level of risk, so as to maintain a sufficient return on equity.

As a result of these changes, there is a greater pressure in maintaining or growing the return on equity. While the impact on capital is discussed widely, the regulations relating to liquidity deserve equal attention. Banks in Oman are maintaining a comfortable LCR and NSFR, which are higher than the requirements as per Basel III.

However, if there is a strain on liquidity in the market owing to subdued oil prices for a longer period, these ratios will pose additional challenges to banks. The capital and liquidity requirements will lead to driving up the interest rates on loans.

ABDULRAZAK ALI ISSA: In light of the introduction of Basel III regulations in Oman, progress has been achieved in strengthening regulatory and supervisory norms with an emphasis on risk management, financial stability, capital adequacy and asset quality. Omani banks are sufficiently well capitalised to adhere to Basel III capital adequacy norms, which will help them to absorb cyclical shocks and losses. As against the minimum required level of 12.625%, the higher levels of capital adequacy maintained by the banks reflect a healthy trend.

The CBO has issued a framework for domestic systemically important banks (D-SIBs) to check the failure or impairment of banks that have profound implications for the economy as a whole. Banks identified as D-SIBs are therefore required to hold rigorous stress testing exercises, have in place a well-defined early warning and crisis management mechanism, and build a robust recovery and resolution planning set-up in addition to a comprehensive risk appetite framework. Additionally, the enhanced capital surcharge for D-SIB is stipulated at 1%. These checks and controls can ensure that in the extreme event of any problems occurring at such banks, the damage to the entire financial system of the country is kept to a minimum.

In light of the need to maintain levels of infrastructure spending, do you foresee a change in the role of banks in project financing?

HUSSEINI: Banks will play a larger role in project financing as the amount of expected funding from the government declines, due to lower levels of revenue from the oil sector. Public sector deposits will serve to partially fund infrastructure projects for the country. Banks have also issued and/ or sought approvals from their boards of directors to issue Euro Medium Term Notes (EMTNs) for the purpose of project financing and liquidity management, as these entail a lower cost of funds. Furthermore, if and when interest rates rise in 2016, this will boost the return of super-liquid banks. In the longer term, if the deficit increases, the perceived creditworthiness of Oman will be reflected in higher sovereign rates, which will lead to local lending rates. Banks with a higher proportion of current and savings accounts will benefit most of all, as their cheap liquidity brings higher returns. The monetisation of deficits by the government usually results in upward inflationary pressures. Indeed, the effect of higher inflation on the banks is expected to be negligible since most of project financing will either be locally funded or go through EMTN issuances.

MADDOCK: Not really. Banks will continue to retain their appetite for feasible projects, particularly those which facilitate economic diversification, for example within the tourism and logistics sectors. We might expect to see the nature of project funding evolve, with an increase in public-private partnership structures in particular. Given the scale of projects that are currently planned within the sultanate, International banks will have a role to play, in addition to the local banks.

ISSA: Notwithstanding the volatile oil prices impacting the overall economic outlook, the Sultanate is pressing ahead with the diversification of the economy and infrastructure development projects. As part of its Vision 2020 economic blueprint, Oman is on track with finding alternatives for oil and gas revenues by investing in maritime ports, special economic zones, logistics hubs, mega-industries, fisheries, tourism and other sectors. The government has affirmed that Oman’s development projects will continue as planned, and steps are being taken to avoid any negative social or economic impact on the population.

Oman’s commercial banks recorded 9.15% growth in total credit at RO17.8bn ($46.1bn) for the first seven months of 2015, compared to RO16.3bn ($42.2bn) over the same period in 2014. In view of continuing low oil prices, the banks are more focused on maintaining credit quality. In such a scenario, overall credit growth may slow down. Meanwhile, interest rates in the country are expected to harden due to a tightening of liquidity.

In which areas do you feel that banks can best enhance their support of small and medium-sized enterprises (SMEs)?

ISSA: Recognising Oman’s socio-economic fabric of Oman and in a bid to boost employment, the CBO has advised banks to formulate a liberal lending policy for the SME segment, requiring them to allocate 5% of their total credit to SMEs. We believe there are opportunities for SMEs in the oil and gas, construction, and infrastructure sectors. SMEs can succeed and enjoy credibility with the government and banks if they remain disciplined and committed to their objectives. Training, mentoring and easy access to finance without collaterals are key to helping SMEs establish successful business ventures. The micro and small business segment, and women entrepreneurs with enterprising talent, must all be given support to strengthen the SME segment in Oman.

HUSSEINI: We at Oman Arab Bank believe that SMEs can play a vital role in developing the national economy through providing employment opportunities and encouraging self-employment. The banks have a much bigger role that goes beyond direct funding. For example, we can support SME incubators; provide training, mentoring and financial advice to entrepreneurs; assist SMEs in developing more comprehensive business plans; and encourage greater innovation and leadership by granting awards to exceptional performers and those who have a good story to share.

MADDOCK: All stakeholders face a range of factors that have influenced the growth of the SME sector. While accessibility to bank finance is not a major factor in itself, banks are actively seeking opportunities to provide such finance. Financial training is perhaps most important of all, and from what I perceive, most banks in Oman have various programmes to assist the SMEs in this regard. Omanisation requirements within the SME sector has been widely debated and recent developments should prove beneficial. Furthermore, the government has determined that at least 10% of its commercial contracts be allocated to SMEs.

To what extent will a rise in dollar interest rates have a significant impact on the way the sector currently functions?

HUSSEINI: Going forward, banks will subscribe to a higher-rate environment instead of an imminent rate hike by the US Federal Reserve expected to be decided in December 2015 with a gradual increase during 2016, which theoretically feeds into policy rates in Oman given the currency peg of the Omani rial to the US dollar. Conditions on the ground, however, remain competitive for both corporate and retail lending. While most banks have decided to put the brakes on the declining lending rate, many are still competing for a larger piece of the retail market pie by offering loans at even lower rates. Eventually, the impact of a dollar rate hike will serve to raise lending rates in Oman, putting pressure on banks from the perspective of corporate social responsibility, to support SMEs as they manage their businesses competitively.

MADDOCK: There is consensus among market commentators that the expected increase in interest rates will be both gradual and phased over a period of several years. It is therefore reasonable to assume that banks will have to pay more over time to attract deposits and to charge higher margins in lending. Moreover, this has played out against the broader economic landscape, which for Oman is influenced by the price of oil. More than about interest rates, banks are concerned about the potential for any rapid reduction in the substantial deposits made by the public sector, which could reduce banks’ liquidity and therefore their capacity to lend. The diversification of deposits and the issuance of debt will both be important considerations for banks going forward.

ISSA: Oman’s decision not to raise its interest rate following the US Federal Reserve rate hike reflects its monetary resilience. With the Omani currency peg to the dollar, the effects of an interest rate rise on account of policy reversal in the US, and a prolonged state of reduced oil prices, could impact Oman’s growth scenario, especially to raise dollar funding, which will become expensive.

To what extent could the Omanisation of the banking sector be adapted to better serve the interests of the sector?

MADDOCK: At Ahlibank we remain comfortable with and supportive of the legislation for Omanisation. It is ultimately the responsibility of banks to train all employees so that they are capable of having every role performed by suitably qualified individuals, with succession plans in place.

ISSA: Our top priority must be accorded for human resources development to equip Omani employees to take up leadership positions in tandem with future challenges.

The leadership pool must be developed from among the new generation of young Omanis, thereby contributing to Oman’s future by investing in demographic talent, and thus better representing the real wealth of the nation as a whole. Further to this, employees must be encouraged to adopt an entrepreneurial approach in running businesses, thereby creating a culture which encourages innovation, taking decisions more efficiently, and making better use of resources.

HUSSEINI: The Omanisation strategy of the banking sector should move towards more a qualitative approach in terms of the job categories involved as well as enhancing development opportunities offered to Omanis to help them optimise their performance and accelerate career development. To achieve this, certain human resource management and development practices need to be considered at the internal and external level. At the internal level, banks should develop strategic human resource development and career planning programmes that aim to build the leadership talent from within the current group of high-potential Omanis. Such programmes will also help banks in their efforts to retain high-performing Omani employees and cultivate their talent pool through focused development to ensure smooth transitions within the business. Other crucial practices in human resources include a robust and task-oriented performance appraisal system, which would enable the banks to identify promising Omani employees and promote them accordingly.

At the external level, the banking sector needs to enhance its collaboration with Omani higher education institutions to ensure that programmes and curricula meet the sector’s needs. One of the prime obstacles to the fulfilment of a high percentage of qualitative Omanisation in the banking sector is the lack of suitably qualified and experienced Omani candidates to fill senior management positions. To meet these challenges, there is a need to encourage coordination and cooperation between banks and the government organisations concerned, as well as higher education institutions to ensure that programmes and curricula are developed to international standards.

This will over time result in the development of a highly skilled and well-qualified Omani workforce to serve in this competitive and growing market.