* Tawarruq not expected to be permitted in upcoming rules
* Banks argue this would hurt their liquidity management
* Could force them to hold funds unprofitably
* Ban would raise pressure on govt to issue short-term sukuk
* Central bank says rules still in draft stage
By Bernardo Vizcaino
DUBAI, Nov 1 As Oman prepares to introduce
Islamic finance, a restriction on the money market instruments
which banks can use may curb their ability to manage funds in
the market, hurting profitability.
Authorities are expected to release Islamic banking rules by
year-end, making Oman the last country in the six-nation Gulf
Cooperation Council to accommodate sharia-compliant banks.
But the draft rules, seen by bankers before their
publication, exclude an instrument which is widely used in some
other countries: commodity murabaha or tawarruq, several banking
sources in Oman told Reuters. They declined to be named because
of the sensitivity of the issue.
"The central bank was careful to ensure Islamic finance is
of high standards," said Mohammad Haris, head of Islamic banking
at Bank Sohar.
"Certain areas, we believe, are too stringent such as
liquidity management," he added without elaborating.
Omani bankers argue that in the initial stage, Oman's
Islamic money market will be too shallow and undeveloped for
them to access it conveniently with tools other than tawarruq.
So banks have been lobbying regulators, asking that tawarruq
be made temporarily permissible until the market can develop
other solutions, bankers said.
Such a provision could be similar to one given to Pakistani
banks in that country's initial stage of building up Islamic
banking, one Omani banker said.
Oman's central bank told Reuters the Islamic banking law was
still being drafted and it would not comment on tawarruq, adding
that an announcement would be made by the end of this year.
In tawarruq, one party buys an asset from a vendor with
payment deferred, and sells it to a third party for cash. The
arrangement allows banks to manage their overnight funds.
But organised tawarruq, where transactions occur in exchange
for a financial obligation, has been criticised by some Islamic
scholars because of its weak link to real economic activity;
Islamic finance bans pure monetary speculation.
In April 2009 the Jeddah-based International Islamic Fiqh
Academy, an international body of scholars, issued a resolution
criticising organised tawarruq as a "deception", hurting its
acceptability in the industry.
Tawarruq, of the organised type and other types, is widely
used in most countries which practice Islamic finance. There are
no reliable measures of transaction volumes, but it forms the
basis for many Islamic credit card transactions in the Gulf,
while Malaysia's stock exchange has a trading platform based on
At least 350 million rials ($909 million) will enter Oman's
Islamic money market when the country's two new Islamic banks
and the Islamic windows of conventional banks start operating,
The figure could climb as high as 550 million rials as other
firms enter the market, said Shaher Abbas, Oman-based director
at Islamic Finance Advisory & Assurance Services (IFAAS).
If banks lack ways to manage the funds in the market, "this
money will be parked until it is deployed. Banks would be forced
to place funds with the central bank at zero - this will put
huge pressure on asset yields," Haris said.
In the absence of tawarruq, some banks aim to use wakala
(agency) agreements under which they would entrust their money
to other institutions to manage. But the small number of Islamic
counterparties would limit this option's appeal, bankers said.
A ban on tawarruq could pressure the government into issuing
short-term sukuk, or Islamic bonds, to fill the gap and help
banks manage their money. If this happens, Oman could move ahead
of some other countries which have been slow to develop issuance
of short-term sukuk.
But so far Omani authorities have shown no sign of starting
an extensive issuance programme. The finance ministry has no
need or incentive to issue large volumes of sukuk, Abbas said.
Also, foreign exposure limits mean Oman's new Islamic
banking operations will have to keep most of their money
onshore. A two-year exemption from or relaxation of the limits,
allowing banks to invest offshore, could alleviate the liquidity
management problem, Abbas said, but authorities have not
indicated they will grant such an exemption.
If there is no action to make it easier for Islamic banks to
manage their money during their initial years of operation, "it
will be a disaster for the banks," he said.
Even if liquidity management problems are resolved,
competition may be tough for the Islamic banks from the start.
In addition to the two dedicated Islamic institutions, Bank
Nizwa and Al Izz Islamic Bank, five banks plan to
offer sharia-compliant products through Islamic windows: Bank
Sohar, Bank Dhofar, Bank Muscat, Ahli Bank
and National Bank of Oman (NBO).
Fuelling competitive pressures, the overall banking market
is quite concentrated: the three largest banks accounted for 62
percent of total assets and 59 percent of total deposits as of
December 2011, central bank data showed.
"Incumbent banks have a competitive advantage over new
Islamic lenders, as they have expertise relating to Islamic
finance products, including Bank Muscat and NBO," said Mahin
Dissanayake, director of financial institutions at Fitch
Bank Muscat has offered Islamic products in Saudi Arabia,
while NBO is part-owned by Qatar's Commercial Bank of Qatar
, which used to operate an Islamic window, he said.
Dissanayake said Bank Sohar, which floated on the Omani
stock market in 2007, had taken three years to gain substantial
market share - an indication of the time which the new Islamic
banks might have to spend to become major players.
IFAAS said it had conducted a market survey suggesting 70
percent of consumers in Oman anticipated opening an Islamic
savings account in the next 12 months, while 77 percent expected
to take out Islamic loans in the next one or two years.
These intentions may not necessarily translate into business
for the new Islamic banks, however. Studies in other countries
such as Qatar have shown many consumers tend to remain loyal to
their existing banks, and religious permissibility is only one
factor for them; quality of service and financial returns can be
(Additional reporting by Saleh Al-Shaibany; Editing by Andrew