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The country’s central bank is rewriting the rules on Islamic finance and conventional banks are being shown the door, writes Mark Dunne.

Last July, Qatar Central Bank governor Sheikh Abdullah bin Saud Al-Thani joined a celebratory opening ceremony for HSBC’s first Qatari branch dedicated to Islamic finance. The event was intended to show HSBC’s commitment to the Islamic market. But seven months later, Saud Al-Thani could prove instrumental in an unceremonious closing of the branch – as well as posing a threat to any other Islamic bank operated by a non-Islamic institution.

In February, the central bank (QCB) ordered all non-Islamic banks to cease writing new Islamic business immediately and to close their Islamic operations by the end of the year, arguing that separating conventional and Islamic banking will allow for greater transparency, better risk management and, crucially, closer adherence to the shariah laws underpinning Islamic finance. “A recent phenomenon has been the emergence of Islamic branches of conventional banks, leading to a co-mingling of their assets and liabilities,” the bank said in a statement regarding the decision.

“The overlapping nature of non-Islamic and Islamic activities of conventional banks made it difficult for them to properly manage the risks encountered by these banks.”

The central bank is well known for its stringent rules for the Islamic operations of conventional banks. Last year it ruled that the assets of banks’ Islamic windows be limited to 15% of their total assets, which was preceded by a requirement for Islamic windows to operate from separate offices to the conventional banking business, hence the opening of HSBC’s Doha branch.

The latest ruling was immediately seen as good news for Qatar Islamic Bank, Qatar International Islamic Bank and Marsaf Al Rayan, shares in which rose by at least 9% following the news. Together with privately-owned bank Barwa, these four banks currently control 17% of Qatar’s banking industry, a market share that is set to rise alongside their power to increase profit margins thanks to the central bank effectively killing off their competition. For conventional banks that have benefited from the growth of Islamic finance until now, the outlook is less clear.

Paradise lost

Despite the ruling, conventional banks will be allowed to manage their existing Islamic loan books until they mature, which could keep them in the market for several years. This leads Stephanie Carillon, a credit analyst at rating agency Standard & Poor’s (S&P), to suggest that conventional banks will suffer little immediate impact on their balance sheets as a result of the decision.

“Islamic banking for conventional banks is 5-15% of their balance sheets, so it is not a major issue,” she says. “It is more a growth challenge rather than an immediate impact. They could still generate earnings from the existing customer portfolio for another three to six years.”

But there will be casualties. The largest, according to Moody’s Investors Service, will be Qatar National Bank (QNB), the country’s largest lender. QNB holds a 39% share of the banking system’s assets and a fifth of all Islamic interests in the country, comprising some 15% of its income in the nine months to September last year. (QNB did not respond to requests for an interview.)

Along with HSBC and QNB, other banks affected by the ruling include the Commercial Bank of Qatar (CBQ) and Doha Bank, the second and third-largest conventional banks, holding 12% and 9% of the market respectively, with the latter deriving almost a tenth of its income from the Islamic market.

QCB’s announcement has left these banks and their peers – International Bank of Qatar, Ahli Bank and Al Khaliji – with several questions about how to comply with the ruling. The main issue will be whether they are allowed to continue trading by applying for separate Islamic banking licences and moving their interests into new entities.

For now, few banks have a clear idea of how the ruling will work. Al Khalij is still deciding how to manage the Islamic business currently on its books. HSBC says that it is too early to make a decision on the action it will take regarding the future of its Doha branch and its wider Islamic banking operations in Qatar.

Reports suggest that the bank is holding discussions with QCB to clarify the situation, which its spokesperson would neither confirm nor deny. Also yet to announce its plans is CBQ. “You don’t need to be a rocket scientist to understand the far reaching impact on our business,” a spokesperson says. “Islamic banking is an aggressively growing sector and suddenly to be told that we are not allowed to be involved with it has certain implications.

”Not all conventional banks are so concerned. A spokesperson for International Bank of Qatar says that the ruling will have little effect on its business due to it only starting its Islamic operations two years ago: “We will be abiding by this [ruling] but the effect on us is minimal compared to our competitors.”

The spokesperson adds that the bank is still deciding what it should do with its Islamic assets: “The instructions only came out recently and at our end it will take time to digest what they mean.”

Breaking up, moving on

QCB has so far given these banks several options. They could choose to wind down their Islamic finance operations altogether or persuade customers to convert their interests into conventional loans in a bid to retain the client once their portfolios mature. S&P’s Carillon believes that it will be easier to convince corporate clients than retail clients to use more conventional banking products.

This will benefit CBQ more than Doha Bank, which has a larger percentage of its business in the retail market.

The final option would be for banks to sell their Islamic finance assets, which could lead to Islamic banks picking up bargains in fire sales. S&P’s Carillon predicts that this will be banks’ preferred route: “We believe this creates acquisition opportunities for Islamic banks locally of the financing book or the entire Islamic window including the relationship with the clients.” She predicts that local players will buy the assets, with little foreign interest.

Choices will need to be made fast. QCB has claimed that it made its ruling after holding “several preparatory meetings and co-ordinating with the concerned banks”. But Amjad Hussain, a partner at law firm Eversheds, claims that the ruling surprised several industry analysts.

“Many observers are concerned by the fact that such a significant decision seems to have been made without a proper consultation process with some of the key stakeholders,” he said in a written statement. “There is a general feeling that the grace period granted to comply with the new regulations is very short, in addition to which, the exact parameter of the circular have not yet been clarified.”

A spokesperson for the International Bank of Qatar, meanwhile, says that the decision was not sudden and that banks were expecting some form of ruling. “The banks did know that this was going to happen”, the spokesperson says, they just didn’t know when. QBC’s spokesperson says they are unaware whether the bank’s directors had any prior warning about the exact nature and timing of the ruling.

After complying with the previous wishes of QCB, it has been a bad start to the year for those banks wanting to expand their Islamic finance operations in Qatar. A fear for conventional banks with Islamic banking interests in other Middle Eastern countries could now be that other central banks may issue similar directives, although there are no such signs yet.
Whatever happens in Qatar, the Islamic banking market is set to be a growth area for those banks that fit the central bank’s vision. For those that don’t, it’s decision time. GTR