A year after Qatar asked conventional banks to stop offering Islamic financial services, an expected windfall for its Islamic banks has yet to materialise. Nor is it clear that banks’ customers are benefiting from the policy.
The episode illustrates the difficulties that countries face as they manage the relationship between conventional and Islamic banking. Trying to adjust that relationship carries risk, for both regulators and the banks themselves.
The Qatar Central Bank (QCB) last year announced that at the end of 2011, conventional banks would no longer be allowed to run “Islamic windows” — sections of the banks which operated according to religious, or Shariah, principles. Islamic banking services could only be offered by separate, dedicated institutions, QCB said.
The central bank’s move was designed to ensure the purity of Islamic finance, by removing any possibility that Islamic loans and deposits could mingle with conventional funds bearing interest, which is forbidden to Muslims.
Before the ban, Islamic windows saw a significant amount of business in Qatar; they accounted for QR54.6bn ($15bn) or 31% of all Islamic banking assets in the country during 2010, according to the International Monetary Fund. Combined assets at all banks, both conventional and Islamic, totalled QR572bn.
So the QCB move looked set to have a seismic impact on Qatar’s banking industry. One institution affected was HSBC Amanah, the Islamic arm of global giant HSBC Holdings; it opened its doors in Qatar in 2010, only to have to close months later.
In the wake of the decision, the shares of the country’s several full-fledged Islamic banks, such as Qatar Islamic Bank and Masraf Al Rayan, surged on expectations that they would attract money leaving the defunct windows.
“We’ll have a much bigger customer base. We see it as a very positive move,” Adel Mustafawi, chief executive of Masraf Al Rayan, said at the time.
Credit rating agency Moody’s Investors Service declared the “segregation of Islamic banking in Qatar is credit negative for conventional banks, positive for Islamic banks.”
It predicted Islamic banks would benefit from access to a larger pool of customers and improve their profit margins. Conventional banks would lose between 8% and 16% of their deposit bases, assets and profits, Moody’s estimated.
It hasn’t happened that way. There was little sign of the expected flow of money into Qatar’s Islamic banks last year; their total assets grew 35%, according to central bank data, but that marked a slowdown from 39% expansion in the previous year.
Masraf Al Rayan’s assets soared 59% last year but profitability declined as measured by return on assets, dropping to 2.55% in 2011 from 3.49% a year earlier.
Meanwhile, the performance of Qatar’s conventional banks improved; their assets grew 23% in 2011, up from a 16% rise in 2010. The biggest negative impact, Moody’s predicted, would be felt by the country’s largest lender, QNB.
But assets at QNB jumped 35% last year and its return on assets actually improved slightly.
The figures suggest that either depositors kept much of their money in conventional banks as Islamic windows closed, or Islamic banks suffered a growth slowdown that more than offset the benefits of the windows closing – or a combination of both.
Globally, banks’ customers can be divided into three categories, according to consultants AT Kearney: loyalists of conventional banks, loyalists of Islamic ones, and a “floating mass” — by some estimates, 60% or 70% of the total — who base their choice of bank primarily on pricing and service quality rather than religious permissibility.
Qatar’s data implies many conventional banks continued to attract the floating mass after their Islamic windows closed.
Most of Qatar’s conventional banks have still not fully divested their Islamic loan portfolios; instead, they have taken advantage of a provision in the ban which, according to commercial bankers, allows them to hold existing Islamic loans until maturity, as long as they do not extend fresh ones.
At Doha Bank, for example, Islamic financing activities represented 7.4% of total loans for 2011, down from 12.6% in the previous year.
Qatar’s move on Islamic windows contrasts with most Muslim countries, which permit the windows to operate as long as the banks show they are taking steps to prevent any mingling of their conventional and Islamic funds.
Islamic banking resembles conventional banking in many respects, with modifications to respect religious principles. For example, depositors do not receive interest but may get a share of profits from funds invested by the bank; loans do not charge interest but may carry certain fees.
Commercial bankers said that in addition to protecting the purity of Islamic finance, the QCB apparently wanted to level the playing field in banking: conventional institutions with Islamic windows were larger than pure Islamic banks, and so enjoyed better economies of scale.
More competition in one area, however, may be offset by the loss of it in another area. Islamic finance customers now have fewer options; an IMF report in January this year said there was a need to “manage the impact on banking sector competition in view of the decline in the number of institutions providing Islamic banking services from 12 to 4.”