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Monday, 3 July 2017

Analysis: Can GCC Islamic banks escape the oil-price cycle?

What was unthinkable, or at least not admitted, just years ago is beginning to happen in Islamic finance. More and more stakeholders now concede that the Shari’ah-authorized way of banking has hit a glass ceiling.
They acknowledge that Islamic banking and financial services have largely failed to innovate at the speed they were expected to, and are got caught in the image warp of not being much different from conventional banking.
It is also admitted that, just like several other businesses, Islamic finance appears to be caught in an oil-price cycle, definitely in the Gulf and wider Middle East region. While acceptance of ground realities is a positive sign, what seem amiss is collective efforts to tackle the challenges in an already fragile economic environment.
But is this the only challenge and what needs to be done about it? Diagnosis as well as prescription differs with different stakeholders and so does priorities.
An IMF working paper, released last year, says that oil price performance has been an important driver of business and financial variables in the GCC economies. “First, stronger performance of real and financial variables tends to be associated with oil price upturns,” the report said.
Dr. Helmi Hamdi, Senior Research Fellow at Aix-Marseille School of Economics, begins with a wider perspective. He says that current problems faced by Islamic finance relate to absence of common regulation and harmonization.
According to him, these challenges have hit the growth and performance of the industry as a whole. However, he hastens to add that this could also be attributed to slowdown of global economic activity, which remained fragile with an uneven growth, thereby affecting Islamic business activities all over the world.

The asset-energy conundrum

According to Dr. Hamdi, primary challenge for Islamic finance emerges from drop in oil and energy prices, which negatively affect growth of oil-exporting countries. “Since most important part of Islamic finance assets is located in oil-exporting countries, the sector has been negatively impacted by the slowdown of economic performance,” he says.
There are industry insiders who have been making similar arguments for a long time now. Rushdi Siddiqui, who is now Advisor at Wall Street Blockchain Alliance and Mentor at VC firm Quest Ventures, and is an industry veteran, says Islamic finance is deeply linked to oil/commodity prices and hence remains as volatile as price per barrel of oil.
“When oil is $80/barrel, surpluses exist, infrastructure projects are many, banks are lending to SMEs, and non-Muslim countries want part of the petro-liquidity. Conversely, when the price bandwidth is $35-50/barrel, there is a lot of pain for governments, SMEs, banks, and consumerism,” Siddiqui wrote as early as late last year.
“The sooner Islamic finance phases out linkage to oil then it will better control its funding and its destiny,” he says. Rushdi’s prescription may be simple, and urgent, but unfortunately, it doesn’t seem to be happening.

Difficult times ahead

Global rating agency, Standard & Poor’s, estimates that Islamic banks in the GCC are expected to face a tough year ahead as the slowdown in asset growth is likely to persist this year. Dr. Mohammed Damak, Head of Islamic Finance at S&P Global Ratings, says GCC Islamic banks’ profitability is likely to be negatively impacted by the rising cost of funding, and squeeze on banks’ intermediation margins.
Dr. Damak believes that as the economic cycle turns, GCC Islamic banks’ asset quality indicators will deteriorate in the second half of this year and in 2018. “Such weakening was not noticeable in in 2016 because – as is typical – banks had started to restructure their exposure to adapt to the shift in the economic environment”, he says.
According to Dr. Damak, very few Islamic banks have set aside significant amounts of profit-equalization reserves, which they build in good years and use to smooth returns, if needed. That said, owing to their relatively low cost bases, GCC Islamic banks should be able to protect their profitability somewhat over the next two years.

Silver lining

It would be unfair to suggest that it is all doom and gloom in the industry. In almost two decades, Islamic finance industry has indeed launched many policies to modernize its financial services.
Dr. Hamdi, for instance, gives the example of Islamic banks today offering a wide range of financial products based on latest technological tools such as e “E-I-banking” and they have embraced latest financial innovations in their business such as FinTech.
“New Islamic financial and investment platforms, micro takaful and micro-Islamic institutions are also new types of innovation. So it is not fair to say that Islamic banks stopped innovating,” he says.
According to him, as for oil price, both Islamic and conventional banks are affected and it is a matter of business cycle. “The history shows that oil price was volatile since 70s. Therefore, both models must adopt new strategy and new business model that is not highly dependent of energy prices in general,” says Dr. Helmi.
Needles to add, this would only happen when oil dependent countries diversify their economies and lower the weight of oil price dependence, which doesn’t seem to be happening anytime soon.
(Ehtesham Shahid - Al Arabiya (English) - 3 July 2016)
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