The 2009/2010 WIBC Competitiveness Report was launched at the 16th Annual World Islamic Banking Conference (WIBC) on the 7th of December 2009 at the Gulf Hotel in Bahrain. Produced in collaboration with McKinsey & Company, the Competitiveness Report highlights
recent developments in Islamic finance, with specific chapters dedicated to liquidity management in the Gulf region, North Africa’s Islamic banking landscape and Islamic investment management.
The 2008-2009 economic crisis has impacted banks globally, with large markets for Islamic finance no exception. Whilst global banks have suffered USD $700 billion in losses in 2008, Gulf countries (including Saudi Arabia, the United Arab Emirates, Qatar, Bahrain, Oman and Kuwait) have also felt the crunch, with little or no growth in 2009. Equity markets in the region have also experienced steep declines in performance, despite a partial recovery in 2009. Gulf banks have faced challenging times, with scarce liquidity, a rising perception of risk and the ever-present reality of credit defaults.
Since the crisis began in 2008, Islamic banks have not been immune from its effects. Overall, Islamic banking penetration has increased in key markets with Islamic banks outperforming conventional banks in growth of assets. However, both the market values and profitability of Islamic banks have come under pressure, narrowing the gap with their conventional peers. In particular, revenues for Islamic banks have declined significantly from 2008, driven primarily by a drop in income from investing activity. A number of Islamic banks have also been more strongly affected by the impact from non-performing loans than conventional banks. Islamic banks also continue to have greater exposure to real estate assets than conventional banks, and also lag behind them in operating efficiency. Liquidity, too, continues to be a significant constraint for Islamic banks. While Islamic banks maintain their market share of deposits, this market share will be subject to increased competition in the “war for deposits”.
The report recommends that in these market conditions, Islamic banks must now determine their future course of action by exploring four important areas. Firstly, they should enhancing and diversify their business mix, by tapping into new growth business lines, such as personal finance, asset management and various areas of investment banking, where some Islamic banks have been less focused in the past. Secondly, Islamic banks should improving risk management, in order to mitigate challenges on both credit and liquidity fronts, by upgrading their risk management capabilities and skills. Thirdly, they should lower the cost of operations and improve service quality, to maintain competitiveness for an increasingly demanding market. Finally, Islamic banks should exploring international growth opportunities, especially where excess capital is available and can be better deployed in under-penetrated markets.
1. The 2008-2009 economic crisis has impacted banks globally, with large markets for Islamic finance no exception
a. The financial crisis has been challenging for economies and banks throughout the world, with the banking sector affected particularly strongly.
- Global banks suffered USD $700 billion in losses in 2008, with the top 25 banks accounting for 83 percent of the write-downs/ impairments from the credit crisis.
- The crisis has impacted worldwide growth though some forecasts for 2010 are more optimistic. According to the International Monetary Fund (IMF) in its World Economic Outlook in October 2009, worldwide GDP growth in 2008 was at 3.3 percent but in 2009, the worldwide GDP is estimated to have contracted by 4.1 percent to -1.1 percent. Worldwide growth is expected to bounce back to 4.2 percent in 2010, according to the IMF.
b. The crisis has also clearly impacted 2009 growth in large markets for Islamic finance.
- GCC economies have felt the crunch, with little or no growth in 2009. According to the IMF, the real GDP of three out of the six Gulf Co-operation Council (GCC) countries (Saudi Arabia, Kuwait and the UAE) contracted in 2009, but all GCC countries are expected to have positive real GDP growth of between 2 to 4 percent in 2010, with Qatar estimated at 18.5 percent. Similarly, in South Asia, Malaysia and Singapore’s GDP contracted in 2009 by more than 3 percent, but these countries with Indonesia are expected to have GDP growth of between 2.5 to 5 percent in 2010.
- Oil prices declined sharply in the second half of 2008 have led to sharp declines in the budget surplus of the GCC. Having reached highs of more than USD $133 per barrel in Brent crude average oil spot prices in July 2008, oil prices fell to an average of more than USD $40 in December 2008 during the crisis, before steadily climbing to more than USD $70 by the end of the 2009. In relation, many of the GCC countries had less than 8 percent of their current account surplus as a proportion of their GDP in 2009, compared to double-digit figures of between 11 to 27 percent in 2008.
- Equity markets have also experienced steep declines since the crisis began in 2008. There has been a partial recovery, particularly for GCC indices where losses have been partially recouped.
- Banks in the GCC have faced also challenging times, with scarce liquidity, a rising perception of risk, and the ever-present reality of credit defaults
2. Since 2008, Islamic banks have not been immune from the crisis
a. Islamic banking penetration is up in key markets with Islamic banks outperforming in asset growth
- Islamic banks continued to experience robust asset growth and out-performed conventional banks during 2008. For example, in both Kuwait and Jordan, the Islamic banks’ assets grew by 15 percent when compared to the total banking sector growing at 11 percent in 2008.
- Islamic windows of conventional banks have continued to grow rapidly constituting an increasing share of Islamic banking. Islamic windows of the top five conventional banks in the Gulf in Qatar and the UAE grew by 80 percent in 2008 when compared to 2007.
- The growth in Islamic finance assets has lead to an increase in increase in Islamic banking penetration in key markets. Qatar’s Islamic finance sector assets have grown from 12.5 percent in 2003 to 20.3 percent in 2008 as a proportion of total banking assets. Turkey’s Islamic finance sector has grown from 9.7 percent in 2003 to 15.7 percent in 2008 as a proportion of total banking assets.
- Reported profitability remained generally higher for Islamic banks especially in the GCC region. For example, in Qatar, the return on average assets for the top five banks in 2008 was 3.2 percent, but for the top three Islamic banks was 5.9 percent. However, Islamic banks’ profitability has declined at a steeper pace, narrowing the gap with conventional banks. For example, in the UAE, the return on average assets of the top 3 Islamic banks was 2.7 percent in 2007, but declined by 0.8 percent to 1.9 percent in 2008. For conventional banks in the UAE, the return on average assets for the top 3 banks was 1.8 percent in 2007, but this declined by only 0.3 percent to 1.5 percent in 2008.
b. However both market values and profitability of Islamic banks have come under pressure, narrowing the gap with conventional peers
- Revenues have declined significantly from 2008, particularly driven by drop in income from investing activity.
- From when the financial crisis started, the stock market performance of Islamic banks has generally mirrored the largely downward trend of conventional banks. In some countries, Islamic banks are losing their advantage compared to conventional banks in terms of market expectations. In June 2008, the price to earnings ratio of Islamic banks in Qatar and the UAE tended to be higher than that of conventional banks, but in 2009, the market had better expectations of conventional banks by comparison.
- A number of Islamic banks have been harder hit by NPLs than conventional peers and continue to face the risk from real estate concentrations even as their operational efficiency continues to lag conventional peers
- Declining revenues from investing activities and an increase in provisions are some of the drivers behind this decline in profitability. In analyzing the aggregate profitability of the top three Islamic banks in Kuwait, Qatar, UAE and Bahrain, investing activity in 2007 represented 4.9 percent of total revenues compared with 3.5 percent in 2008. Similarly, provisions for the same set of banks in 2007 represented 0.4 percent of the total costs compared with 1.2 percent in 2008.
- The higher operating costs of Islamic banks compared with conventional banks have also exerted pressure on their profitability. The operating costs of the largest three Islamic banks in Turkey represent 4.4 percent of average assets, compared with 3.3 percent for the whole banking sector. In the Gulf, the operating costs of the largest three Islamic banks in Kuwait represent 2.5 percent of average assets, compared with 1.6 percent for the whole banking sector.
- Some Islamic banks had a higher non-performing loan (NPL) ratio in 2008 across key markets. In Kuwait, NPLs accounted for 4.7 percent of the top 3 conventional banks by assets, compared with 8.6 percent for conventional banks. In the UAE, NPLs accounted for 1.6 percent of the top 3 conventional banks by assets, compared with 3.0 percent for conventional banks. NPLS for 2009 may increase further for Islamic banks across these key markets as the full effects of real estate slowdown sink in.
- Islamic banks also continue to have a high proportion of real estate assets. According to end of year reports, the top three Islamic banks in the UAE have 26 percent of their banking assets in the real estate sector, compared to 19 percent for conventional banks. In the Kuwait, the top three Islamic banks have 24 percent of their banking assets in the real estate sector, compared to 20 percent for conventional banks. Overall, the high concentration of real estate assets in the Islamic banking sector is consistent with previous years. Additionally, returns for top real estate companies have also under-performed the market during the crisis, further undermining Islamic banks’ profitability.
c. Liquidity continues to be a significant constraint for Islamic banks. While Islamic banks maintain their market share of deposits, it will be subject to increased competition in the “war for deposits”
- On the liquidity front, Islamic banks have a more pronounced maturity mismatch than conventional banks. Based on a sample of the top 7 conventional and Islamic banks by assets in the GCC, the net liquidity gap for a contractual maturity period of one to five years was 23 percent of total assets for Islamic banks in 2008, compared with 16 percent for conventional banks in the same period. However, Islamic banks source more funds from deposits than conventional banks. Customer deposits for all Islamic banks in the UAE, Kuwait, Qatar and Saudi Arabia in 2008 represented 69 percent of liabilities, compared with 54 percent of all liabilities for conventional banks in the same region and period.
- Islamic banks have also maintained their share of deposits over recent years. The top three Islamic banks in Qatar and Saudi Arabia have since 2005 consistently represented between 14 to 18 percent of their deposits as a proportion of aggregate deposits in the country. However, some Islamic banks are now offering higher indicative profit rates for customer deposits, sometimes more than 1 percent higher than the national interbank rate. Islamic banks’ reported capital positions remain strong, though the gap is also shrinking in most markets and might be further tested with rising NPLs. For example, in 2007, the top three Islamic banks in Qatar had a capital adequacy ratio of 26.8 percent, more than 12.2 percent than the top four conventional banks at 14.6 percent. In 2008, the same Islamic banks in Qatar had a capital adequacy ratio of 21.7 percent, now more than 7.4 percent than the top four conventional banks at 14.3 percent.
3. In the aftermath of the crisis, Islamic banks must now determine their future course of action by exploring four important areas
i) Enhancing and diversifying their business mix, by tapping into new growth business lines, such as personal finance, asset management and various areas of investment banking, where some Islamic banks have been less focused in the past
- Personal finance products have sustained a strong growth momentum in the GCC over the last few years.
- For example, in personal finance products, the volume of personal loans in the GCC grew from USD $30 billion in 2003 to USD $80 billion in 2008, representing a 22 percent per annum growth rate. The volume of credit cards in the GCC grew from USD $2.3 billion in 2003 to USD $7.4 billion in 2008, representing a 26 percent per annum growth rate.
- Islamic funds are an increasing priority for fund managers. In a global survey conducted among CEOs of asset managements funds in 2008, when asked ‘What kind of products does your firm offer, or plan to offer in the next 2-3 years, in the Middle East?’, more than of all firms who responded agreed or strongly agreed that they would offer Islamic funds. When the same question was posed to US firms, 64 percent of them responded in the same way as did 57 percent of EU firms.
- Islamic banks have had limited presence in leading investment banking and capital markets activity. Despite USD $210 billion of investment banking volume in the GCC, no Islamic bank can be found in the top ten of the league tables for 2006-2008 for the areas of mergers and acquisitions and syndicated lending.
- The global Sukuk market has seen declines in 2008-09 but is expected to bounce back in 2010. In 2007, there were USD $71 billion in global Sukuk issuances, which fell to USD $36 billion in 2008 and USD $45 billion in 2009. The sukuk sector experienced a significant turn-around in the second half of 2009 with reported pipeline of deals up to USD $50 billion. A liquidity shortage and low risk approach can assist the sector to shift the increasing share of borrowing to the capital market.
- The infrastructure investment pipeline will be a key driver of Sukuk growth. Saudi Arabia has announced real estate investments of USD $202 billion required for financing, compared with USD $250 billion in the UAE, volumes which may change in the aftermath of the financial crisis. However, even under a conservative scenario, there are significant projects in the region in infrastructure, which will require financing.
- Sovereign issuance is expected to drive an increasing share of the Sukuk market in the GCC. Sovereign Sukuk represented a 57 percent share of GCC Sukuk issuances in 2008, compared with only 6 percent in 2005.
ii. Improving risk management, in order to mitigate challenges on both credit and liquidity fronts, through upgrading risk management capabilities and skills.
- Islamic banks must review their capabilities across the entire credit risk value chain from disciplined loan origination, risk-adjusted approval and pricing, proactive portfolio monitoring to efficient and effective collections.
iii. Lowering cost of operation and improving service quality, to maintain competitiveness for an increasingly demanding market
- Global banks have used five key levers to run successful cost improvement programs, which would be useful for Islamic banks: optimizing cost to serve in distribution, maximizing their back office and IT efficiency, optimizing the scale of factories or moving offshore, remove the layers from the managerial structure and fostering a productivity mindset.
iv. Exploring international growth opportunities, especially where excess capital is available and can be better deployed in under-penetrated markets
- There are three models that can be used to execute an international expansion strategy for Islamic banks – universal banking, niche banking in target countries, and joint ventures with existing market players. A number of criteria, such as market potential, ease of entry and degree of competition, should be considered when making such strategic choices. Global Arab Network