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The third challenge concerns products: they must be specific to Islamic banking and acceptable to Sharia law. This challenge has been easier to address, as many products have been tested in other markets. The main requirement is to ensure that the Sharia board of each bank guarantees the proposed products are Sharia-compliant.
Solutions to the barriers were well addressed, partly because, being late to the market, Oman was able to learn from other countries experiences Magd & McCoy, 2014).
While conventional banking is still predominant in Oman, the market now also includes an increasingly vibrant Islamic-banking segment that was immediately accepted and has grown rapidly. In the first nine months of 2017, it expanded by 29 percent, the fastest rate globally (Oxford Business Group, 2019). There are now two dedicated Islamic banks, and of the seven local commercial banks, six have Islamic windows.
With all this happening and the laws of the sultanate not being Sharia-based, the Central Bank was fortunate to be able to consider the examples of other GCC countries to build strong governance criteria.
The soundness of the Omani financial sector through the 2008 global financial crisis is largely due to the conservative stance taken by its Central Bank, well known in the region for its strong regulation and governance. With the changes in 2012 to allow Islamic banking, the Central Bank was tasked to make sure that it not only set in place strong governance, but also supported the new banking system and upheld Sharia principles. It learned from the experiences of other GCC countries that both a comprehensive Islamic banking regulatory framework and a higher Sharia supervisory authority are needed to ensure compliance.
The Islamic Banking Regulatory Framework introduced in December 2012 included the immediate establishment of a Higher Sharia Supervisory Authority. The Central Bank of Oman also wanted to ensure correct financial reporting in this new sector and worked closely within the standards of the Accounting and Auditing Organization for Islamic Financial Institutions. The result was the Islamic Banking Regulatory Framework, which extends to 591 pages.
After the regulatory structure was set in place, one of the early considerations concerned whether Oman should have a dual Islamic-banking system that includes windows. The Central Bank was well aware that allowing conventional
banks to begin Islamic-window operations would promote diversity and inclusion.
However, allowing windows could also be perceived as promoting uneven opportunities, because conventional banks have the ability to draw from their parent banks’ resources.
Prohibiting windows, nonetheless, would mean denying conventional banks the opportunity to set up outlets to serve existing customers. It would also deny the general public access to Islamic banking until fully fledged Islamic banks became established. In taking the decision to also allow Islamic operations through Islamic windows, the Central Bank of Oman fulfilled its critical responsibility to mitigate the risks of non-adherence to Sharia principles (Islamic Financial Services Industry Stability Report, 2018, box 1.1: Development of Islamic Banking Sector in Oman, 17- 24)). Drawing lessons from the experiences of Qatar and Kuwait, the Central Bank of Oman knew that regulations for windows would need to be comprehensive and clear.
The Oman Islamic Banking Regulatory Framework is inclusive in its management of windows. Among other things, it stipulates that they can offer only Islamic banking products and services. Conventional-bank branches cannot carry Islamic-banking business, and there is to be no comingling of funds. Windows are to have independent and compliant IT systems as well as a dedicated treasury to manage Sharia-compliant instruments. The windows also need to have a clear vision and business plan that the Central Bank will approve, regularly review and monitor. All senior management must be properly qualified, with appointments approved by the Central Bank. Windows are constrained in relation to their net worth for prudential limitations. Their single borrowing limits would be reliant on the banks’ net worth. All these rules are set to guarantee that Sharia principles are strictly adhered to, and that the operations of conventional banks’ windows are on a level playing field with the newly established Islamic banks.
Banks are also to install their own Sharia supervisory boards to oversee and monitor all aspects of Islamic banking. The appointment of appropriately qualified scholars to these boards also must be approved and monitored by the Central Bank.
Penalties for noncompliance with Sharia principles in Oman are tough. If violations occur, transactions will be canceled and income attributable to the bank or window
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donated to Muslim charities. These rules place the reputation and sustainability of the banks at stake (Alam et al., 2019).
To ensure that there is a continuing supply of qualified staff, the Central Bank and the commercial banks in Oman worked with the College of Banking and Financial Studies to establish a dedicated bachelor's degree in Islamic banking. Staff can enroll in specialist subjects to enhance their Islamic-banking knowledge. This setup provides a distinct incentive to assist with ensuring knowledgeable operations and compliance.
The Central Bank also recognized the need for some initial regulatory support. For a limited time, it relaxed some of its rules to give the new operations a fighting chance against the already established conventional banks. A case in point:
banks in Oman are limited to 15 percent of a total loan portfolio for housing finance and 35 percent for other personal finance. With consideration of the large number of nonparticipants in banking, Islamic banking entities were permitted for two years to exceed these limits up to a combined maximum of 75 percent for personal finance. This relaxation was gradually reduced by December 2017 (Alam et al., 2019).
The Central Bank of Oman set good guidance in place from the beginning and supported the sector, working in consultation with external associations, existing banks and educators. The market was ready and enthusiastic about the new Islamic offerings.
The difference made by having a strong regulatory framework is very clear.
Within five years, Islamic assets had grown to 12.4 percent of total bank assets. Growth in 2017 was 23.8 percent, against the 5.3 percent growth of conventional banking assets, outperforming GDP growth of 8.7 percent.
The quality of assets has also been maintained, with nonperforming loans of Islamic-banking entities at 0.35 percent, compared to the total banking sector’s 2.8 percent — 6.4 percent in Bahrain and 5.9 percent in the UAE (Annual reports from Central Banks of Oman, Bahrain and the UAE).