(Clarifies last paragraph attributed to Rafique)
By Bernardo Vizcaino
SYDNEY, June 27 (Reuters) - A regulatory framework for Islamic finance is taking shape in Oman as government bodies move towards meeting the country's stated aim of making sharia-compliant products available to the public this year. But logistical challenges and the limited size of the market may prevent entrants to the business from making quick profits.
Legislation covering takaful (Islamic insurance) and sukuk (Islamic fixed income securities) is expected to be finalised by the end of the third quarter of the year, Capital Market Authority officials told Reuters.
Approval of the country's first takaful licence will follow soon afterwards, as three applications have already been received by the regulator, Ahmed Al Harrafi, takaful team leader at the CMA, said by telephone.
This complements efforts by the country's central bank to introduce a law that will supervise Islamic banks; the law is in its final stages of review, said Mohammed Al Abri, senior director at the CMA.
Last year, after insisting for years that its banking industry should be purely conventional, Oman reversed its stance and said it would introduce Islamic finance, partly to prevent outflows of funds to sharia-compliant institutions elsewhere in the Gulf.
But the introduction of the regulatory framework may not produce a rapid surge of activity. Many institutions are still grappling with the need to obtain product expertise, arrange oversight by boards of Islamic scholars, train staff and build computer systems.
"There is an expectations mismatch," Azmat Rafique, head of Islamic banking at Oman Arab Bank, told Reuters. "On the ground things haven't been finalised...and banks are still gathering teams and systems."
Last week newly formed Bank Nizwa, the country's first Islamic bank, failed at a shareholders meeting to appoint its board of directors, despite an initial public offer of shares that raised 60 million rials ($156 million) last month. This could potentially delay its schedule for launching products.
Also, banking competition will be stiff. Bank Nizwa obtained its banking licence last year along with Al Izz International Bank, another new Islamic institution; they will bring the total number of locally incorporated banks to nine.
Oman will thus have 19 commercial banks for a population of only about 2.8 million, with the three largest lenders initially accounting for about 60 percent of total banking assets, according to central bank data.
Competition will be increased by the fact that conventional banks will be allowed to use Islamic windows to offer sharia-compliant products through their existing branch networks. Bank Muscat, which has Oman's largest branch network of 130 offices, this week joined Bank Sohar and National Bank of Oman in saying it would deliver products this way.
Converting some existing conventional banks into Islamic banks could streamline the broad banking industry, but the central bank has not indicated whether this will be permitted, commercial bankers said. The industry may in any case not be advanced enough to handle such conversions, said Rafique.
Recent consolidation in the banking sector has been limited to a merger of HSBC's Omani business with Oman International Bank, the country's fifth largest lender, which obtained approval earlier this month.
Rafique predicted 10 percent of existing bank customers in Oman would eventually make the switch to Islamic banks, which would also attract a similar number of people who are currently outside the banking sector because of their religious belief in avoiding interest.
The takaful legislation, on the other hand, will not allow the use of Islamic windows but instead require stand-alone operations with paid-up capital of 10 million rials, Al Harrafi said.
But such capital requirements are difficult to justify in a sector eager to build scale, said Shyam Zankar, regional head at Bahrain-based Medgulf Allianz Takaful.
In addition, takaful companies will also have to be publicly floated on the country's stock exchange within five years of launch, Al Harrafi said, adding that this requirement might dampen the interest of at least one of the applicants.
Two firms have begun headhunting for senior positions in anticipation of entry into Oman's takaful market, said a Gulf-based chief executive of an insurance firm, who asked not to be named.
In the area of monitoring Islamic product standards, Oman is opting for the decentralised approach which prevails in the Gulf, rather than the centralised Malaysian model. This could facilitate early growth of the industry, by permitting a wider range of competing products, but perhaps limit broad interest in Islamic finance across the population because of the lack of a single, commonly accepted sharia board overseeing the industry.
The CMA, which became a member of the Malaysia-based Islamic Financial Services Board in March, considered creating a centralised sharia supervisory body but this option was not chosen, Al Harrafi said. An Islamic banking circular from Oman's central bank urged each bank to establish its own sharia board.
The standards of the Accounting and Auditing Organisation for Islamic Financial Institutions, a Bahrain-based industry body, will be used as guidelines by the central bank, Rafique said, adding that only the accounting standards are mandatory. (Editing by Andrew Torchia)