CENTRAL BANK OF OMAN FINANCIAL STABILITY REPORT Issue 5: 2017 CENTRAL BANK OF OMAN FINANCIAL STABILITY REPORT Issue 5: 2017 © 2017 Central Bank of Oman. All rights reserved Reproduction is permitted provided an acknowledgment of the source is made. Feedback on this Report may be given at [email protected] Published by Financial Stability Department Central Bank of Oman P.O. Box 1161 Postal Code 112, Ruwi Sultanate of Oman Head Office Tel : (+968) 24 777 777 Fax : (+968) 24 777 767 This publication can also be accessed through Internet at http://www.cbo.gov.om His Majesty Sultan Qaboos bin Said FOREWORD It has been more than two years since the sharp fall in oil prices, however, uncertainty about the future path of the price of oil remains. Nonetheless, oil prices have been relatively stable since December 2016, which provided policymakers with a better understanding of the new economic reality. We observe signs of improved global economic outlook. Catching up with the U.S., the EU economy has shown marked improvement in 2016. The Asian economies, especially our main trading partners, China and India, are growing at a steady pace. Nonetheless, there are growing new risks. The U.S. withdrawal from the Paris Climate Accord might increase the supply of hydrocarbon and put a downward pressure on oil prices. The dynamics of Br exit are uncertain and could have a significant impact on financial stability in Europe and the rest of the world. China’s financial instability could be a function of its significant debt and growing housing market problems. The region is also entering a new phase of political instability, which could have a significant spillover into economic and financial instabilities. Being entrusted with the maintenance of financial stability of the Sultanate, the Central Bank of Oman remains watchful of these developments. Given global risks, on balance, we are optimistic about financial stability in the Sultanate. The economy faced clear challenges, including contractions in 2015 and 2016, but proved stable. International forecasts anticipate economic growth to resume next year. The government has been active in taking steps to consolidate its budget. Measured reforms, including the pace of economic diversification, have been taken and policies were put in place to increase revenues and reduce expenditures. The Central Bank of Oman continues to maintain a comfortable level of foreign reserves, which is sufficient to back-up the peg. During 2016, the Omani banking sector remained well capitalized and profitable with low infection ratio. Banks remained fairly liquid without any bout of serious stress. The credit growth remained healthy and the risks are well-contained. Our stress tests indicate low solvency and liquidity risks for the banking sector in the face of severe shocks. The cooperation among policy makers at the global level to coordinate financial sector regulations continued in 2016. The Central Bank of Oman ensured that its regulatory framework and supervisory policies are supportive of financial stability and economic growth. Our regulations also ensured that Oman complies with the international legislation and global best practices. During the year, a new Anti-Money Laundering Law was promulgated, Bank Resolution Framework was formulated, and policies to improve Financial Inclusion were introduced. Furthermore, guidelines on Sound Compensation Practices, Correspondent Banking Relationships, and adoption of IFRS 9 were issued. Oman is also on track in implementing Basel III capital and liquidity standards. Moreover, the Payment and Settlement Systems in Oman remained robust. Despite economic headwinds, we believe that the overall financial stability of the Sultanate remains intact. Hamood Sangoor Al-Zadjali The Executive President CONTENTS Page No Foreword Financial Stability Assessment of Oman-An Overview I Chapter I. Macro-Financial Outlook 01 Chapter II. Financial Institutions 33 Chapter III. Financial Sector Regulation And Infrastructure 59 Chapter IV. Stress Testing of the Banking Sector 72 List of Boxes Page No. 1.1 Measuring Total Factor Productivity 12 1.2 Investment Demand in Oman 16 The Macro-Financial default-risk stress testing approach of the Central Bank of 1.3 20 Oman 1.4 Inflation in the Sultanate of Oman 26 1.5 The Government Debt 29 1.6 Estimating Import Demand Function for Oman 31 2.1 Banking Stability Index 35 2.2 Combating Non-Performing Loans 41 On Co-existence of Islamic and Conventional Banks: Do These Banks Differ in 2.3 54 Business Structure 3.1 Financial Technology 60 4.1 Shock Levels for Solvency Stress Tests 74 4.2 Interbank Contagion Effects 79 4.3 Macro Stress Test for Oman: Assumptio ns, Scenarios and Projections 80 4.4 Assuptions Underlying the Liquidity tress Testing 81 List of Figures Page No 3.1 Process Flow for Bank Resolution in Oman 62 List of Graphs Page No 1.1 Global Output 01 1.1.1 TFP Growth 1990-2015 14 1.1.2 Average TFP Growth 15 1.2 China and India real GDP Growth 02 1.2.1 Private Investment Function 19 1.3 Oman real GDP Growth Estimates 03 Page No 1.3.1 Actual and Forecast of the Default Rate 23 1.3.2 Out-of-Sample Projection, Oil Price Shock 24 1.3.3 Out-of-Sample Projection, Overnight Interest Rate Shocks 24 1.3.4 Out-of-Sample Projection, Combined Oil and Interest Rate Shocks 25 1.4 IMF Forecast Revision real GDP Growth Rate 03 1.4.1 The Phillips Curve 27 1.4.2 Calvo Price Equation 27 1.5 Total Investments as a Percent of Current GDP 04 1.5.1 Surplus and Debt Level 28 1.5.2 Debt-GDP and Growth Rate 30 1.6 Oman Nominal GDP Growth 04 1.6.1 Import Demand Function 32 1.7 Measures of the Output Gap 05 1.8 Oman Oil Prices 05 1.9 Brent Oil Prices 05 1.10 Foreign Reserves 06 1.11 GCC Real Exchange Rates 06 1.12 Global Inflation Rate 07 1.13 Oman’s Inflation Rate 07 1.14 Balance/Nominal GDP 08 1.15 External and Domestic Government Debt/GDP Ratio 08 1.16 Current Account percent of GDP 09 1.17 The Trade Account 09 1.18 Credit Growth 09 1.19 Narrow Money (M1) Growth 10 1.20 Broad Money (M2) Growth 10 1.21 M1 Growth 10 1.22 M2 Growth 11 1.23 VIX Index 11 1.24 MSM Performance 11 2.1 Assets / Structure of Financial Sector 34 2.1.1 Banking Stability Map 35 Page No 2.2 Growth in Banks Assets 34 2.2.1 Banking Stability Map 35 2.3 Uses of Funds 36 2.4 Flows in Asset Components 36 2.5 Flows in Asset Components 36 2.6 Private Credit Gap 37 2.7 Gross Loans 38 2.8 Risk Weighted Assets 38 2.9 Credit Growth 38 2.10 Foreign Currency Loans to Total Business Loans 39 2.11 Real Estate Financing & Exposure 39 2.12 Household Indebtedness to Income 39 2.13 Trends in Non-Performing Loans 40 2.14 Provisions Against NPLs 40 2.15 New NPLs and Recoveries 40 2.16 Restructured Loans 43 2.17 Special Mentioned to Gross Loan Ratio 43 2.18 Category-wise Breakup of NPLs 43 2.19 Policy and Overnight Interbank Rates 44 2.20 MSM Index and Returns 45 2.21 Stock Market Exposure of Banking Sector 45 2.22 Forex Exposure to Teir-1 Capital 46 2.23 Foreign Currency Assets & Liabilities 46 2.24 Cash Reserve Maintenance 46 2.25 Gap to Asset Ratio (in per cent) 47 2.26 Lending Ratio and Credit to Deposit Ratio 47 2.27 Sources of Funds 47 2.28 Customer Funding Gap 48 2.29 Breakup of Bank Deposits 48 2.30 Structure of Deposits 49 2.31 HHI of the Banking Sector 49 2.32 Banking Sector Concentration-by Total Assets 50 Page No 2.33 Concentration of Loans and NPLs 50 2.34 Credit Concentration 50 2.35 Solvency Profile of Banks 51 2.36 Frequency Distribution of CAR 51 2.37 Earnings Indicators 52 2.38 Composition of Non-Interest Expenses 52 2.39 Islamic Banking Indicators 53 2.40 Asset Structure of NBFIs 53 2.41 Mutual Funds 55 2.42 Assets Structure of FLCs 55 2.43 Trends in Non-Performing Loans 56 2.44 Funding Structure of FLCs 56 2.45 Earnings Indicators - FLCs 57 2.46 Insurance Penetration and Density 57 2.47 Gross Premiums and Retention Ratio 58 2.48 Net Claims and Loss Ratio 58 2.49 Money Exchange Companies 58 3.1 Tends in Value 66 3.2 Trends in Volume 66 3.3 Modes of payment: Tends in Value 67 3.4 Modes of payment: Tends in Volume 67 3.5 Daily Aggregate Closing Balances 68 3.6 Liquidity Concentration 68 3.7 Liquidity Concentration 68 3.8 Daily Payment Concentration 69 3.9 Shares in Payment System Activities 70 3.10 Cheque Clearing Duration 70 3.11 Reasons for unpaid cheques 71 4.1 Losses Resulted From the Differnet Risk Factors Under the Assumed Stress 72 Scenarios 4.2 CRAR of Local Banks After Shocks Under Balance Sheet Approach 72 4.3 CRAR of Foreign Banks After Shocks Under Balance Sheet Approach 73 Page No 4.4 Increase in The Current NPLs Before CRAR Drops Below CBO Requirement 73 For Local Banks 4.5 Increase in The Current NPLs Before CRAR Drops Below CBO Requirement 75 For Foreign Banks 4.6 Impact of 5 Largest Banks’ Borrowers Default on Their CRAR for Local Banks 75 4.7 Impact of 5 Largest Banks’ Borrowers Default on Their CRAR for Foreign Banks 75 4.8 CRAR of Local Banks After Shocks Under Moderate Macro Scenarios 77 4.9 CRAR For Local Banks After Shocks Under Severe Macro Scenarios 77 4.10 CRAR of Foreign Banks After Shocks Under Moderate Macro Scenarios 78 4.11 CRAR of Foreign Banks After Shocks Under Severe Macro Scenarios 78 4.12 Average Days of Survival Using Cash and Securities 78 4.13 CRAR of Foreign Banks After Shocks Under Moderate Macro Scenarios 78 List of Tables Page No 1.1 World Trade 02 1.1.1 Dynamic-OLS Estimate of Aggregate Production Function 13 1.2 Demand Indicators 04 1.2.1 OLS Estimates of Oman’s Investment Demand equation, 2001 to 2015 17 1.3 Global Oil Supply/Demand 06 1.3.1 Out-of-Sample Projections of