While Islamic financing formally started in Qatar in 1983 with the establishment of Qatar Islamic Bank, the Islamic finance market opened in Qatar to conventional banks in 2005 when the Qatar Central Bank (QCB) authorized conventional banks to offer Shariah-compliant finance products to their clients through Islamic windows.

Consequently, the Qatari Islamic finance market was until recently open to fully independent Islamic banks as well as conventional banks authorized by the QCB to offer Islamic financing through an Islamic window.

With the Islamic finance market in constant growth over the last 20 years with a market share of around 20 per cent, a large number of conventional banks established in Qatar took advantage of this opportunity and are now offering both Islamic and conventional financing to their clients (this is in particular the case for Qatar National Bank, HSBC, Doha Bank, Commercial Bank of Qatar and others).

This dual-regime period is now about to come to an end due to recent specific directives issued by the QCB to each of the concerned conventional banks that have Islamic windows.

I. The Directives

The QCB has recently notified conventional banks running Islamic financing activities in Qatar that they should (a) refrain from opening new Islamic branches, accepting Islamic deposits and conducting new Islamic finance operations and (b) manage their outstanding Islamic finance assets and liabilities up to December 31, 2011 by collecting the balances (in accordance with their existing conditions and maturity dates) and by paying Islamic deposits upon maturity. After that, any other remaining Islamic assets need to be managed by the affected banks in specifically dedicated portfolios or transfered to the Islamic banks. Following cessation of all Islamic finance activity, conventional banks are free to use premises previously used by Islamic finance branches for conventional banking activities.

II. The Rationale

The QCB has justified its decision on the following supervisory as well as monetary-policy grounds:

1. Supervisory Issues

According to the QCB, the supervisory issues stem from the “overlapping nature of non-Islamic and Islamic activities of conventional banks” and the “comingling of their activities and services”, leading to difficulties for conventional banks to properly manage the following areas:

a) Bank risks

Islamic finance operations are characterized by a more complex nature with regard to returns, liquidity, credit and market risks than conventional banking products. According to the QCB, this is a particular challenge if the funding of Islamic finance operations (such as Mudaraba, Musharaka, Istinaa and Ijara) happens through conventional fixed-income deposits. Accordingly, applying “oversight instruments and prudential ratios and indexes used for risk management” at the same time to both Islamic and conventional operations becomes too complex insofar Islamic and conventional banking risks are reflected in the same financial position.

b) Financial reporting

Again, due to the “overlapping nature” of conventional and Islamic activities, the QCB considers it too difficult for conventional banks to “prepare consistent financial reports governed by unified international standards”, impacting negatively on the proper financial analysis of said reports.

c) Capital adequacy

Furthermore, the QCB highlights that it is currently preparing separate instructions to be issued to Islamic banks on capital adequacy in accordance with the standards of the Islamic Financial Services Board (IFSB) which will differ “significantly from the instructions on capital adequacy relating to conventional banks” (Basel II and Basel III) and states that it will be difficult for conventional banks to combine these two types of regimes in one financial position. Moreover, the QCB is of the view that Islamic branch capital cannot be separated from the bank’s capital for independent risk weighting.

d) Financial stability

The QCB has also raised concerns that the offering by conventional banks of Islamic and conventional products poses “a difficult challenge for Islamic banks to maintain their stability and growth rate” and affects competitive neutrality.

2. Monetary Policy Issues

The QCB has also put forward monetary policy issues to explain its recent decision. The segregation of conventional and Islamic activities shall make the application of monetary policy directives (such as the required reserve, the QCB rates, etc.) easier to administer and shall also improve the QCB framework of liquidity management and the efficiency of open market operations.

III. Initial Assessment and Outlook

The QCB has assessed and determined specific regulatory challenges that arise from the combination of Islamic and conventional products (for example, regarding the management and supervision of profit sharing investment accounts in comparison to conventional fixed-income deposits). The QCB believes that its work identifying the specific differences and similarities between these products shall definitely benefit the prudential supervision of banks in Qatar. While the attempt to improve existing regulatory structures for dealing with Islamic and conventional banking activities should be applauded, some residual uncertainties remain. In particular, the press release issued by the QCB does not indicate whether banks could be allowed to spin-off their Islamic operations and whether international banks which already have established Islamic arms would also fall within the ambit of the new approach. It is fair to assume, however, that the QCB has no intention of permitting or tolerating any alternative structures or mechanisms the purpose of which would be to segregate Islamic and non-Islamic banking activities in any bank subject to its supervision.

Consequently, the QCB’s approach will have a significant impact on the competitive landscape for Islamic banking in Qatar. This has already been seen with the circa 10 percent increase in the share price of each of Qatar Islamic Bank and Masraf Al Rayan on the day following the announcement. Also, shares of affected conventional banks suffered a significant loss in value. In addition, Moody’s, a rating agency, stated in the week thereafter that “(t)he loss of Islamic banking franchise is credit-negative for Qatari conventional banks, which derive 10-15 per cent of their yearly earnings from Sharia-compliant banking”.