Discussion Paper on

Assessment of Liquidity Conditions of Commercial Banks in Oman

Economic Research and Statistics Department

Central Bank of Oman

Post Box-1161, Ruwi-112 Sultanate of Oman Tel: 968-24777777, Fax: 968-24777714 E-mail: ERSD@cbo.gov.om

Assessment of Liquidity Conditions of Commercial Banks in Oman

I. Introduction In order to revive growth momentum in the economy, the Central Bank of Oman has been pursuing accommodative monetary policy since the last quarter of 2008. The Omani economy, which suffered setback in 2009 following decline in the prices of crude oil in the international markets due to global financial crisis, recovered significantly in 2010 and continued to sustain the growth momentum in 2011 despite adverse global developments. In this context, there is a need to periodically review liquidity conditions in the banking system as liquidity management plays a critical role under the fixed exchange rate regime. More specifically, the objectives of this paper are: a) to understand if any structural liquidity problem exists in the banking sector that can constrain the credit flow to the productive sector of the economy; b) to comprehend whether the liquidity conditions are appropriate and consistent with easy monetary policy pursued by the CBO; c) to evaluate whether there are early signs of liquidity tightening due to sustained growth momentum; d) to conclude whether there is any need for proactive policy initiatives by the CBO, particularly in the context of domestic and global developments. In order to make an assessment of liquidity conditions in the banking system in Oman, the paper reviewed following indicators: a) growth of credit and deposits at the aggregate as well as sectoral levels; b) commercial banks net foreign assets position; c) their excess reserves with the CBO; d) lending ratio of the commercial banks; and e) the interest rate scenario prevailing in both money and credit markets. The study relates to the recent past covering the period from December 2009 to February 2012 - the latest period for which data are available.

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II. Structural Liquidity Condition Following recovery of the Omani economy, growth of commercial banks total credit accelerated from 6.2% in 2009 to 9% in 2010 and further to 16.7% in 2011 (Table 1). The total deposit growth also accelerated from 5.8% in 2009 to 14.6% in 2010 and further to 19.6% in 2011. In other words, total deposit growth, which was modestly lower than the credit growth in 2009, surpassed the credit growth in the next two years. As the deposit growth in the Omani banking system has been higher than the credit growth during last two years, prima facie, one can conclude that there is no structural shortage of liquidity in the banking system. In order to probe further, sector-wise breakdown of both deposit and credit is examined, which indicates that Government is a net lender to the banking system as its net deposit (deposit less borrowing) with banks increased from RO 1.8 billion in December 2009 to RO 2.3 billion in December 2010 and further to RO 3.3 billion by December 2011 (Table 2). Private sector continued to remain a net borrower from the banking system during the period under review, while public enterprises, which were net lender in December 2009, turned out to be net borrower thereafter. Without government deposits held with the commercial banks, it would have been difficult for commercial banks to sustain credit growth to the private sector and the public enterprises. Despite adverse global developments, as the crude oil prices remain at an elevated level, Government would continue to earn surplus revenues, particularly from the oil sector. Therefore, large government deposits with the commercial banks are expected to continue, unless Government chose to build up assets abroad. So long as the Government is expected to maintain large deposits with the commercial banks, it is unlikely for the banks to face any structural shortage of liquidity in extending credit. Hence, downside risks to credit expansion exists in Oman in case of fall in the prices of crude oil in the international markets and consequent withdrawal of deposits by the Government from the banking system to meet its proposed expenditures as per the Annual Budget 2012.

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Within the prudential regulation, commercial banks can supplement their domestic resources by borrowing from abroad. Hence, net foreign assets (NFA) of commercial banks can serve as an alternate liquidity indicator in the banking system. More recourse to borrowing from abroad is an indication of shortage of liquidity in the domestic market. Per contra, building up of assets abroad by banks could be interpreted as surplus liquidity condition in an open economy like Oman. The NFA of commercial banks, which was negative in December 2009, turned positive thereafter and increased steadily during 2011 and 2012 so far (Table 3). Notwithstanding low interest rate prevailing abroad, outflow of resources from the banking system implies surfeit of domestic liquidity in Oman. III. Excess Reserves with the CBO With effect from December 26, 2008, the CBO reduced reserve requirement from 8% of the designated deposits/ liabilities of commercial banks to 5% as part of the easy monetary policy with a view to provide flexibility to banks in liquidity management and credit deployment. Moreover, the CBO continued to conduct weekly auctions of 28-day CBO CDs to mop-up excess liquidity from the banking system. In view of this, excess reserves with the CBO by the commercial banks need to be seen in conjunction with the CBO CDs outstanding at any point of time. Table 4 shows that commercial banks daily average excess reserves with the CBO since December 2009 fluctuated in a narrow range between RO 300 million and RO 450 million (except RO 222.2 million in July 2011). Including the CBO CDs outstanding, the excess reserves in a broader sense, remained above RO one billion throughout the period under review. This implies large availability of excess liquidity in the banking system that could be utilized in case of pick-up in demand for credit in Oman. IV. Lending Ratio Regulation In order to know whether the existing macro-prudential regulation is a constraint for expansion of credit, the lending ratio of commercial banks during the recent period is examined. As against the prudential limit of 87.5%, commercial banks

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actual lending at the aggregate level continued to remain much below the prudential limit (Table 5). Even without any increase in deposit, commercial banks have the capacity to increase credit by nearly an additional RO one billion to reach the limit. As the deposit growth use to take place simultaneously with the credit expansion, commercial banks are unlikely to face any regulatory constraint to meet the growing credit requirement in 2012 unless deposit growth decelerates significantly or Government withdraws its deposits from the commercial banks. V. Interest Rate Scenario As the money market is shallow in Oman, it is desirable to start with the policy rates. The repo rate remained unchanged at 2% in Oman during the period under review. The commercial banks did not take recourse to borrowing from the CBO under the repo window during the period under review as they were flush with funds. On the contrary, Omani banks had strong appetite for CDs auctioned by the CBO on a weekly basis despite near zero CBO CD rate. As a deliberate policy option, the cut off rates of the CBO CDs were decided at a discount compared to the prevailing LIBOR rate so that arbitrage opportunity would not be available to the commercial banks. Large roll over of CBO CDs at a low rate of interest during the period under review is an indication of surplus liquidity in the banking system. The overnight inter-bank call money rates were a little above the CBO CD rates throughout the period under review. This implies that the CBO could be able to mop-up structural excess liquidity from the banking system through the weekly auctions while the frictional liquidity found its equilibrium in the overnight call money market at a modest premium over the CBO CD rate. Since October 2011, the CBO CD rate looked up modestly consistent with the corresponding LIBOR rate (Table 6). The overnight inter-bank rate also inched up in consonance with the CBO CD rate. This cannot be interpreted as early sign of liquidity tightening as these rates have softened once again in the more recent period (February 2012).

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Reflecting the comfortable liquidity condition, both RO deposit and RO lending rates continued to soften in Oman during the period under review. While the weighted average RO deposit rate declined from 2.23% in December 2009 to 1.69% in December 2010 and further to 1.42% in December 2011, the weighted average RO lending rate softened from 7.44% to 6.84% and further to 6.19% during the same period (Table 7). The foreign currency deposit and lending rates continued to remain significantly lower than the domestic deposit and lending rates during the same period. The broad conclusion that is emerging from the above interest rate scenario is that the prevailing interest rates are consistent with the easy monetary policy pursued by the CBO. VI. Outlook The overall outlook for sustaining growth in Oman remains positive in 2012. Hence, expansion of credit is expected to accelerate further in 2012. The equity market, which was subdued until recently, witnessed visible increase in activities in 2012 so far. Keeping in view buoyancy in the equity market, many companies in Oman are lined up for issuance of IPOs or rights issues. Mentioned may be made about Omantel Telecommunications Company, Voltamp, MSN Power, Galfar Engineering & Contracting, Sohar Power, National Finance, Nawras etc. In addition, several banks are expected to enter the primary market for raising resources in the near future such as Bank Nizwa, Al Izz International Bank, Bank Muscat, Oman Arab Bank, Al Ahli Bank, Bank Sohar etc. These offers are at different levels of processing with the Capital Market Authority. The exact time and amount of their issuances are being worked out. Subscription to these issues is expected to be made mostly by the Omani residents (households and institutions). Other than some subscription from residents of the GCC countries, other non-resident subscriptions may be negligible as the global recovery continues to be fragile. Appetite for each issue would depend on the pricing of each issue. Some issues may be underwritten by commercial banks. At the time of subscription, there is likelihood of withdrawal of bank funds to a significant

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extent or banks may be called upon to give loans to prospective subscribers. If several issues are bunched together, there may be some pressure on the domestic liquidity, at least for a temporary period till the proceeds return to the banking system. The CMA can spread the issuances over time to avoid the frictional liquidity problem in banks. VII. Concluding Observations

The liquidity conditions continue to remain comfortable with the banking system in Oman consistent with easy monetary policy pursued by the CBO. Assuming the crude oil prices to remain at an elevated level, the government would earn surplus revenues from the oil sector and therefore, government deposits with the banking system would remain at least at the current level that will help sustain expansion of bank credit, particularly to the private sector. Easy liquidity condition in the banking system could also be observed from large roll-over of CBO CDs and commercial banks excess reserves with the CBO. Despite low global interest rates, banks in Oman built-up sizable amount of assets abroad, implying outflow of resources due to excess liquidity in the banking system relative to its demand. Interest rate scenario in Oman is characterized by softening trend due to excess liquidity. Despite buoyancy in the MSM and likely issuance of a number of IPOs/ rights issues in 2012, their impact on bank liquidity may at best be frictional; unless issuances of large IPOs are bunched together. There is no regulatory constraint which may come in the way of credit expansion in Oman. The present liquidity position is appropriate and does not warrant any proactive action by the CBO to support the recovery.

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Table 1: Major Banking Indicators

(RO million) Private Sector Deposits 6541.5 (2.6) 7,236.9 (10.6) 7,229.4 (9.3) 7,046.3 (5.7) 7,147.7 (5.6) 7,234.7 (4.9) 7,473.0 (7.4) 7,381.7 (6.2) 7,424.9 (8.1) 7,287.8 (5.7) 7,779.2 (11.4) 7,878.6 (13.4) 7,974.0 (11.2) 8,031.3 (11.0) 8,127.7 (12.4)

Year/month Dec-09 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12

Total Credit 9,834.4 (6.2) 10,724.3 (9.0) 10,754.3 (8.1) 10,842.0 (8.7) 10,976.0 (9.8) 11,018.8 (10.2) 11,172.5 (11.1) 11,450.4 (12.6) 11,576.0 (13.1) 11,717.5 (12.8) 11,882.2 (12.4) 12,110.4 (13.6) 12,354.4 (17.0) 12,514.9 (16.7) 12,643.7 (17.6)

Private Sector Credit 8,996.3 (5.0) 9,557.3 (6.2) 9,539.4 (3.2) 9,582.9 (5.4) 9,715.4 (5.7) 9,735.9 (6.8) 9,768.2 (8.2) 9,964.2 (8.6) 10,100.3 (9.2) 10,230.2 (9.0) 10,340.3 (8.6) 10,555.3 (10.8) 10,636.8 (13.1) 10,800.0 (13.0) 10,879.8 (14.1)

Total Deposits 9175.6 (5.8) 10,516.8 (14.6) 10,558.5 (14.1) 10,604.7 (12.2) 10,585.4 (7.2) 10,657.6 (7.8) 10,962.6 (11.7) 11,152.5 (12.9) 11,259.6 (14.3) 11,202.9 (12.6) 11,772.4 (18.1) 12,184.9 (21.2) 12,282.7 (18.1) 12,573.3 (19.6) 12,508.6 (18.5)

Note: Figures in the brackets are percentage change over the previous year. Source : Central Bank Of Oman

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Table: 2 Sector Wise Distribution Of Credit & Deposits

Government Lending * Net Claims 71.8 47.8 52.9 67.7 43.3 42.7 42.9 43.1 43.1 43.4 40.7 31.3 32.8 32.9 32.8 -1,761.3 -2,253.4 -2,255.6 -2,423.4 -2,460.7 -2,493.7 -2,572.2 -2,778.9 -2,851.6 -2,889.1 -2,934.3 -3,044.6 -3,042.2 -3,340.1 -3,187.9 Private Sector Deposits Lending 6,541.5 7,236.9 7,229.4 7,046.3 7,147.7 7,234.7 7,473.0 7,381.7 7,424.9 7,287.8 7,779.2 7,878.6 7,974.0 8,031.3 8,127.7 8,996.3 9,557.3 9,539.4 9,582.9 9,715.4 9,735.9 9,768.2 9,964.2 10,100.3 10,230.2 10,340.3 10,555.3 10,636.8 10,800.0 10,879.8 (RO million) Public Enterprises Deposits Lending 724.2 864.2 904.1 956.5 823.2 772.3 759.8 830.9 821.2 861.0 906.8 1,100.7 1,071.9 980.5 983.2 577.6 921.9 959.9 990.6 1,019.9 1,053.3 1,176.2 1,254.9 1,252.4 1,252.3 1,265.6 1,294.5 1,442.8 1,460.3 1,485.3

Year/month Dec-09 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12

Deposits 1,833.1 2,301.2 2,308.5 2,491.1 2,504.0 2,536.4 2,615.1 2,822.0 2,894.7 2,932.5 2,975.0 3,075.9 3,075.0 3,373.1 3,220.7

*Direct lending by commercial banks; excludes investment in GDBs. Source : Central Bank Of Oman

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Table 3: Commercial Banks Net Foreign Assets

(RO million) Outflow(+) Inflow(-)

Year/month

Foreign Assets

Foreign Liabilities

NFA

Dec-09 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12

1730.4 1601.5 1718.96 1675.5 1643.6 1728.1 1700.5 1739.8 1917.1 1921.811 2053.6 2105.9 2275.8 2316.26 2464.9

1942 1438.4 1446.8 1320.8 1352.917 1532.3 1369.2 1488 1535.6 1580.7 1627.6 1609.2 1729.8 1847.259 1849.8

-211.6 163.1 272.2 354.7 290.7 195.8 331.3 251.8 381.5 341.1 426.0 496.7 546.0 469.0 615.1 374.7 109.1 82.5 -64.0 -94.9 135.5 -79.5 129.7 -40.4 84.9 70.7 49.3 -77.0 146.1

Source : Central Bank Of Oman

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Table 4: Excess Reserves with CBO

(RO million) Year/month Dec-09 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Excess Reserve Averages per Day 359.7 313.1 388.9 359.5 369.9 448.1 392.6 407.7 222.2 324.3 378.8 283.6 367.4 294.1 377.4 CD Outstanding 1,389.9 804.0 1,535.8 914.7 706.0 1,059.0 933.0 1,163.0 866.0 844.0 1,434.0 1,143.0 593.0 1,372.0 1,243.0 Excess Reserve Including CD 1,749.6 1,117.1 1,924.7 1,274.2 1,075.9 1,507.1 1,325.6 1,570.7 1,088.2 1,168.3 1,812.8 1,426.6 960.4 1,666.1 1,620.4

Source : Central Bank Of Oman

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Table 5: Lending Ratio of Commercial Banks

(RO million) Year / Month Dec-09 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Deposits Permitted Lending
(87.5% of Deposit base)

(A)
10379.22 11470.20 11366.89 11322.13 11278.74 11464.20 11683.69 11909.41 11919.26 12026.20 12482.66 12726.90 12758.03 13219.97 13110.23

Net Lending, inclusive of eligible Govt. Soft Loans (B)

9497.74 10333.98 10354.25 10435.88 10567.09 10605.89 10754.99 11035.20 11154.19 11296.99 11462.84 11687.90 11926.38 12124.58 12244.55

Lending Ratio (%)

79.78 78.53 79.36 80.28 81.61 80.57 80.20 80.75 81.56 81.87 80.04 80.03 81.45 79.90 81.40

Difference (A)-(B)
881.48 1136.22 1012.64 886.25 711.66 858.31 928.70 874.21 765.07 729.21 1019.82 1039.00 831.65 1095.39 865.68

11905.60 13158.55 13047.44 12999.23 12948.17 13163.10 13410.09 13666.51 13676.62 13798.28 14321.65 14605.20 14642.02 15175.44 15042.24

Source : Central Bank Of Oman

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Table 6: Money Market Rates

Year/Month Dec-09 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 CBO CD Rate 0.050 0.068 0.061 0.066 0.068 0.060 0.046 0.030 0.025 0.030 0.039 0.077 0.087 0.100 0.108 0.087 Repo Rate 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.00 (% per annum) Overnight Interbank Rate 0.076 0.098 0.092 0.101 0.108 0.096 0.095 0.088 0.090 0.084 0.072 0.081 0.113 0.108 0.125 0.106

Source : Central Bank of Oman

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Table 7 : Weighted Average Interest Rates (percent per annum)

Deposits Total RO deposits Dec-2009 Dec-2010 Jan-2011 Feb-2011 Mar-2011 Apr-2011 May-2011 Jun-2011 Jul-2011 Aug-2011 Sep-2011 Oct-2011 Nov-2011 Dec-2011 Jan-2012 2.227 1.693 1.659 1.544 1.509 1.468 1.444 1.446 1.427 1.434 1.448 1.427 1.414 1.416 1.394 Total FCY deposits 0.915 0.795 0.756 0.830 0.859 0.837 0.846 0.910 0.857 0.904 0.892 0.940 0.950 1.027 0.921 Total Deposits (RO+Fcy) 2.053 1.554 1.528 1.440 1.413 1.379 1.354 1.362 1.335 1.352 1.361 1.350 1.338 1.349 1.319 Total RO Lending 7.442 6.835 6.822 6.760 6.704 6.672 6.616 6.505 6.490 6.476 6.427 6.373 6.222 6.189 6.167

Lending Total FCY Lending 2.869 2.379 2.373 2.375 2.314 2.290 2.293 2.248 2.264 2.249 2.325 2.257 2.256 2.384 2.325 Total Lending (RO+Fcy) 6.475 5.919 5.913 5.873 5.810 5.793 5.767 5.690 5.691 5.684 5.649 5.579 5.499 5.523 5.485

Source : Central Bank of Oman

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