Islamic banking operations in Oman have grown to account for over 4 percent of the country's total banking assets in the past two years and could double that ratio by 2018, a study by Thomson Reuters found.
The sultanate introduced Islamic finance at the end of 2012, becoming the last country in the six-nation Gulf Cooperation Council to do so.
Since then, two full-fledged Islamic banks and six Islamic windows at conventional banks have opened their doors; they held a combined 1.1 billion rials ($2.86 billion) in assets as of June, or a 4.4 percent share of total banking assets, the study found.
That is far from the roughly 25 percent market share that Islamic banks enjoy in the Gulf Arab region, but close to the 5 percent share in countries such as Turkey and Egypt.
Under a base scenario, the study estimates Oman's Islamic banking operations could reach 5 billion rials of assets by 2018, a 7 percent share of estimated total banking assets at that time. A best-case scenario puts the figure at 7.1 billion rials, a 10 percent share.
But Islamic banks still need tools to help them manage their funds and ensure profitability; Bank Muscat's Islamic unit was the only operation to post profits in 2013, the study said. Bank Sohar's Islamic unit posted its first profit in the first quarter of this year.
The government is working on its first issuance of sukuk and the central bank has set up a task force to develop sharia-compliant liquidity management tools, Oman's central bank chief Hamood Sangour al-Zadjali was quoted as saying in the study.
The need for Islamic interbank tools is relatively acute in Oman because regulations ban the use of commodity murabaha, a money market contract widely used elsewhere in the Gulf.
"To the credit of Islamic banking providers in Oman, they have managed to operate successfully given the constraints they face in the interbank market," Zadjali said.
The Capital Market Authority has now finalised rules governing issues of corporate sukuk, after making amendments to ensure their tax neutrality vis-a-vis conventional bonds.
"We are targeting the approval of the CML (Capital Market Law) and issuance of the sukuk regulation by the second half of 2014," Ahmed Al Qassabi, the CMA's acting general manager of issues and disclosures, was quoted as saying.
When Oman introduced its Islamic banking rules, it took a highly prescriptive approach to ensure the religious permissibility of the industry. But some banks have sought relaxation of certain rules until the market matures.
Last year, the central bank granted Islamic banks a one-year relaxation on the amount of foreign assets which they can hold.
Bank Muscat, which operates the largest Islamic window in Oman, said in the study that it was seeking relaxation of capital requirements for Islamic windows, aiming to calculate these on a consolidated basis with the parent bank.
Islamic banks need to expand the types of products which they offer, and focus on non-retail business and on diversifying their lending portfolios, said Zadjali.
In the long term, there could be scope for mergers and acquisitions in the sector, as some lenders may seek to offload their Islamic windows if they don't deem them strategic priorities, the study said.
"The choice for conventional banks to operate Islamic banking windows rests with them. Some see windows as a defensive strategy while others see them as opportunities," said Zadjali.