The Islamic Side Of Oversea-Chinese Banking Corporation

Oversea-Chinese Banking Corporation (SGX: O39) announced the opening of its first Islamic branch, OCBC Al-Amin in Sandakan, Sabah a few days back.

That will be the second branch in Sabah, and OCBC is looking to expand further in the region. The bank first commenced its Islamic banking business in 2008, during the depths of the financial crisis. Since then, it has expanded to 13 branches within 7 years, showing its continued interest in expanding their presence in the Islamic banking segment.

Islamic banking present an interesting opportunity for OCBC, tapping into an opportunity that the other two local banks are less actively competing in. Even though the market is not big, approximately only $2 trillion worldwide, the consensus is that there are significant opportunities for Islamic banks to service Muslim customers who are seeking Shari’ah-compliant products.

Islamic banking industry has been enjoying double digit growth for the past decade, based on S&P Rating Services. Islamic financial institutions in Malaysia grew 8% in first half of 2015, twice as fast as conventional banks.

For those who might be unfamiliar with Islamic products, general banking products are considered unacceptable by Muslims because the charging of interest on a loan is not permitted under Shari’ah law.

Since most banks’ business model is to charge interest for loans provided, conventional banks are not considered Shari’ah-compliant. For banks to be Shariah-compliant, the financial products including simple fixed deposits, mortgage loans, etc. are structured differently from conventional banking products.

They are not allowed to guarantee a fixed return or charge a fixed rate for loans. They are usually structured as a profit-sharing deal rather than a direct loan with interest.

The Islamic banking of OCBC was the key driver of a 5% increase in net income for OCBC Malaysia. OCBC Al-Amin provides an expansion opportunity in Malaysia which constitutes 16% of its core income in the third quarter 2015.

Whilst the growth story might be compelling, there are risk attached to growing Islamic banking.

Firstly, it is impossible to separate Islamic financing from falling oil prices, say, especially for Malaysia where oil production powers a significant part of the economy. Specific allowances for loans rose to $56m in third quarter 2015, almost doubling from $30m last year.

During turbulent times in Malaysia’s economy, OCBC’s dabbling in Islamic banking might not reap immediate results. But should the Malaysian economy improve, it is likely that OCBC will be the largest beneficiary from the long-term economic growth in Malaysia.

Furthermore, given that Islamic financial products are structured differently from conventional products, it requires a certain degree of economy of scale to be profitable.

In Sept 2015, Islamic Bank of Singapore, the only fully-fledged Islamic bank in Singapore closed down. The bank was formed by a joint venture between DBS Group  (SGX: D05) and prominent investors based in Gulf Cooperation Council. Whilst Islamic banking is on the rise, it is also an expensive market to capture.

Based on current results, net income from OCBC has been rising for the past four years, from S$1,220m to S$1,421m, approximately 3.5% growth per year. It seems like OCBC Al-Amin is heading in the right direction and could continue to contribute positively to OCBC Group.

The Motley Fool's purpose is to help the world invest, better. Click here now for your FREE subscription to Take Stock -- Singapore, The Motley Fool's free investing newsletter. Written by David Kuo, Take Stock -- Singapore tells you exactly what's happening in today's markets, and shows how you can GROW your wealth in the years ahead.

Like us on Facebook to keep up to date with our latest news and articles. The Motley Fool's purpose is to help the world invest, better. 

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Wilson Ong  doesn’t own shares in any companies mentioned.