The Islamic finance industry has seen exceptional growth in the last 30 years. Many optimistic predictions have been made regarding the enormous potential for future development. There has been continuous expansion of total Islamic finance assets as well as a sophistication of products, together with an ever-growing number of countries, companies, and institutions participating in the industry.
In 2019, the total assets value of global Islamic finance markets amounted to about 2.88 trillion US dollars. The projected total asset value for the global Islamic finance markets will amount to 3.69 trillion US dollars by 2024.
The pace of growth of Islamic finance is a bold one (at about 15-20% growth per year), much higher than conventional finance, but it is not sufficient to replace conventional finance. It is striking that the industry does not progress at a rhythm of 40-50% per year or more, given its novelty and supposed appeal to 1.6 billion Muslims worldwide.
But what exactly Islamic banking is? Often the term ‘Shariah-compliant’ is used to denote the ethical and transparent standards demanded of classifying the products and services offered as Islamic. Interest in its all forms is strictly prohibited (Haram) in Islam Islamic banking is interest-free (Riba-free), assets-based, and ethically driven at its core and has many similarities with other religions. On the other hand, commercial banks are interest-based and don’t have many rules about which industries they support or invest in. Islamic banking promotes an asset-based relationship, extending beyond the typical ‘credit check’ and into advising and evaluating the fit for the customer. This may mean stringent or better standards than traditional financing models, which has generally led to the lengthier processing of Islamic finance applications.
In Islamic finance, money is a liquid instrument meant as the medium of exchange rather than the commodity itself. The real difference to commercial banking comes in the form of how a customer is viewed. In this sense, it’s more holistic and partnership-based rather than judging someone’s creditworthiness. However, the advent of financial technology (fintech) has revolutionized this aspect of the financial services value chain. At the same time, an increase in customers demanding to know how and where their money is being used or invested has resulted in an explosion of demand for Islamic fintech products and solutions. Perhaps naturally, the continued growth of Islamic finance is translating into increased prominence within global financial markets, particularly in Muslim-majority countries in the Middle East and Southeast Asia. For example, in the GCC – the world’s largest Islamic finance market, with around 45% of the global share – sharia-compliant banking assets as a proportion of total banking assets have grown significantly in recent years. In Saudi Arabia, Shariah-compliant assets rose from just 29% of total banking assets in 2018 to 50.6% in 2020, while the corresponding figures increased from 37.9% to 42.5% in Kuwait and 19.7% to 26.6% in Qatar.
Malaysia is the world’s third-largest Islamic finance market, the proportion of sharia-compliant finance rose from 22.8% to 30.1% over the same period. Institutional investors, banks, and companies in Muslim countries, especially in the GCC, still prefer to use conventional finance, while some important western institutions have already experienced backlashes in the domain. More than a year after the initial onset of the coronavirus pandemic, the Gulf banking sector is seeing an increase in mergers and acquisitions (M&A), as lenders continue to deal with the economic fallout. In May 2020, it was anticipated that Covid-19, combined with the associated crash in oil prices, would accelerate a trend towards M&A among Gulf banks; where most institutions were expecting constrained profitability despite performing well in risk indicators.
Malaysia is which accounted for an astonishing 80% of all Sukuk issuances. Malaysia participates actively in the international development of Islamic finance but Iran is rarely invited to join the effort. It is therefore difficult to imagine how Islamic finance can develop if its champion, Iran, does not participate. The development of Islamic finance is therefore hypertrophied and does not show the balanced growth that could be expected from an industry claiming to be universal. Many of the biggest economies in the
Muslim world (such for example Indonesia and Turkey) do not participate as fully as they could in the development of Islamic finance, nor have many of them reached their full potential.
Perspectives for Muslim countries Islamic banking started with a simple idea, providing Muslims with products that will satisfy their spiritual concerns. As for the western countries, there is a long way for Islamic finance to go before it can have a significant impact. Only a few western countries have authorized Islamic finance and provided similar conditions to those applied to conventional finance. Serious political barriers are preventing the development of Islamic finance. There were indeed some remarkable examples of Islamic finance in western countries, but these examples are rather in the category of exceptions than the rule.
Many proponents of Islamic finance assume that should western countries accept Islamic finance, its success is guaranteed. This is wishful thinking because even if all regulatory and tax burdens disappear in the west, it is not certain that customers, Muslims or not, would embrace Islamic finance. Why should France, the UK, or Germany be more ready to accept Islamic finance than some big Muslim countries? How can we expect Islamic finance to develop in France or the UK if it is not growing in Turkey or Algeria?
The future of Islamic finance is therefore first and foremost in Muslim countries, where room for growth still exists, provided education and political willingness are secured. It is a waste of money and time to insist on pushing the development of Islamic finance in western countries, where competition with conventional finance is fierce and merciless. After remaining resilient in 2020, the Islamic finance segment is performing strongly this year, as an improved economic environment, a rise in the number of large projects, and an increased focus on environmental, social, and governance (ESG) factors combine to drive demand. Despite the twin challenges of Covid-19 and the fall in global oil prices, the segment’s assets grew by 10.6% last year, according to global rating agency S&P.
Although this was down on the 17.3% growth rate recorded in 2019, it was nevertheless a strong performance in light of the global recession, with many suggesting that the segment’s positive growth was a sign of its strong future potential. Building on this, S&P forecast that the global Islamic finance industry will grow by 10-12% annually throughout 2021 and 2022. This positive projection is largely built on an expected economic recovery in key Islamic markets in the Gulf and Southeast Asia, driven by the rollout of large infrastructure projects in countries like Saudi Arabia and Qatar, and an increase in Sukuk (Islamic bond) issuances, which S&P expects will reach $140-155bn this year, up from $139.8bn in 2020.
Indeed, some individual lenders have experienced far more dramatic growth, with the Dubai-based Emirates Islamic recording a 358% year-on-year growth in net profits over the first nine months of the year.
The Islamic finance sector is an integral part of Pakistan’s National Financial Inclusion Strategy (NFIS) and will continue growing in 2022. A report issued by Moody said that according to the enhanced NFIS targets, the government of Pakistan and the State Bank of Pakistan (SBP) target an Islamic banking market share of 25% by 2023 from 17% in 2020.
The report noted that the government and central bank are also supporting the sector by introducing a Shariah-compliant regulatory framework and adopting the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) Shariah standard.
The report says that the Islamic finance sector is set to continue growing in 2022 as the accelerating economic recovery brightens the outlook for credit growth despite challenges from a rise in interest rates and a decline in Sukuk issuance amid higher oil prices.
Islamic banks’ asset growth globally will also continue to outperform their conventional peers this year, the rating agency said. Strong fundamentals are also expected to drive the expansion of assets under management for the Islamic funds’ industry. However, Sukuk issuance, which was reduced in 2021, is expected to decline further in 2022. Sukuk issuance dropped in 2021 after five consecutive years of growth. It declined 12% to $181 billion amid lower sovereign funding needs as higher oil prices boosted revenue, particularly in the GCC states. The majority of issuance last year, nearly $128 billion, had long-term maturities of more than one year, according to the report.
It has been asked lately what the future of Islamic banking looks like and how do we get there? The answer depends on the following five important aspects:
1. The regulators around the world are more open to the concept, with a range of banking licenses issued for Islamic fintech. However, there’s also a need to better understand the requirements of a Shariah-compliant bank. This will mean a Shariah board composed of Islamic scholars.
2. The standard banking regulations also need to be adhered to, which comes with its own rules and regulations. So, to be Shariah-compliant, the business has to be robust operationally and require deep knowledge and expertise.
3. Islamic finance is currently valued at around $2.4 trillion and is expected to grow steadily by 10-12% from 2022 onwards. It’s traditionally been an underserved customer segment by incumbent banks, creating an opportunity for new entrants.
4. Global trends such as open banking introduce a level of transparency and justice into the financial system. This creates diversity in offerings, especially among younger generations keen to see their money supporting environmental, societal and governance (ESG) causes in their communities.
5. Islamic banking is expected to play a prominent role in Sukuk offerings – financial products whose terms and structures comply with Sharia to create returns similar to conventional fixed-income instruments like bonds.
The economic recovery in key Islamic finance markets will boost credit growth and demand for Shariah-compliant products and it is expected that Islamic banks’ assets will continue to grow to outperform their conventional counterparts.
The Islamic finance industry has been on a growth path in recent years. Despite the pandemic, Islamic financing expanded at an average compound rate of 10.5% in 2020 and 2021, while conventional loan growth expanded at 3.4% during the same period.
In Muslim majority countries, Islamic banks manage to attract populations for ethical and religious reasons. Though they would remain outside the banking system still have a higher reservoir of growth compared to the conventional banking system.
The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Shaikh could be reached at nazir_shaikh86@hotmail.com.