With an aggregate worth of $2.4 trillion and following a recent decade-average growth of around 6.6%, S&P Global’s predictions suggest that global Islamic finance market will show lower single digit growth in 2020-2021, says an industry expert.

With an aggregate worth of $2.4 trillion and following a recent decade-average growth of around 6.6%, S&P Global’s predictions suggest that global Islamic finance market will show lower single digit growth in 2020-2021.

The predictions also suggest a recovery in the market following the recession, with Malaysia, the GCC and Turkey leading the recovery. The Sukuk issuance is expected to drop by $62 billion, but the recovery is expected to be achieved through liquidity injections from central banks and innovations by the Islamic banks.

Despite the slowdown in growth, experts in S&P Global are labelling the pandemic crisis as an opportunity for transformative development in the global Islamic financial market. During the crisis, core Islamic finance countries did not resort to Sukuk as their primary source of funding. The sector has continued to innovate and diffuse financial tools of savings mobilisation and capital creation.

We present a brief overview of the post Covid challenges and opportunities of the Islamic banking and Sukuk market, and discuss how innovations can make a difference.

Islamic banks’ share in the global Islamic finance industry continues to be predominant, amounting to 71.7% share in 2019. Globally this sector registered only a 0.9% growth in total assets during 2018-2019, although a moderate slowdown in asset growth in 2020 is widely projected.

This is mainly due to slow growth in oil prices, plus low economic growth in GCC economies which resulted in reduced opportunities for the overall banking system, and in turn led to sluggish lending growth. The pandemic crisis is expected to add more problems. Although the sector survived the 2008 financial crisis, the quest towards rapid modernization, enhanced quality control and the strong financial performances of Kuwaiti, Qatari and UAE-based Islamic banks are deemed insufficient to register quick recovery of the asset position. The pandemic-led loss of economic growth and employment in the region will make the situation complex unless there are significant improvements in Shariah compliance, innovation of financial tools and Fintech.

The predicted risks of Islamic Banking operations in the GCC, as identified and commonly agreed by IFO 2019 and IFSB, are higher cost of risk and lower profitability. The IFO 2019 expects that standardization of Shariah compliance may contribute to an improvement in the clarity of investment risk vis a vis risk management, which will eventually reduce the cost of risk for Islamic banks.

The pandemic crisis has prompted financial institutions to pay greater attention to environmental, social and governance (ESG) risks to build enhanced resilience in their operations. The Islamic finance principles have never been too far away from the assessment of such risks. Nevertheless, the crisis is a great opportunity to identify the areas of improvement through which these risks can be prioritised. A recent study by EIKON global database shows that Sharia compliance screening can add value to ESG performance of stakeholders.

For Islamic banks, the recent focus has been on Islamic finance social instruments such as Qard Hassan (e.g. the GCC central banks’ initiative to open liquidity lines to financial institutions to provide subsidized lending) and Waqf (e.g. the initiative to provide affordable housing solutions to people who have suffered loss of income).Undoubtedly, Islamic banks will play a vital role in bringing such initiatives closer to their intended outcomes.

In addition, introduction and diffusion of Fintech across all stakeholders in the Islamic banking industry is also expected to build transaction resilience and reduce transaction costs and risks. This should include adopting and applying state of the art technology to ensure (1) ease and speed of transactions (e.g. money transfers), (2) improved traceability and security of transactions (e.g. blockchain), (3) enhanced accessibility of Islamic financial services (e.g. crowdfunding for affordable housing), and (4) clearer and more robust compliance with regulations and Shariah requirements (e.g. Regtech).

While the Fintech solution sounds attractive to an educated and tech savvy generation of bankers and banking stakeholders, the implementation of Fintech is far from simple, especially in regions where Islamic banks run their major operations.

This is related to the lack of financial literacy, inclusion and participation. While these are concerns of economy-wide importance, and thereby require a holistic approach to resolve, the combination of adequate supervision and a strongly enforced regulatory framework of banking and finance remains the single most important sectoral prerequisite for the successful implementation and diffusion of Fintech in the Islamic banking industry.

According to the IFSI Stability Report 2019, in contrast to the Islamic banking sector, the Islamic capital market was showing high growth (around 25%). However, its share in the total Islamic financial services has always been relatively low. The majority of this share is comprised of the Sukuk market. Islamic financial assets were mainly concentrated in the GCC (42.3%) and in Asia (28.2%), with large proportions of sovereign Sukuk issued by two major contributors, Saudi Arabia (31.9%) and Malaysia (32.8%).Other countries that played a vital role in the growth of the Sukuk market are UAE, Indonesia and Bahrain.

The global Sukuk market observed a sharp increase in international Sukuk issuance in 2016 and 2017, registering 29% and32%, growth. However, the growth in issuance suffered a drop to 5.5% in 2018, and according to reports by S&P Global, the drop is expected to continue during the pandemic crisis. The pandemic-led drop in base Sukuk is expected to be supplemented by new issuance of ESG friendly Green Sukuk, socially responsible Sukuk (e.g. to support education and healthcare) and Sukuk related to blockchains.

The S&P IFO 2019 suggests that the process of standardization of Shariah compliance across the Islamic financial markets is still slow, and despite significant efforts made by standard-setting bodies, some market participants still consider the process to be an unrealistic one and instead argue in favour of harmonization that would allow for some flexibility for implementation. This debate is live, and addressing it requires a separate and perhaps a more comprehensive discussion.

About the author

Dr. Sheikh Selim is Programme Director – Economics & Money Banking Finance and Head of Education at University of Birmingham Dubai