Islamic finance industry to sustain growth in 2020

JEDDAH — The Islamic finance industry will continue to grow slowly in 2019-2020, S&P Global Ratings said in a new report Monday. The industry expanded by

about 2% in 2018 compared with 10% the previous year, according to S&P Global estimates, with strong support from the sukuk market.

In 2017, most of the growth stemmed from jumbo

sukuk issuances in some Gulf Cooperation Council (GCC) countries, but this was followed by an

about 5% reduction in issuances in 2018.

In 2019, S&P expects the market to fare much better

given the significant volatility in key parameters such as oil prices and geopolitical risk.

The growth of banking assets has also slowed down in almost all core Islamic finance markets. “Of specific note, Turkey and Iran lead the decline under a trend that we expect will continue in the next 12-24 months.” Malaysia, Indonesia, and the GCC countries were among the few sources of industry growth. As the economic cycle might turn at some stage, we believe a low-single-digit growth rate over the next two years is a fair assumption.
However, we see three potential accelerators in the next few years: inclusive standardization, fintech, and the social role of Islamic finance.

1. Inclusive Standardization

A prerequisite for faster growth is inclusive standardization, the standardization of Shariah interpretation and legal documentation that factors in the requirements of all the stakeholders. For issuers, inclusive standardization would mean less complexity and time needed to put together their sukuk and tap the market. Ideally, an issuer would be able to take a set of standard legal documents, plug-in its underlying asset, and go to the market. The process should be equivalent from a time, effort, and price perspective to issuing a conventional bond.

For investors, inclusive standardization means the capacity to understand the risks related to their instruments and avoid situations where they lose money because they, or any other stakeholders, have interpreted the legal provisions of sukuk contracts in a specific way. For Shariah scholars, inclusive standardization means factoring the requirements of the market and creating some room for innovation.

2. Fintech Disruption

Market participants typically see fintech as a risk for the financial industry, but we think fintech could also help unlock new growth opportunities through the faster execution and better traceability of transactions. Fintech could help the industry in four ways:

• Ease and speed of transactions. This is particularly true for payment services and money transfers. Islamic finance industry players can benefit from the possibilities fintech and other innovations offer to enhance their services and attractiveness. Technology could also reduce costs, allowing the redeployment of staff to higher added-value operations.

• Traceability of transactions. Using blockchain could help reduce the industry’s exposure to risks related to transaction security or identity theft. It could also disrupt the way sukuk are issued and managed. Blockchain could resolve three challenges related to sukuk issuance and management:

•The traceability of underlying assets, which would help investors to better understand the risks related to sukuk in their portfolios.

• The traceability of cash flows, which would help issuers to implement prompt corrective actions

if one of the underlying assets underperforms. – The traceability of investors, which together with smart-contract protocols could create faster, and even out-of-court, resolutions for sukuk disputes.

3. ESG Opportunities

Islamic finance, which must abide by the goals or objectives (maqasid) of Shariah, shares some links with ESG considerations and the broader aim of sustainable finance. As regulators and policymakers around the world seek to establish a more sustainable, stakeholder-focused, and socially responsible financial system, we see areas where Islamic finance and sustainable finance align. For example, Islamic finance’s goal to protect life aligns with sustainable finance principles, which emphasize environmental and social protection. These include either refraining from developing or financing operations that could harm the environment or the health or wellbeing of humankind. Green sukuk is an example of instruments that can be used to finance environmentally friendly projects. — SG

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