Islamic trade finance has benefitted from shifting preferences towards Shariah-compliant banking and could serve as one of the key growth drivers to help the nearly $1 trillion Islamic finance industry double in size.
The global Islamic finance industry, which has been growing between 15 to 20 per cent a year, is widely expected to reach $2 trillion in the next three to five years.
While Islamic banking and Islamic bonds, or sukuk, are expected to lead growth, bankers say Islamic trade finance could serve as the dark horse emerging to propel the industry further.
Trade finance, the lifeblood of global commerce, underpins 60-80 per cent of the $12-13 trillion trade in global merchandise and practitioners say it is safer than other forms of lending.
Total trade finance among the 57 members of the Organization of the Islamic Conference, which includes Saudi Arabia, Malaysia and Turkey, is expected to reach $4 trillion by 2012, said Mohamad Nedal Alchaar, secretary-general of the Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI).
"(Islamic finance) could tap 20 per cent of the total trading financing, that's very reasonable," Alchaar said, adding that while the current Islamic trade finance market remains fragmented and non-competitive, there has been a shift towards pushing trade finance among Islamic practitioners.
Part of the increased interest in Islamic trade finance is that the Islamic finance industry, which prohibits interest, has matured and can provide complicated instruments, such as Sharia-compliant hedging products to protect trade transactions, said Yakub Bobat, global head of HSBC Amanah commercial banking.
"If you don't have access to Islamic hedging, there will be a currency conversion impact. In the absence of those solutions, people go for conventional," Bobat said. "But the proposition is now complete and you can now use Islamic hedges for trade transactions."
Bobat said such innovations in the industry will help persuade people inclined toward Shariah-compliant business to opt for Islamic trade finance over conventional forms.
In Islamic trade finance, a bank will provide a letter of credit, guaranteeing import payments using its own funds, for a client based on sharing the profit from the sale of the item.
But some banks are still wary of providing Islamic trade finance services, citing it as more costly and time consuming.
In addition, some see little difference between conventional and Islamic trade finance as both are fee-based products, resulting in lower demand for the Islamic product.
Changing that view will be key for the industry, said Shabir Randeree, chairman of the European Islamic Investment Bank.
EAST-EAST TRADE FLOWS GROW
"There is a very compelling reason to promote this product given that the returns of trade financing can be very attractive, much more than real estate financing, for example," he said. "Providers of this product have not been as aggressive in promoting it."
But with increasing cross-border trade among Asian and Middle Eastern countries, demand for more Sharia-compliant financing from Muslims is still expected to increase.
Asia to Middle East trade flows more than doubled between 2005 and 2008, according to the World Trade Organization.
"If I compare three years back, volumes have gone up overall in the Islamic trade finance market," said Ghazanfar Naqvi, managing director, Islamic origination and client coverage at Standard Chartered Saadiq.
"It's a function of more awareness and more offerings. Today we are seeing customer preference changing and trade finance is a key component of growth in Islamic finance."
Naqvi said it was difficult to pin down tangible global figures for Islamic trade finance as the majority of deals are not public transactions.
The International Islamic Trade Finance Corp. (ITFC), an independent entity within the Islamic Development Bank, said in its annual report that it approved $2.17 billion in Islamic trade finance transactions at the end of 2009.
That grew to around $2.55 billion in 2010, with a majority of transactions taking place in OIC member nations.
HSBC Amanah's Bobat said Islamic trade finance will be a significant contributor to growth in Islamic finance but the industry will have to look beyond asset finance.
"The industry today is pretty much focused on asset finance and it needs to have the ability to capitalise on trade," he said. "(Islamic trade finance) should be as much bread and butter business as it is for conventional trade flows."