Islamic finance more than a blip on West's radar
As the world's financial systems found themselves struggling through another challenging year in 2009, Islamic finance reached a new landmark. By year end, the steadily growing sector saw a cumulative total sukuk issuance reaching $100 billion (Dh367.3bn). In 2009, assets of the top 500 Islamic banks grew by 28.6 per cent to $822bn, up from $639bn in 2008.
Many Islamic financial institutions appear to have been insulated from the global financial crisis, largely due to the Islamic finance principles that prohibit interest. Consequently, Islamic finance institutions refrained from investing in structured products that played a significant role in the downfall of major global financial institutions.
Our analysis at Standard & Poor's, where we currently rate 26 sukuk, indicates that Islamic finance will continue on its positive growth trajectory as it begins to evolve from its niche position in the financial sector to a more mainstream and globally-recognised compartment of the financial system. Geographic expansion and the influence of major international financial institutions in particular will play a significant role in the development of Islamic finance over the medium and long term.
Considerable interest in developing the sector has been noted in non-traditional centres of Islamic finance, specifically in Europe. The UK leads this effort, with major conventional financial institutions playing an instrumental role in developing local Sharia-compliant offerings. Islamic finance in France is still in its nascent stages. However, the country has also begun to progressively implement the necessary fiscal and regulatory adjustments to prepare the ground for the emergence of Islamic finance locally. Both countries are currently deploying efforts to make their tax and regulatory frameworks more attractive to Islamic finance institutions. Italy and Malta, meanwhile, have been organising events to gain expertise in the field as they evaluate the possibility of implementing Islamic finance offerings in their respective domestic markets.
Western interest in the sector, through both the participation of major global banks and through demand for Islamic finance offerings in Western economies, also signifies continued growth potential of the sector. Major global banks and law firms have already participated in the structuring and offering of a large number of sukuk as they develop customised investment solutions for their clients. Meanwhile, increased access to Western economies may help Islamic financial institutions gain entry into diversified economies with a wide array of asset classes for investment, and generally stronger legal frameworks.
The Gulf continues to play a significant role in the development of the sukuk market. However, this influence was muted due to the major economic slowdown faced by the UAE and the correction of Dubai's real estate sector. The recent standstill agreement surrounding Dubai World's debts and the uncertainty regarding the repayment of Nakheel sukuk, which was subsequently resolved, has also contributed to creating a more risk-averse climate amongst investors. This sentiment could potentially spread to other Gulf countries, impeding access to the market for issues there. A brighter spot in the Gulf, however, is Saudi Arabia, which has a strong pipeline of government-sponsored projects in the works, some of which could potentially be financed through sukuk issuance.
While prospects for growth look bright, the sector does continue to grapple with a number of challenges. Despite relative success in 2009, two prominent defaults in the sukuk market by Saad Group and The Investment Dar, have blemished the sector's track record and have reminded those involved that defaults can and do happen in Islamic finance. However, once investors have a clearer view of the possible outcome of these two recent defaults, the sukuk market is likely to gain momentum, perhaps after making some adjustments reflecting lessons learned.
Overall, Islamic finance has come a long way, positioning itself as a recognised and relevant segment of finance, with bright growth potential. While South-east Asia fuelling growth over the coming year, Islamic finance's foray into Western markets will be an interesting development for all major players to watch.
- The authors are Islamic finance analysts at Standard & Poor's. The views expressed are their own
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