The COVID-19 pandemic caused the global economy to plunge into one of the worst recessions of all times. The global banking sector also came under pressure caused by economic disruptions and business suspensions due to extensive lockdowns. Islamic banking was no exception. Performance shortfall and downturns were evident during these testing times, which had a negative impact on Islamic finance credit ratings.

Global Islamic finance assets reached approximately US$2.88 trillion in the 2019 calendar year (CY19), recording a year-on-year growth of about 14%. Historically, the growth trajectory of the industry has remained steady recording at compound annual growth rate of 7.8% between CY14 and CY19. The industry is broadly classified into the following segments: Islamic banking, Islamic capital markets (including Sukuk and other capital market products), Takaful and other Islamic finance institutions offering other products such as microfinance.

Based on industry segments, Islamic banking constitutes about 70% of total Islamic finance assets and is considered a highly competitive market with a large number of international players.

In capital markets, Sukuk are the flagship Islamic capital market product and the fastest-growing segment in the Islamic finance industry, reaching to aprroximately US$754 billion by the second quarter (Q2) of CY21, a growth of about 5% from the previous quarter.

Review of 2021
The credit ratings of Islamic banks in 2021 were a reflection of improved performance indicators and a track back to normalcy. The performance of the top 100 Islamic banks revealed a growth in asset base by about 12%, though profits of the sector slid by about 15%.

The overall credit ratings of the largest Islamic banks (in terms of their asset size) remained or reverted to stable outlooks due to recovered performance and growth momentum. Al Rajhi Bank, one of the largest banks (in terms of asset base) reverted back to a ‘stable’ outlook in June 2021 from ‘negative’ in the previous rating review by Fitch Ratings. Similarly, Bank Al Jazira and Alinma Bank, two of the top 15 Islamic banks, reverted to ‘stable’ outlooks (July 2021) from their previously assigned ‘negative’ outlooks by Fitch.

An important factor to note is that the banking industry in most parts of the globe, conventional and Islamic, was protected amid the pandemic through government and/or regulators’ support and relief packages. The support was mostly provided to mask the risk that would have otherwise eroded the industry’s asset quality and also to fill in the liquidity gaps where needed. Resultantly, the credit rating curve of Islamic banks did not tremor from the fallout of the crisis and remained substantially intact with no downgrades of the top Islamic banks.

Among all segments of the Islamic finance industry, the Sukuk market reflected the highest level of volatility amid the pandemic, majorly on account of uncertainty in the oil market impacting the liquidity position of issuers in GCC countries. Crashing oil prices and the low interest rate environment urged the oil exporting countries to secure funds through Sukuk issuance, predominantly in the second half of 2020. 2021 opened up with sluggish issuance that geared up in Q2 2021 when Saudi Arabian Aramco raised about US$6 billion in capital through a Sukuk issuance assigned an ‘A’ rating by Fitch.
However, overall Sukuk issuance during 2021 is expected to remain slightly lower than that in 2020 due to recovered oil prices and a recovery in economic stability. The credit ratings of the Sukuk market remained largely stable in 2021. The defaulted Sukuk volumes remained as low as approximately 0.27% of gross Sukuk issued to date, demonstrating the sound financial muscle of the Sukuk issuers.

Preview of 2022
2021 demonstrated a strong comeback at many levels. Therefore, 2022 is expected to be a transformative yet stabilization period for the Islamic finance sector. Islamic banking is expected to record a double-digit growth in asset base of about 10–12% in 2022. The economic recovery of major Islamic countries and the oil price movement will be the key determinants for the growth prospects of the industry. The credit ratings of Islamic banks will focus on the way the banks sustain their liquidity profile amid a demand– supply mismatch during recovery cycles.

Other key areas would be the shifts in the funding mix following the pandemic and asset quality management as growth rebounds and government/regulator relief packages expire.

Conclusion
The Islamic finance industry is a systematically important part of most of the Islamic economies. Its fast-tracked expansion has now created a pressing need for the industry to progress on standardizing its legal and regulatory framework based on its own standards and needs. This would not only enhance the industry’s dimensional growth in capital markets but would also enhance the assessment criteria and reference for the development of its credit rating universe.

Saniya Tauseef is the team lead of the Research & Publishing Unit, Pakistan Credit Rating Agency (PACRA). She can be contacted at [email protected]