Where are we heading?
The drop in Islamic finance growth that we saw in 2016 is likely to continue in 2017, in our opinion. While we estimate the industry’s total assets will reach US$2.1 trillion at the end of 2016, we think two factors will weigh on the growth in 2017:
The impact of policy responses to the decline of oil prices in core markets, and
The lack of standardization in the industry, which is still made up of a collection of local small industries rather than a truly global industry.
Still, Islamic finance will have the impetus to continue progressing and maintaining some growth in 2017. The subdued but still positive economic growth of core markets, the continuous demand from an expanding customer base, the broader consensus around the need to standardize legal structures and Shariah interpretation, and the industry’s potential contribution to the sustainable development financing goals of the United Nations (UN) are likely to help the industry to somewhat progress in 2017. We are of the view that standardization, if achieved, could put the industry back on track for stronger growth in the coming years. Overall, we expect the size of this industry to reach US$3 trillion sometime in the next decade.
2016 was a difficult year
The Islamic finance growth rate has declined significantly in 2016, reducing to around 5% compared with double-digit growth in the past decade. The industry remains concentrated primarily in some oil-exporting countries, with the GCC countries, Malaysia and Iran accounting for more than 80% of the assets which we estimate will reach US$2.1 trillion by the end of 2016. The significant drop in oil prices, the ensuing significant reduction of core markets’ economic growth (with the exception of Malaysia) and the policy responses being implemented in the form of spending cuts, have reduced growth opportunities.
We observed that banks in core markets are growing more slowly than in the recent past and are suffering from the shift in their environment. In the same vein, the Sukuk market has not played a countercyclical role as an alternative source for governments to close their funding gaps and maintain spending in 2016. When oil price started to drop in 2014, several market commentators predicted a windfall of Sukuk issuance, arguing that governments in core Islamic finance countries will rush to the market. It did not happen, due to various factors including the length and complexity of Sukuk issuance.
Looking at 2016 numbers, we saw that conventional debt issuance has been the biggest winner as it almost doubled compared with 2015. Some market observers have attributed that to the low prevailing interest rates and also the desire of some core countries to preserve the liquidity of their local Islamic banks. However, these observers forgot that a significant portion of investors in Sukuk comes from the same people that invest in conventional bonds, particularly those based in Europe and the US. Also, these observers forgot that there is a large reported gap between Sukuk demand and offer, estimated by some market participants to be between US$100-300 billion per annum. Finally, despite the tremendous opportunities to grow, the Takaful sector has remained a marginal player in local and global contexts.
2017 will likely be equally difficult but will see the stabilization of industry growth
We expect the growth of the industry to stabilize in 2017 at around 5%. We think that the less supportive economic conditions will continue to prevail in some core markets, with Malaysia being the exception thanks to its more diversified economy and its proactive policy response. We also think that the Sukuk market will continue to play a modest role in providing funding to some core countries of Islamic finance (particularly in the GCC due to the cumbersome process of issuance and in Iran due to international sanctions).
We do not rule out a scenario where we might see higher issuance from some governments in the GCC, assuming the efforts on the standardization of legal documentation and Shariah rulings start to show tangible results. Some GCC countries have either introduced new regulations or laws for Sukuk issuance or announced publicly that part of their funding mix will be done through Sukuk in the next 12 months.
In addition, the financing of the UN sustainable development goals could also create some growth opportunities in the future but we see them as modest. Finally, Iran has the potential to be a new significant contributor to the growth of the Islamic finance industry, should the remaining sanctions be removed and its regulatory environment brought up to speed. Yet it remains to be seen when sanctions will be removed and whether issuances from Iran will attract significant interest from traditional Sukuk investors based in Asia and the GCC.
Conclusion: United and more integrated, the industry will grow stronger
The Islamic finance industry would benefit from more integration and higher support from its standard-setting bodies and regulators. More Sukuk issuance could give Takaful operators less risky investment choices, help banks to manage their liquidity and funds to have some fixed income revenues and invest in profit and loss-sharing instruments. Banks could start to offer Takaful products more systematically. Integration is an achievable goal if regulators create a more supportive regulatory environment and scholars and other technical or legal stakeholders work together to achieve standardization. United and more integrated, the industry would grow stronger.
Dr Mohamed Damak is the global head of Islamic finance at Standard & Poor’s. He can be contacted at [email protected].