Until recent years, Islamic leasing has enjoyed a competitive edge over its conventional counterpart. This is stemmed from two key features embedded in the Ijarah product. First is the application of fixed interest rates during the whole facility period. This is considered a synthetic hedging against interest rate fluctuations. Second is the implementation of Shariah principals allowing Islamic banks to own the leased asset. As a result, Islamic banks have generated lucrative profits by attracting conventional clients and ultimately attaining a larger market share.
Consequently, conventional banks introduced fixed and floating interest rate leasing, forcing Islamic banks to introduce floating Ijarah in order not to lose their market share. Also, some conventional banks launched leasing subsidiaries granting them security access on the leased asset through tri-party agreements. So, did Islamic banks lose its intrinsic advantage over the conventional? To answer this question, we need to know how Ijarah performed in 2020. What is the contemplated outlook in 2021?
Review of 2020
According to the IFSB Services Industry Stability Report issued in July 2020, the GCC captured the largest share of global Islamic banking assets at 45.4%. Nevertheless, and as a result of the pandemic and low oil prices, 2020 had a negative impact on GCC conventional and Islamic banks as depicted in Diagram 1. For the first time since 2013, the asset growth of both conventional and Islamic banks are equivalent at an almost 2% rate. To curb the weak growth, central banks launched several stimulus packages. This boosted Ijarah-based product associated mainly through sovereign Sukuk. For example, Indonesia issued Ijarah-based retail Sukuk for around US$342 million to finance the country’s economic recovery allowing retail investors to participate through online channels utilizing Islamic fintech.
As per the PwC 2020 Middle East Working Capital study, around US$36.5 billion in excess working capital is currently trapped on the balance sheets of Middle Eastern companies. Weaker credit policy controls slowing collection rate, shifting demand patterns and rigid supply chain are all factors contributing to liquidity challenges and inventory buildup for most companies in the Middle East especially the SMEs. Such an economic situation could explain the purpose of the sustainability Sukuk issued by the IsDB. In June 2020, the IsDB issued a US$1.5 billion sustainability Sukuk offering to curb the negative impact of COVID-19. Around 53% of the issuance’s proceeds will be allocated to the MENA region with a special focus on SMEs in an attempt to ease the liquidity squeeze faced by many companies in the region.
Preview of 2021
2021 could be a promising year for the Ijarah product to act as a key solution for some of 2020’s economic turbulences or concerns. According to the S&P Islamic Finance Outlook 2021, deteriorating banking asset quality will be the main challenge facing banks in the GCC in 2021. This should not be a problem for Islamic banks since most of its products including Ijarah are asset-backed facilities.
Another promising opportunity for Ijarah is to integrate it into environmental, social and governance (ESG) offerings such as the IsDB’s sustainability and green Sukuk issuance. Associating such issuance with a fixed Ijarah product could act as a catalyst to boost the Islamic finance market. Availing funds with fixed interest rate to SMEs would accelerate economic recovery.
The same idea is also applicable to any other green Sukuk issuance. In addition, the timing of implementing new accounting treatments and standards for Ijarah to match international accounting standards could ease the pandemic’s negative impact on many clients’ financial statements.
Another lucrative horizon for the Ijarah market is to entice global sovereign funds to issue Sukuk Ijarah as a main source of raising required funds. Such institutional investors hold massive real estate assets that are generating fixed income stream.
Based on the prevailing interest rates in the global markets, sovereign funds could easily bundle specific generating assets with a Sukuk issuance that ultimately creates a lucrative spread. Such assets could include healthcare projects and/or Shariah compliant tourism projects. These two sectors are expected to be on the rise during 2021.
Once a profitable edge for Islamic banks, fixed rate Ijarah could be the same factor necessary for creating an intrinsic antidote. With regards to Islamic fintech, banks could further enhance their deposit liabilities cost of fund catering for the fixed rate asset assumption. Even better, launching Islamic digital banks or what is known by ‘phygital’ banks could tap new horizons in both retail and commercial products.
Samar Abuwarda is an experienced professional in structured transactions with multiple organizations in Egypt and internationally. She can be contacted at [email protected]