The UAE Islamic finance sector maintained steady growth throughout 2020 despite challenges posed by low oil prices and the COVID-19 pandemic. Growth in Islamic banking assets and Sukuk was healthy, Takaful was generally steady and growth in Islamic fund management accelerated. The focus on improvising regulation and standardization also picked up pace.
Review of 2020
Though economic activity in the UAE slowed considerably, as per the Central Bank of the UAE’s data as at the third quarter of 2020 (Q3 2020), total assets of Islamic banks in the country increased by circa 7.2% over the previous year. This compares with a 6.5% year-on-year growth for conventional banks. Total Islamic bank assets as at August 2020 stood at AED607 billion (US$165.24 billion) compared with AED505 billion (US$137.47 billion) four years ago.
Though asset growth was reasonable, most banks reported lower profit, higher non-performing loans and the closing of several branches. While increasing non-performing loans is a problem for the banking sector as a whole, it is more so for Islamic banks in particular because Shariah principles prohibit imposing any kind of penalty interest on defaulted payments.
Consequently, in order to maintain healthy capital ratios and achieve synergy benefits, the wave of mergers within Islamic banks continued in 2020. Early in the year, Dubai Islamic Bank acquired Noor Bank, thereby forming the largest Islamic bank in the UAE with combined assets of over AED275 billion (US$74.86 billion).
The Sukuk market in the country had a productive year with healthy activity both in the primary as well as the secondary market. Though the COVID-19 pandemic slowed the issuance of Sukuk globally, innovation in the form of the rolling-out of green Sukuk; recovery bonds; environmental, social and governance-compliant Sukuk and such gained momentum.
In the UAE’s primary market, the most high-profile issuance in 2020 came from the Dubai government. In addition to a US$1 billion 30-year bond, the Dubai government also issued a 10-year Sukuk facility of US$1 billion at a profit rate of 2.76%. The deal was over five times oversubscribed, thereby achieving the lowest-ever profit rate.
In the secondary market, Sukuk prices moved in tandem with the fall in US Treasury yields as well as the negative impact of several credit rating downgrades. That said, overall liquidity in the Sukuk market was low. Given the scarcity of Sukuk securities, investors generally prefer not to sell Sukuk unless there is a possibility of a material credit risk.
On the insurance front, Takaful companies in the UAE are catching up with conventional insurers though market share of Islamic insurance products is still below 20% of the total gross written premiums in the sector. Besides a steady growth in gross premiums, Takaful operators’ profitability also improved, mainly benefiting from regulatory changes made in 2017/18 in the main business lines of medical and motor vehicle insurance in the country.
The Islamic fund management industry recorded good growth in 2020, owing to the launch of several new Shariah compliant funds. Waha Capital launched a new Shariah compliant fund in Q3 2020 to meet growing investor demand and expects it to attract more than US$500 million.
The open-ended Waha Islamic Income Fund will invest in Sukuk and equity markets around the world. SHUAA Capital also launched three Shariah compliant funds — SHUAA High Yield Sukuk Fund, Nujoom Aggressive Fund and Nujoom Balanced Fund — and has already secured US$75 million-worth of commitments.
2020 was a year of substantial progress on the regulatory front. The Dubai Islamic Economy Development Centre accelerated its work on a very worthwhile ambitious project, called the global Islamic finance code, focused on developing legally enforceable laws for all Islamic finance-related transactions and involved entities. The project has robust support from the UAE government, IsDB, AAOIFI, IFSB, International Islamic Financial Market, International Islamic Finance Academy, central banks, Islamic financial institutions, capital market regulatory authorities and practitioners. The project is likely to be completed by the middle of 2021.
Preview of 2021
Once completed, it will roll out the Islamic finance law which will be signed in a treaty by OIC member countries and be adopted as the legal standard. It will certainly be a game-changer for the industry as it will address the long-standing need for standardization of contracts based on Shariah principles as well as the interpretation of the Shariah guidelines themselves. The standardization in turn will likely reduce complexity and boost market confidence. It will also reduce discrepancies in practices across the globe, and eventually translate into positive outcomes for the Islamic economy as a whole.
The IMF expects the UAE economy to contract by over 6% in 2020, followed by growth of circa 1.5% in 2021. Given the recent regulatory developments as well as the focus of the government on pushing to make the UAE the hub of Islamic finance, we expect growth in Islamic finance to outpace the conventional sectors in the coming few years.
Though penetration of most Islamic finance products in the UAE is still below 25% of the total, the government’s focus on making the UAE the hub of Islamic finance in the Middle East and the accelerated pace of regulatory reforms are bearing fruit.