Islamic Banking: Growth To Slow, But New Markets To Surface

BMI View: Islamic Finance is set for continued growth as several countries vie to become global centres, although expansion rates have peaked. At present, we expect Malaysia to remain the global leader in Islamic banking, although there will be concerted competition from Dubai. In addition, there is huge growth potential in India, Nigeria and Thailand.

We forecast strong growth for the USD1.7trn global Islamic finance industry over the coming quarters as several new markets come to the fore. It has been our long-held view that rather than becoming an integrated global financial system, Islamic banking will see the creation of regional hubs. Even with this slightly fragmented outlook, we still expect significant growth for the sector. That said, we think the impact of low base effects is beginning to wear off and we expect to see lower growth rates in the coming years.

Political Will Needed To Support Growth

Upward Trend To Remain In Place
Global Islamic Bond & Loans Issuance

BMI View: Islamic Finance is set for continued growth as several countries vie to become global centres, although expansion rates have peaked. At present, we expect Malaysia to remain the global leader in Islamic banking, although there will be concerted competition from Dubai. In addition, there is huge growth potential in India, Nigeria and Thailand.

We forecast strong growth for the USD1.7trn global Islamic finance industry over the coming quarters as several new markets come to the fore. It has been our long-held view that rather than becoming an integrated global financial system, Islamic banking will see the creation of regional hubs. Even with this slightly fragmented outlook, we still expect significant growth for the sector. That said, we think the impact of low base effects is beginning to wear off and we expect to see lower growth rates in the coming years.

Upward Trend To Remain In Place
Global Islamic Bond & Loans Issuance

Political Will Needed To Support Growth

At this stage, much of the growth taking place in the global Islamic finance industry is relatively organic, as shari'a-compliant banks continue to enter new and untapped markets around the world. Indeed, much of the bullish sentiment surrounding the industry has generally focused on the basic facts that some of the world's fastest growing economies are those with significant Muslim populations, and where the local banking sectors remain relatively underdeveloped. Banking sector assets-to-GDP (a rough gauge of the depth of a domestic banking sector) in Indonesia and Pakistan - the countries with the two largest Muslim populations - stands at only 49% and 45% respectively. In countries such as India moreover, which has a minority Muslim population of approximately 177mn, political obstructionism and regulations (such as laws requiring banking to be based on interest) are preventing Islamic finance from taking root. This stands to reason that given the sheer size of the markets which have yet to be introduced to shari'a-compliant financial products, the industry's growth potential over the coming years remains immense.

Slowly Heading Higher
Bloomberg Takaful Index

Divergent Paths For Lebanon & Oman

For Lebanon, the lack of government support is the key reason why we do not expect significant growth in Islamic Banking in the country. Islamic banks in Lebanon are subject to double taxation of their financing operations because they act as merchants - they must acquire a given asset prior to selling it to their customers. In addition, Shariah-compliant products are structured into separate contracts, such as the promise to sell and the sale contract in Murabaha operations. Under this system, each contract is subject to a financial stamp duty of 3%. At present, therefore Islamic Banking in Lebanon is at a considerable disadvantage to conventional banking and until we see government support for the sector, which is unlikely for the foreseeable future given more pressing concerns, then the country will miss out on growth in the global Islamic Banking sector.

Finance To Remain Dominant
Global - Share Of Islamic Bonds (2013)

In Oman, this is less of a concern as the style of government is more inclusive and the Islamic opposition movement is far smaller. Our moderately bullish view on the prospects of Islamic banking in the country corresponds with our outlook for the conventional banking sector. We expect Omani commercial banks to record solid expansion over 2014 and 2015, with an acceleration in both deposit and lending growth compared to the of 2013. A robust pipeline of infrastructure and industrial projects will continue to offer sizeable opportunities to the country's largest banks.

GCC Islamic Bonds (2014)
Underwriter Market Share % Amount (USDmn) Issues
HSBC Bank PLC 29.5 1,766.6 4
JP Morgan 19.5 1,166.6 3
Deutsche Bank AG 15.5 926.2 3
Banque Saudi Fransi 10 599.9 1
National Commercial Bank 5.6 333.3 1
Gulf International Bank BSC 5.6 333.3 1
Citi 2.8 167.9 2
Dubai Islamic Bank 2.8 167.9 2
Emirates NBD PJSC 2.8 167.9 2
Abu Dhabi Islamic Bank 1.6 92.9 1
Barclays 1.6 92.9 1
Source: BMI, Bloomberg

Malaysia To Remain World Leader

As Islamic finance is still in a relatively embryonic stage of development, we expect the strongest growth to take place in those markets in which the government has taken on the role of actively championing the development of the sector. With many potential customers still hesitant about using shari'a-compliant financial services, a benign regulatory environment may not be sufficient to attract key industry players. Rather, we believe those governments which are keen on making their countries regional or global Islamic finance hubs will need to push ahead with introducing increasingly attractive incentives to the industry, which could help facilitate more individuals and corporates shifting into the sector. It will be these key markets - most notably Malaysia and the UAE - which will drive the development of Islamic banking over the longer term, rather than the larger untapped markets of Asia and Africa, in our view.

From our standpoint, one of the most exciting markets to watch over the coming years will be Turkey, where the industry is only just beginning to get off its feet following years of suppression due to political sensitivities. As of early April 2014, the country was in the process of establishing new regulations that would allow for more widespread use of sukuk. At the moment, the government and corporates can only issue ijara, while the new legislation would approve the use of istisna, marabaha, mudaraba, musharaka, and wakala. With Islamic banking assets accounting for only 5% of the total commercial banking sector's assets, there is considerable scope to deepen the country's shari'a-compliant financial markets.

Untapped Markets
Population of Select Muslim-Majority Countries, mn (2012)

Impediments Remain

As we have noted on several occasions in the past, the lack of a standardised global framework for the industry remains one of the most pressing challenges confronting Islamic banks which wish to expand overseas into new markets. A lack of cross-border cooperation between key hubs of Islamic banking in Asia and the Middle East, in addition to policy uncertainty and political risk in several future growth markets, will undermine the industry's expansion in 2014 and beyond.

New Markets Emerging

  • Japan Bank for International Cooperation (JBIC) plans to sell its first Islamic bonds in 2014 to fund a project in Indonesia, according to the bank's Executive Officer for Asia Pacific Tatsuhiko Takesada. JBIC's proposal to sell ringgit sukuk will keep alive Malaysia's ambition for foreign bond sales in its currency, after a 47% fall in such offerings in 2013.

  • The Commercial Bank of Kuwait has revealed that 85% of its shareholders have approved a plan to convert the lender into a full-fledged Islamic bank. The decision does not take immediate effect, rather it a first step in a legal process involving several studies and approvals.

  • The State Bank of Pakistan (SBP) has issued fresh instructions to standardise the shari'a practices of Islamic banking institutions (IBIs) concerning foreign bill discounting. The instructions will apply with immediate effect. The circular issued by the SBP on March 27 2014, states that 'Salam' of foreign currency is not a preferred transaction; but if any IBI is willing to undertake such transactions, the same will be implemented at 'the weighted average rate of previous day's transactions' implemented by the IBI with its customers.

  • India is planning to establish a body for fine-tuning and promoting Islamic finance before issuing license to commence full-fledged banking operations, according to India's Minister of Minority Affairs Rahman Khan (Arab News). 'We need to set a framework for rules for different financial products to be offered by these banks or through the Islamic banking windows,' Khan said. The minister seeks to introduce several Islamic financial products and has urged the ruling party to expedite the process of introducing certain amendments to the laws to support Islamic banking.

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