Islamic Finance 2022-2023: Same constraints, new opportunities

The global Islamic finance industry continued to expand in 2021 with assets up 10.2 per cent, versus 11.4 per cent in 2020, supported by banking asset growth in some GCC countries and Malaysia, sukuk issuances exceeding maturities, and the solid performance of the Islamic funds industry.

S&P Global Ratings expects stronger economic growth in core Islamic finance countries and will boost industry assets about 10 per cent during 2022–2023. However, global headwinds could change the picture, with the US Federal Reserve and other major central banks further tightening their monetary policies. 

We expect sukuk issuance will decline this year as lower, more expensive global and regional liquidity, increased complexity, and reduced financing needs for issuers in some core Islamic finance countries amid higher oil prices, deter the market. Corporate entities’ cautious capital expenditure growth also supports our view. Total sukuk issuance dropped to $74.5bn in first-half 2022 compared with $93.3bn during the same period in 2021, both in local and foreign currency. However, we forecast new issuances will still exceed sukuk maturing in 2022, estimated at about $96bn.

More broadly, we note that Islamic finance remains a collection of local industries rather than a truly globalised one. Even after 50 years, the industry is still concentrated in oil-exporting countries and seems unable to attract interest beyond its original territory. In our view, the lack of competitiveness for some Islamic finance products and complexity related to structuring sukuk are the main factors deterring noncore players and particularly non-Muslim jurisdictions. In the UK for example, Islamic finance is still a nascent segment. This is despite the government having issued two sovereign sukuks and the listing of several sukuks on the London Stock Exchange (LSE).

We believe that Islamic finance will likely remain a very minor player in the U.K until the industry shows a real economic added value compared with conventional banking solutions and beyond the compliance with Sharia principles. We have also observed the same trend in Africa. Despite the strong opportunities in theory, for example the chronical deficit in infrastructure and significant foreign funding needs of the continent, the total volume of sukuk issuance reached around $2.5bn over the past decade.

The picture is unlikely to change until sukuk issuance process becomes equivalent to conventional issuance process from a time, effort, and cost perspective. Such transition is complicated by the opposing forces of Sharia scholars advocating more equity-like characteristics and investors preferring more debt-like characteristics. In our view, if sukuk become equity-like instruments, investor and issuer appetite will likely diminish significantly. Therefore, standardising and satisfying the requirements of all stakeholders is a plausible way for the industry to remain attractive. We believe there are sukuk structures for the full spectrum of instruments, from fixed income to equity like.

However, there are still growth opportunities, particularly in the industry’s increased focus on sustainability and digitalisation. We expect to see higher volumes of green and sustainability sukuk (from a low base) as issuers look to broaden the investor base and include funds aligned with sustainability themes. Many Islamic finance countries are exposed to climate transition risk and several are developing or implementing transition strategies, including significant investment in clean energy.

The total issuance of sustainable sukuk reached $3.9bn in the first half of 2022 compared with $5.3bn for the full year 2021. Digital sukuk could provide a quicker and cheaper way for issuers to tap Islamic finance markets due to the limited number of intermediaries involved. Potential benefits include enhanced transaction security, traceability, and integrity, which could further strengthen compliance with Sharia. However, this assumes the availability of reliable technology and the readiness of legal frameworks to accommodate these instruments. It also requires the presence of standard legal documents that can be used as a template for sukuk issuance.

Reducing the time, cost, and minimum issuance volume requirements in this way could open the sukuk market to a broader range of issuers. Investors in digital sukuk will continue to bear traditional risks, however, including credit market and liquidity risk. They will also be exposed to higher operational risks stemming from technology stability and cyber risks. In addition, they would need a vehicle to transact digitally, such as a stable Islamic coin or a central bank digital currency.

Dr. Mohamed Damak is the senior director & global head of Islamic Finance