The overall global Islamic financial services sector was worth approximately US$2.44tn at the end of 2019, up from US$2.19tn in 2018, according to the Islamic Financial Services Board’s (IFSB’s) Stability report 2020. The international standard-setting body notes in its report, dated July 2020, that this growth is based on “significant improvement” in Islamic banking, Islamic capital market activity, and takaful (Islamic insurance).

Here are five things to know about Islamic finance, drawn from The Review’s article on the subject in the February 2021 issue.

1. The sukuk market

In 2014, the UK became the first country outside of the Islamic world to issue a sovereign sukuk, which saw £200m of Shariah-compliant bonds sold to investors in the UK, the Middle East and Asia.

According to Refinitiv, the global sukuk market has proved resilient to the impact of Covid-19. In the first nine months of 2020, issuance reached a total of US$130.5bn, an increase on the US$127.3bn issued over the same period in 2019.

Sovereign issuance in the first half of 2020 exceeded US$50bn, according to Refinitiv’s Sukuk bulletin Q2 2020, with Malaysia and Saudi Arabia leading the way with issuances of US$13bn and US$12bn respectively.

2. Potential for Islamic finance expansion

Farmida Bi CBE, chair of Europe, Middle East and Asia at the international law firm Norton Rose Fulbright, describes Islamic finance as being well developed from an institutional perspective and says there are many countries where it fits neatly into regulatory frameworks. However, she suggests that the future of Islamic banking and finance lies mainly in the retail banking sector. “In large Muslim-majority countries where there is limited access to banking generally the potential for growth is enormous,” she says.

Her recommendation for anyone interested in pursuing a career in Islamic finance is to become familiar with conventional finance first, because Islamic finance operates within the conventional framework. “They need to know how these products work in order to understand how to make a case for Shariah-compliant products.”

There is also the potential to expand the existing Islamic finance customer base. For example, in countries where banks are operating in underdeveloped areas, where large sections of the population do not have access to bank accounts, according to Professor Carol Padgett, head of the ICMA Centre at Henley Business School, University of Reading. She says that these banks are trying to expand their customer bases, as there is less profit to be shared amid the global economic downturn.

However, further education of potential customers is vital, according to Stella Cox CBE (for more on Stella see The Review’s ‘Leading the charge’, published in 2017), managing director of DDCAP Group, a fintech and systems solutions firm that provides responsible intermediary services to the Islamic financial market. She suggests that many consumers who have not used Islamic finance products remain wary.

3. Developing Shariah-compliant products

A 2017 Aston Business School study notes that UK-based Muslims are concerned about Islamic banks’ propensity to employ scholars born and educated in Muslim-dominated countries and who, as a result, are perceived as lacking understanding of the financial needs of those living in the UK. The paper finds a “generalised lack of interest in marketing” of Islamic banking products to consumers.

“In the institutional space,” says Stella, “it is about developing capital markets, encouraging sovereigns and major corporates to issue Shariah-compliant securities as well as conventional bond options, and developing benchmark curves and yields comparable to traditional issuance to create a deep, liquid marketplace.”

Stella notes that the Bank of England’s Shariah-compliant liquidity facility, which will enable eligible banks to take and place liquidity in an interest-free way, has now been launched, having been in the pipeline for a number of years. In a speech on 2 December 2020, Andrew Hauser, executive director for markets at the Bank of England, confirmed its intention to make the Shariah-compliant liquidity facility available to eligible firms in Q1 2021.

4. Opportunities in responsible finance

In terms of responsible finance and Islamic finance, there have been a number of encouraging developments on the regulatory front, such as value-based intermediation in Malaysia. Bank Negara Malaysia, the country’s central bank, describes value-based intermediation as a process designed “to deliver the intended outcomes of Shariah through practices, conduct and offerings that generate positive and sustainable impact to the economy, community and environment, consistent with the shareholders’ sustainable returns and long-term interests”. The bank has centralised Shariah advisory and developed a legal and regulatory framework to ensure end-to-end compliance of diversified Islamic financial business.

Also in Malaysia, the Joint Committee on Climate Change was set up in September 2019 as a platform for regulators and financial institutions to work together to deepen their understanding of climate risks and develop tools to effectively respond.

The UAE has established three Guiding Principles on Sustainable Finance: integration of environmental, social and governance (ESG) factors into governance, strategy and risk management; the adoption of a minimum eligibility requirement to help identify sustainable financial products; and the promotion of appropriate ESG-related reporting and disclosures.

“As much as there is an opportunity to apply technology to improve the customer experience and reduce costs, there is more of an opportunity in responsible finance to grow the market, increase ESG investors’ interest in Islamic finance, and deliver greater benefit for society,” says Blake Goud, CEO of the Responsible Finance & Investment Foundation, a UK-based organisation that aims to bring together the global responsible finance and Islamic finance markets.

The S in ESG is also highlighted in the 2021 edition of S&P Global Ratings’ Islamic finance outlook, which says there is an opportunity for the Islamic finance sector to demonstrate the social aspect of core Shariah objectives.

The report refers to the potential of social instruments of Islamic finance to help address the impact of Covid-19 on corporates and banks through unremunerated or subsidised liquidity to help them cope with short-term loss in revenue and allow them to preserve employment.

5. Challenges in responsible finance

Blake says there are fundamental issues regarding how clearly the Islamic finance sector fulfils its aspirations. He suggests that in many markets where growth has slowed, Islamic banking has reached a saturation point – at least in its current iteration of products designed to provide financial services to those who require or strongly prefer Shariah-compliant options. The IFSB’s Stability report 2020 notes that Islamic banking’s share of the overall Islamic financial services market fell in 2019 for the third consecutive year.

“The next stage of its development is going to be more challenging because it brings a distinctive ethical proposition, but lags behind when it comes to showing clearly how the ‘compliance’ structures that have developed can adapt to include new challenges that go beyond just product design and deal with systemic issues like climate change,” he says.

As the urgency on climate change grows, there is an expectation that investors will turn towards more ethically oriented financial institutions if they see their interests matched by the financial institutions’ actions.

Islamic finance includes a detailed governance system to translate ethical considerations into viable commercial opportunities and, as more emphasis is placed on ESG issues and on climate-related financial risks, these will also have to be addressed.

Blake believes part of the challenge is strategic, since the principles of responsible finance have to be seen as strategically aligned with an Islamic finance provider’s business. “It is already clear that there is an ethical alignment between Islamic finance and the UN’s Sustainable Development Goals,” he says. “The next step is to merge the ethical alignment and strategic impact of responsible finance practices in Islamic finance.”

The full article was originally published in the February 2021 flipbook edition of The Review.

The full flipbook edition is now available online for all members.