The global Islamic finance industry continues its growth path. S&P Global (S&P) in the recent report expects around 10% growth across the industry in 2023-2024 after expanding by a similar number in 2022. This excludes Iran.
The Gulf Cooperation Council (GCC) countries, notably Saudi Arabia and Kuwait, largely fueled this performance, supported by a large, one-off acquisition in the latter.
Elsewhere, growth was either muted or held back by local currency depreciation. At the same time, sukuk issuance continued to spur the industry’s expansion despite slowing issuance volumes overall.
While S&P generally expects volumes to diminish in 2023, they still believe that new issuance will exceed maturing sukuk, resulting in another positive contribution of the sukuk market to industry growth in 2023. The Islamic funds and takaful sectors are also likely to continue to expand.
Structural weaknesses still curb the industry’s broader geographical and market appeal, though. As S&P had stated in previous reports, they believe that progress toward greater standardization, in part supported by the digitalization of sukuk issuance for example, could enhance the industry’s structural growth potential.
At the same time, the increasing focus on sustainability-related themes by core Islamic finance players will create new opportunities for the industry.
“We expect the contribution of sustainability-linked sukuk to continue increasing in the next 12-24 months, albeit from a low base,” said S&P.
Strong Growth Will Persist
The Islamic finance industry continued to expand in 2022, with assets up by 9.4% compared with 12.2% in 2021, supported by growth in banking assets and the sukuk industry.
“In South-East Asia, we expect the Islamic banking industry to grow at around 8% over the next couple of years, despite an economic slowdown in the major markets of Malaysia and Indonesia,” said S&P.
Robust demand for Islamic products and services and low penetration, particularly in Indonesia, support this trend. In both markets, S&P expects Islamic banking to continue to gain market share as growth outpaces conventional banking.
S&P believes that sukuk issuance volumes will continue to fall in 2023, albeit at a slower pace than in 2022. They expect lower and more expensive global liquidity, greater complexity related to structuring sukuk, and reduced financing needs for issuers (due to fiscal surpluses from higher oil prices) in some core Islamic finance countries to deter the market.
Corporates are likely to contribute to issuance volumes, particularly in countries where governments have announced transformation plans. Introducing mechanisms for the revaluation of underlying assets could be one of the next obstacles that the market may face.
S&P will continue to consider any future developments relating to regulation and standardization and how they may affect future issuance volumes.
If sukuk became an equity-like instrument, S&P believes that investor and issuer appetite, as well as pricing mechanisms, would likely change significantly. Sustainability and digitalization could help the sukuk market to shore up future contributions to the Islamic finance industry.
Despite their small contribution to the industry, S&P expects the takaful and fund sectors to continue to grow. S&P expects takaful to expand at an annual rate of around 10%, supported by continued nominal GDP growth, the expansion of infrastructure investment and medical insurance covers, and some inflation-related tariff adjustments.
Fund growth will hinge on the performance of the capital markets, given its structure of around one-quarter equity funds and another 60%
money market or sukuk funds.
“Overall, we believe a growth rate of about 10% is achievable for the industry over the next two years,” said S&P.
S&P sees the Islamic finance industry as a collection of local industries rather than a truly globalized sector. In 2022, Saudi Arabia and Kuwait drove most of the growth in banking assets.
Similarly, Malaysia and GCC countries accounted for a large portion of the sukuk market during the same period. Interest in tapping the sukuk market from players beyond the industry’s original boundaries seems to be limited to countries in need to open all available financing options.
The industry is therefore looking at ways to enhance its competitiveness and appeal to distinguish itself from the conventional fixed-income market. Streamlining products and processes to make them more appealing to new issuers is one of these methods.
S&P believes that measures taken by stakeholders, particularly standard setters, and increased digitalization could also help. On the other hand, S&P notes the potentially conflicting views of Sharia scholars, who favor more equity-like characteristics for sukuk, and investors that prefer more debt-like features.
S&P sees this as a factor that could disrupt the market and believes that digitalization could help alleviate this issue as it would require a set of standard legal documentation that would be used for digital sukuk issuance.
However, having adequate physical and nonphysical infrastructure in place, along with the necessary supervision and regulatory framework, would be prerequisites for success in this area.
In addition, a regulatory environment for digital sukuk and a monetary bridge between the physical and digital ecosystems could enhance market access.
Sustainability-Linked Themes Could Support Future Growth
Despite the natural alignment of Islamic and sustainable finance, sustainability-linked sukuk issuance remains limited. S&P believes that this will change, and S&P expects to see higher volumes of sustainability-linked sukuk as issuers try to meet investor demand and core Islamic finance countries seek to reduce their carbon footprint and support the global energy transition.
Many Islamic finance countries are pursuing strategies to help them transition to greener economies. S&P believes this indicates growth potential for green sukuk issuance and expects to see greater activity in this space as issuers tap global investor interest.
Although less visible, S&P believes that the social aspect behind Islamic finance holds appeal as the economic impact of various political and geopolitical shocks continues to thwart populations in certain countries.
Banks are also likely to unlock growth opportunities related to their sustainability agenda. Over the past three years, many banks in core Islamic finance countries have publicly commented on their sustainability plans.
While some have been more ambitious than others, this shows their public commitment to certain levels of sustainability-related financing or a certain percentage of their overall financing.
“We therefore expect green products and services for corporate and retail customers will contribute to the growth of Islamic banking assets,” said S&P.