he market for Islamic financial products is growing fast
AFTER morning coffee but before the keynote speaker came the muezzin’s recitation from the Koran: “Those who consume interest cannot stand except as one stands who is being beaten by Satan into insanity.” But those attending the Global Islamic Financial Forum needed no reminders that Muslims are supposed to eschew interest: the industry based on that premise is booming. Ernst & Young, a consultancy and accounting firm, estimates that Islamic banking assets grew at an annual rate of 17.6% between 2009 and 2013, and will grow by an average of 19.7% a year to 2018. Khalid Howladar of Moody’s, a rating agency, calls this “a landmark year” for Islamic finance, in that it is moving from “a very esoteric asset class to one that’s more… global.”
Most of the world’s Muslims are not so devout that they completely abjure conventional finance: even in Saudi Arabia, the assets of Islamic banks account for barely half of all banking assets. Muslim account-holders, Mr Howladar explains, tend to be more concerned with the products and service on offer than with the strictures of sharia (rules based on Muslim scripture). But Islamic finance, he says, has become sophisticated enough to appeal on both counts. Humphrey Percy, who heads the eight-year-old Bank of London and the Middle East, believes that most of his customers came not out of fierce piety, but “purely as a value proposition”.
Though the principles underlying Islamic finance are as old as the religion itself, modern banks did not start offeringsharia-compliant products until the mid-1970s. Since then it has grown into a global industry, with total assets of around $2 trillion. Most of that (nearly 80%, according to Malaysia’s central bank) is entrusted either to Islamic banks or to the Islamic units of conventional banks. The rest takes the form of sukuk, Islam’s answer to bonds (15%); Islamic investment funds (4%) and takaful, the Islamic version of insurance (1%). In 2012 Iran accounted for 43% of the world’s Islamic banking assets, with Saudi Arabia (12%) and Malaysia (10%) ranking second and third.
The demand created by this rapidly growing pool of Islamic capital has spurred the growth of sharia-compliant products. These take many forms, but none may pay or charge interest, nor can they invest in things that Islam forbids (so no alcohol, pork, gambling or pornography). In an Islamic mortgage, for instance, a bank does not lend money to an individual who buys a property; instead, it buys the property itself. The customer can then either buy it back from the bank at a higher price paid in instalments (murabahah) or make monthly payments to the bank comprising both a repayment of the purchase price and rent until he owns the property outright (ijara).
By the same token, a holder of sukuk has not technically lent the issuer money; instead, he owns a nominal share of whatever the money was spent on and derives income not from interest but either from the profit generated by that asset or from rental payments made by the issuer. At the end of the sukuk’s term the issuer returns the principal to the investor by buying his share of the asset. Cynics may point out that the difference between these structures and a conventional bond or mortgage is, in practice, rather slight: both provide predictable income to those who make their capital available.
But that does not seem to have dampened their appeal. Bahrain’s central bank issued the first sovereign sukuk in 2001; from 2002 to 2012, annual issuance grew at an average rate of 35%, from $4 billion to $83 billion (see chart), dwarfing even the healthy growth of Islamic banking assets. Most sukuk are denominated in the currency of the issuer and intended for local investors, but international issuance is growing, from 10% of the sovereign sukuk issued in 2010 to 20% in 2014. Of the $296 billion of sukuk outstanding as of July, Moody’s estimates that sovereigns account for 36%, with Malaysia the leading issuer. In June Britain became the first western country to issue sovereign sukuk; its £200m ($322m) sale attracted orders of £2.3 billion.
Western firms are also beginning to usesukuk to raise money. Société Générale and Bank of Tokyo-Mitsubishi UFJ, a French and a Japanese bank respectively, have issues in the works; Goldman Sachs is reportedly considering a $500m offer.
Despite strong recent growth for Islamic financial products, there still is room for further expansion, both in relatively unbanked Muslim countries in the developing world and in the West. As the orders for Britain’s issue showed, demand for sovereign sukuk is strong. Hong Kong and South Africa are scheduled to issue dollar-denominated sukuk later this month. Luxembourg, Russia, Australia, the Philippines and South Korea have also shown interest.
There are potential pitfalls. Goldman’s previous attempt to enter the market foundered amid claims its proposed sukuk did not comply with sharia. Indonesia has scaled back its issuance of one type of sukuk due to similar complaints. Malaysian scholars approved an Islamic credit card based on a transaction known as baya al-ina, which Arab scholars have rejected as being too close to interest-based lending.
Such rows have led to calls for greater international standardisation—hence the creation by national regulators of such entities as the Islamic Financial Services Board, which issues both religious and prudential guidance, playing the same role as the Basel Committee does for conventional banks. Zeti Akhtar Aziz, governor of Malaysia’s central bank, believes it will foster “harmonisation in how institutions are regulated”. But since Islam has no overarching authority that can approve its rulings, there will always be disputes.