After COVID-19, what is the next step for Islamic finance?Written by Oxford Business Group
Although Islamic banks emerged relatively unscathed from the 2008 global financial crisis, VIDOC-19 has a deeper impact. However, this disruption could provide opportunities to diversify the sector and accelerate its expansion once the pandemic is over. Compared to conventional institutions, Islamic banks are more exposed to small and medium-sized enterprises (SMEs), microfinance and retail lending, particularly in Asia. The economic performance of the major Islamic financial jurisdictions is expected to remain moderate for the rest of the year.
As a result, although the industry was previously on a strong growth trajectory in 2020, the rating agency Standard & Poor's predicted in June that it would record low to mid-digit growth in 2020-21, due to both the pandemic and the uncertainty of oil prices. In comparison, last year's growth of 11.4% was supported by a more dynamic sukuk (Islamic bonds) market and new growth opportunities. Nevertheless, Standard & Poor's believes that Covid-19 could unlock the long-term potential of the sector, arguing that the pandemic offers "an opportunity for more integrated and transformative growth with a greater degree of standardization, greater emphasis on the social role of the industry and significant adoption of financial technology".
Sukuk is a financial certificate similar to a bond in a conventional bank. It is a key element in the Islamic financial ecosystem. However, the sukuk market is more concentrated, smaller and less liquid than its conventional counterpart. In addition, the issuance process remains relatively complex and lengthy, and involves higher transaction costs.
In this context, the overall issuance volume is expected to decrease this year, although there will be a slight recovery after the sharp decline observed in recent months. Standard & Poor's expects issuance to reach $10 billion in 2020, compared to $162 billion in 2019. However, there are signs that the pandemic could lead to an expansion of the role of sukuk..
In June, for example, the Islamic Development Bank (IsDB) raised $1.5 billion with its first "Sukuk of Sustainability", designed to help the recovery of Covid-19 in its member countries. The proceeds will be used exclusively for social projects within the framework of the IsDB's sustainable financing, focusing on "access to essential services" and "SME financing and job creation".
Following the success of the sukuk, the President of the IsDB, Bandar Al Hajjar, then called on the Islamic financial industry to "promote sustainable and social sukuk as an alternative asset class that has the potential to counteract the multiple impact of the Covid-19 coronavirus.
Also in June, Indonesia issued a $2.5 billion global wakalah sukuk in three tranches, including a $759 million green sukuk dedicated to sustainable development.
The sukuk was oversubscribed by almost seven times the target amount. Its main objective was to support the government's coronavirus control programme, as well as to "strengthen Indonesia's position in the global Islamic financial market and support the development of Islamic finance in the Asian region," Dwi Irianti, director of Islamic finance at the ministry of finance, told local media.
Despite being home to the largest Muslim population in the world, Indonesia has not yet taken full advantage of Islamic finance. Therefore, sukuk is an encouraging sign that the potential of the sector is beginning to be tapped. Meanwhile, it was recently announced that Malaysia's Ministry of Finance will launch a RM500 million ($120 million) "Sukuk Prihatin" on 22 September. The revenue will be used to finance economic stimulus measures, as well as to help micro-enterprises, improve broadband coverage in schools and fund research into infectious diseases.
While the coronavirus has caused headwinds across the industry, these examples show how it has also led to a greater awareness of the potential of Islamic finance. How can this momentum be maintained and strengthened as we enter the post-pandemic world?Digitisation and the increased importance of financial technology (fintech) are essential.
"Covid-19 has led us to accelerate the digital transformation that was already underway before the pandemic," Ayman Sejiny, CEO of ICD, told OBG. This will help widen access and increase the sector's social transformation role. In addition, fintech can increase standardisation, streamline processes, reduce costs and increase transparency, making Islamic financial instruments more competitive with conventional forms.
As far as sukuk are concerned, standardisation is particularly important, both in terms of the theory behind the vehicle and the legal documentation associated with it. Further standardisation will also enable Islamic banks to make progress in new areas. "Islamic finance now needs to explore new sectors such as health and tourism, in line with Sharia law. We need to work hard to develop appropriate Islamic banking products for these sectors," Sejiny told OBG..
It is also possible that Islamic finance tools could play a greater role in promoting trade, which could help stimulate economic recovery in emerging markets. "The Covid-19 epidemic has opened up new opportunities for Islamic financial markets, such as the provision of Sharia-compliant trade finance products, as well as trade development programmes to promote greater attention to social impact, sustainability, innovation and digitisation," Hani Salem Sonbol, Managing Director of the International Islamic Trade Finance Corporation, told OBG. .
So while Islamic banking continues to face significant headwinds related to Covid-19, the crisis could be a major turning point in the global growth of the sector. The economic performance of the major Islamic financial jurisdictions is expected to remain moderate for the remainder of the year.
Published in: atalayar.com, 16 September 2020