The prospects for the global Islamic finance industry in 2023-2024 continue to be positive although growth dynamics continue to be concentrated in the key traditional markets.
In its latest report titled “Islamic Finance 2023-2024: Growth Beyond Core Markets Remain Elusive,” S&P Global Ratings concludes that despite a forecasted economic slowdown, global Islamic finance assets are set to grow in 2023-2024, largely due to favourable dynamics in a few core markets; while Sukuk issuance will likely continue to decline in 2023, new issuances will exceed maturities; and sustainability-linked Sukuk issuances will likely continue to increase, albeit from a low base. S&P expects around 10% growth across the industry in 2023-2024 after expanding by a similar number in 2022 (excluding Iran).
“The Gulf Cooperation Council (GCC) countries – notably Saudi Arabia and Kuwait,” emphasised S&P, “largely fuelled 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 we generally expect volumes to diminish in 2023, we 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. We continue to exclude Iran from our calculations due to the lack of disclosure by Iranian banks.”
However, the rating agency maintains that structural weaknesses still curb the industry’s broader geographical and market appeal. “We 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.”
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 sector. The Islamic finance industry market size comprising banking, funds, Takaful and Sukuk assets, for the first time topped the US$3 trillion mark in 2022 – up from US$2.75 trillion in 2021, driven overwhelmingly by the banking and Sukuk segments.
GCC countries, mainly Saudi Arabia and Kuwait, spurred 92% of growth in Islamic banking assets in 2022. In Kuwait, this was mainly due to the acquisition of Ahli United Bank (AUB) by Kuwait Finance House (KFH). “Over the next couple of years,” says Mohamed Damak, S&P’s Primary Credit Analyst of the Report, “we expect the latter to convert its conventional activities to Sharia’a compliance in line with its acquisition plans. In Saudi Arabia, the implementation of Vision 2030 and continued growth in mortgage lending supported the 2022 performance.” Despite this growth scenario, S&P expects a material slowdown in GCC economies’ real GDP growth in 2023-2024, compared with 2022, largely based on lower oil production. However, it expects Saudi Arabia’s banking system performance will continue to underpin a large portion of the expanding Islamic finance industry. In other GCC countries, growth of about 5% appears plausible in the absence of new major government investment cycles.
The rating agency projects Islamic banking in South East Asia to grow at around 8% over the next couple of years, despite an economic slowdown in the major markets of Malaysia and Indonesia. Robust demand for Islamic products and services and low penetration, particularly in Indonesia, support this trend. “In both markets, we expect Islamic banking to continue to gain market share as growth outpaces conventional banking.”
Elsewhere, in Tȕrkiye, the depreciation of the lira has been a constraint. Pressure on the Egyptian pound is also unhelpful for the industry, although the contribution of Egypt and Tȕrkiye to the industry’s banking assets generally remains modest.
S&P is less bullish about Sukuk issuance, predicting volumes will continue to fall in 2023, albeit at a slower pace than in 2022. The reasons for this include 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. This is particularly so in Saudi Arabia, where the banking system will be limited in its capacity to finance multiple projects related to Vision 2030 implementation. Issuers with high financing needs, such as those in Egypt and Tȕrkiye, are also likely to tap the Sukuk market as part of their strategy to mobilize all available resources.
For example, Egypt has established a US$5 billion Sukuk programme and issued its first Sukuk in early 2023 for a total of US$1.5 billion. “We understand that this attracted significant investor interest, with more than US$6 billion demand and a 59% allocation to investors from the Middle East and North Africa. The profit rate of the three-year Sukuk was set at 10.875%, which at the time was broadly in line with the yield on Egypt’s conventional bond with a similar maturity date of 2026. Overall, we think that the volume of new issuances will continue to exceed maturing Sukuk,” added S&P.
The rating agency notes a significant decline in foreign currency-denominated Sukuk issuance over the past 12 months, though, mainly on lower and more expensive global liquidity. In addition, the market continued to suffer from uncertainty around regulation and standardization. For example, challenges related to the adoption of AAOIFI Standard 59 in the UAE resulted in a significant decline in foreign currency-denominated Sukuk – from around US$10 billion per year in 2018-2020 to around US$4 billion per year in 2021-2022.
“Introducing mechanisms for the revaluation of underlying assets could be one of the next obstacles that the market may face. We 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, we believe that investor and issuer appetite, as well as and pricing mechanisms, would likely change significantly. Sustainability and digitalization could help the sukuk market to shore up future contributions to the Islamic finance industry,” maintains S&P.
Perhaps the most damning observation of the S&P report is that it 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,” notes the Report, “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. We believe that measures taken by stakeholders – particularly standard setters – and increased digitalization could also help. On the other hand, we note the potentially conflicting views of Sharia’s scholars, who favour more equity-like characteristics for Sukuk, and investors that prefer more debt-like features. We see this as a factor that could disrupt the market.”
Similarly, despite their small contribution to the Islamic finance industry, the Takaful and fund sectors to continue to grow. S&P expect 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. However, fund growth will hinge on the performance of the capital markets, given its structure – around one-quarter equity funds and another 60% money market or Sukuk funds. Overall, S&P believes a growth rate of about 10% is achievable for the industry over the next two years.