What is the post-pandemic future of global Islamic banking?

While Islamic banks emerged relatively unscathed from the 2008 global financial crisis, Covid-19 is having a deeper impact. Compared to conventional financial institutions, Islamic banks are more exposed to small and medium-sized enterprises (SMEs), microfinance and retail lending – particularly in Asia. The industry was on track for strong growth in 2020, but due both to the pandemic and oil price uncertainty, in June of that year international credit ratings agency Standard & Poor’s projected it would record low- to mid-single-digit growth in 2020-21. This is compared to 11.4% growth in 2019, which was underpinned by a more dynamic sukuk (Islamic bond) market and new growth opportunities. Nevertheless, the disruption could provide opportunities to diversify the segment and accelerate its expansion once the pandemic subsides.

Sukuk Issuance

Financial certificates similar to bonds in conventional banking, sukuk are a key element of the Islamic finance ecosystem. However, the sukuk market is more concentrated, smaller and less liquid than its conventional counterpart. In addition, the process for issuance remains relatively complex and time-consuming, and involves higher transaction costs. While the overall volume of sukuk issuance was muted in 2020, there are signs the pandemic could expand the role of sukuk. In June 2020, for example, the Islamic Development Bank (IsDB) raised $1.5bn with its first-ever Sustainability Sukuk, designed to aid pandemic recovery in its member countries. Proceeds will go exclusively towards social projects under IsDB’s Sustainable Finance Framework, with a focus on “access to essential services” and “SME financing and employment generation”. That same month Indonesia issued a $2.5bn wakala (agency) sukuk in three tranches, one of which was a $759m green sukuk, dedicated to sustainable development. The principal aim of this sukuk, which was oversubscribed by nearly seven times, was to support the government’s Covid-19 programme, and strengthen Indonesia’s position in global Islamic finance. Meanwhile, the UAE’s First Abu Dhabi Bank issued the first sukuk globally in 2021 – a five-year $500m sukuk in January, which was oversubscribed three times.

Post-pandemic Prospects

While Covid-19 has given rise to industry-wide headwinds, these recent examples demonstrate how it has also prompted increased awareness of the potential of Islamic finance. To sustain and increase this momentum in a post-pandemic world, digitalisation and financial technology (fintech) will be key. “Covid-19 has led us to accelerate the digital transformation that was already under way prior to the pandemic,” Ayman Sejiny, CEO of the Islamic Corporation for Development, told OBG. This will expand access and increase the socially transformative role of the segment. In addition, fintech can increase standardisation, streamline processes, reduce costs and boost transparency, making Islamic financial instruments more competitive relative to conventional forms.

Standardisation is particularly important for sukuk, both in terms of the theory underpinning the vehicle and the legal documentation associated with it. Greater standardisation will also enable Islamic banks to move into new areas. “Islamic finance should now explore new sectors such as health and sharia-compliant tourism. We should work hard to develop Islamic banking products suitable for these sectors,” Sejiny added.

There is also the potential for Islamic finance to play a greater role in trade, which could help to boost recovery across emerging markets. “The Covid-19 outbreak has put in motion new opportunities for Islamic finance markets, such as the provision of sharia-compliant trade finance products, as well as trade development programmes to promote a stronger focus on social impact, sustainability, innovation and digitalisation,” Hani Salem Sonbol, CEO of International Islamic Trade Finance Corporation, told OBG. While Islamic banking faced significant headwinds related to the pandemic, the crisis could ultimately constitute an important watershed in the global development of the industry.