Waiting game: High potential for sharia-compliant offerings, but regulatory uncertainties remain

As financial services firms regain ground after a tumultuous 2011, conditions are ripe for sharia-compliant banking, investment funds, insurance ( takaful) and bonds and equity instruments ( sukuk) to put Egypt on the global Islamic financial services (IFS) map. The concerns about conventional banking, resulting from the global financial crisis, and the expansion of IFS firms from the GCC and Malaysia bode well for the segment.

DEMAND: With more Egyptians than the populations of the GCC members and Malaysia combined, indigenous demand could be substantial. At present there are around 200 Islamic banking branches among Egypt’s sharia-compliant institutions, accounting for about LE120bn ($20.08bn) in assets, less than 1% of the global market, despite the country’s size. Within the country, IFS assets are estimated to account for only 4% of the country’s total. According to consultancy Ernst & Young’s 2011-12 “World Islamic Banking Competitiveness Report”, the Middle East and North Africa region’s Islamic assets exceeded $416bn in 2010 and are projected to reach almost $1trn by 2015, making Egypt and its neighbours key figures in the growth of global IFS.

HISTORY: The first firm to sell sharia-compliant products in Egypt began operations more than five decades ago as a microfinance institution. By the 1980s IFS products had become widely available in Egypt, but a series of scandals involving IFS funds running Ponzi schemes and the secularist government’s hesitance to encourage its development, dampened interest.

In other predominantly Muslim markets, IFS has taken off in the past 15 years. In the Gulf and South-east Asia, the populations’ demand and the resurgence of commodities has pushed the sector to new heights. Surpluses from the record prices of oil and other natural resources have left governments, businesses and individuals looking for new avenues for investment.

Moody’s has estimated the total market potential for IFS at around $5trn. As IFS providers have sprung up, grown, consolidated and started looking abroad, awareness of IFS, and correspondingly penetration rates, have increased. For example, as the sector began taking off between 2003 and 2008, the penetration rate of IFS in Qatar went from 12.5% to 20.3%, while in Turkey, it grew from 9.7% to 15.7% in the same period.

Regulators, particularly in Bahrain and Malaysia, have supported the development of IFS firms as their sharia-compliance credentials and local knowledge have helped them carve out a market that international conventional financial giants had been slow to address. This has put local firms on the map and aided government efforts to diversify resource-dependent economies away from commodities in favour of skilled services.

LOCAL OPERATORS: Recent concerns over the solvency of some of Egypt’s largest banks, including Commercial International Bank, National Bank of Egypt (NBE) and Banque Misr, could highlight the advantages of IFS to Egyptians. In November 2011 Moody’s downgraded its ratings for five of the country’s top banks due to concerns over their sovereign debt holdings and the interim government’s ability to support the banking system in the event of a major failure. There are several local Islamic banks and Islamic windows of conventional banks, though far fewer than the population can support. At the time of press there were a total of 14 banks with Islamic licences from the Central Bank of Egypt. Among the Islamic banks are Faisal Islamic Bank, Al Baraka (majority owned by the Bahrain-based Al Baraka Group) and the National Bank for Development, which was a commercial institution purchased in 2007 by Abu Dhabi Islamic Bank and subsequently converted into a fully Islamic operation.

Conventional banks with Islamic windows include NBE, Banque Misr and Ahli United Bank. Commercial lender AlexBank has announced that it plans to set up an IFS unit in 2013. HSBC Amanah executives have voiced interest in entering the Egyptian market as well.

If legislators can work effectively to pass proposed reforms, one of the major roadblocks to IFS’s development will have been removed and the banking sector could expect to see a surge of interest from IFS firms.