The Islamic finance industry is growing at a fast pace but, despite being valued at more than $700 billion (Dh25.7bn) in terms of assets, it remains highly fragmented, said a new Moody’s report.
“Islamic finance is becoming increasingly ‘internationalised’, but essentially remains a collection of disseminated and still weakly co-ordinated local operations,” Anouar Hassoune, a Moody’s analyst and author of the report, said. “A number of forces within the Islamic financial universe tend to contribute to its fragmentation.
“The core principles underlying Islamic financial products, although subject to vast consensus as to their formal content, remain differently interpreted and differently weighted in practice,” Hassoune said.
“The market for Sukuk alone, accounting for around $100bn at year-end 2007, has exceeded the GDP of a country the size of Morocco,” Hassoune said. Moody’s noted that current excess liquidity prevailing in Gulf economies has fuelled both sustained demand for the products supplied by international financial institutions (IFIs) and the booming expansion of the market for sukuk, while contributing to creating a very close link between Islamic banks and what remains to date a relatively illiquid compartment of the bond market.
Nevertheless, the rating agency expects liquidity in the Sukuk market to improve gradually as the variety of sukuk issuances widens.
Not only are volumes expected to exceed $150bn by the end of the current decade, but the nature, geographic location and credit quality of future issuers are also expected to considerably evolve and diversify.
At this stage, the Islamic financial industry remains very much intermediated – more widely dominated by financial intermediaries capturing deposits to recycle them into on-balance-sheet asset portfolios than by disincarnated, de-territorialised and virtual capital markets.
Moody’s said that some 90 per cent of Shariah-compliant assets are concentrated on IFIs’ balance sheets and on those of conventional banks offering Islamic financial services and products through “Islamic windows”.
In Moody’s opinion, the lack of technical and contractual standardisation impedes the capacity of Islamic finance, as an alternative financing and investment model, to enhance its globalisation process, without necessarily forbidding its internationalisation.
Initiatives aiming at either introducing Islamic finance or strengthening its position are mushrooming across a wider range of countries but these remain country specific and weakly co-ordinated, despite the endeavour of several cross-border organisations to bring some consistency to the concept.
“Building in prospective views is not an easy task in such a young industry. But we expect the sukuk market to become more complex, larger, more diversified and more liquid as it evolves over time,” Hassoune added.
Equally, IFIs are expected to explore new geographic horizons as well as new business lines, become more competitive and contribute to the gradual emergence of a more disintermediated Islamic financial industry – one with a reduced presence of Islamic banks.
Future is full of ‘challenges’
The future is full of challenges and constraints for the Islamic financial industry, the Moody’s report on Islamic finance industry said.
One of the challenges of the Islamic banking industry in the Gulf region is precisely to leave enough space for established players to grow organically and to avoid new competitors jeopardising margins by way of excessive cannibalisation, the report said. “It appears that demand, liquidity and market growth prospects are at this stage robust enough to accommodate the newcomers without weighing too heavily on the overall returns of the industry.
Moody’s said the capacity of the Islamic banking market to weather the risks attached to new competition with limited damage on margins is potentially important as, firstly, the profitable retail segment is expected to grow for demographic reasons and secondly the IFIs remain small institutions in absolute terms, and will find it difficult to absorb the spectacular growth of the market for sukuk, therefore leaving more space for disintermediated capital markets to emerge.
Moody’s added that size and diversification are the crucial challenges for the Islamic financial industry