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Islamic Finance

Islamic finance can supplement the financial response to the coronavirus in the UAE using ESG to manage risks and return economy to growth

This article is a chapter out of the e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" that is available as a pdf download from HERE. Read the article in the e-book for the complete set of tables, charts and references. 


The United Arab Emirates has avoided many of the direct impacts caused by the spread of the coronavirus, such as overwhelmed hospitals, seen in other countries through a focused and proactive response to containing the virus’ spread. According to data from the UAE Ministry of Health & Community Protection, there were 13,038 cases as of May 1 with 111 confirmed deaths.1 One of the most challenging elements of grappling with the outbreak of COVID-19 is understanding the true scope of infection.

During the beginning months of the spread of COVID-19, there was a perception from markets that the virus’ economic impact would be contained to China with some minor global ripples being driven primarily by supply chain disruptions. As the virus spread across Asia through the end of February, global equity markets as well as those in the UAE, began a sharp decline reflecting a reassessment of the anticipated economic impact of COVID-19. During the first half of March, the decline in equity markets in Dubai and Abu Dhabi intensified along with a global market crash.

The seriousness of the decline was reflected across equity markets, and even spread across credit markets up to and including US Treasuries. Central banks, including the Central Bank of the UAE  (CBUAE), took action to stabilize banks and financial markets, and their efforts stabilized markets starting around the third week of March. As COVID-19 cases continued to increase into early April, CBUAE brought additional stimulus that continued to support recovery of equity markets.

Equity markets will continue to be vulnerable to the level of new cases and uncertainty about the degree to which COVID-19 has spread locally. Although measures implemented to date have been successful at stabilizing markets, the UAE is susceptible as are most countries to a lack of data. It has taken efforts to improve data using measures such as opening 14 drive-through testing centers, as well as using existing hospitals and specialist health centres, starting from the end of March and by prioritizing testing for those most at-risk including the elderly and pregnant women. By April 1, the UAE had the capacity to perform tens of thousands of tests per day, and by the beginning of May, approximately 1.2 million tests had been performed, equivalent to about 12% of the population.

In relative terms, this testing success means the outbreak is more likely to remain contained relative to harder hit countries where testing is not as widely available. Within the UAE, the containment measures have varied across the seven emirates, with particularly strong measures such as a 24-hour per day curfew and lockdowns for two commercial districts in Dubai with significant residential concentrations of foreign laborers. The first day of Ramadan saw easing to allow greater freedom during the holy month. These easing measures included the opening of malls across the country with physical distancing measures still in place to protect public health including a requirement for residents to stay at home from 10pm to 6am, and similar easing was undertaken in other emirates, to allow opening of public transportation of businesses as long as they limited their capacity to 30%.

From the perspective of all banks in the UAE, Islamic banks included, the direct impact from COVID-19 on earnings has been limited. Many of the cases of COVID-19 have occurred among the migrant worker populations that were generally financially excluded before the pandemic and did not represent a significant customer base for UAE banks.

Among the UAE’s banks, including Islamic banks, the indirect financial impact is more severe as many customers, whether as employees or businesses, have seen a sharp hit to their incomes during the lockdown. The duration of that impact, its severity and the relative impact it has on Islamic versus  conventional banks depends on how much exposure each has to the sources of this indirect impact. Banks are also able to gain some mitigation of the adverse impacts of the lockdown as a result of the effectiveness of the central bank and regulatory policies that have been adopted since mid-March.

At a time when the financial stability issues have been largely contained, the attention of Islamic banks should focus on their ability to do more to respond to the social and economic issues that will face the UAE and ensure a strong recovery. Islamic finance is unique because it brings an explicitly ethical approach to the conduct of financial services to facilitate activity in the real economy. In the past, the real economy impact has been derived from its provision of financing.

There is a potential opportunity in this time of global need for Islamic finance to create a positive social return by recognizing the environmental, social and governance (ESG) issues that are relevant to their customers. By working with customers on these issues, Islamic banks will ensure better risk management during a challenging time.

UAE quick to minimize COVID-19 impact on Islamic banks

The CBUAE announced two rounds of support for the banks which did not differentiate between conventional and Islamic banks. The first supporting measures were adopted on March 15 in a 100 billion dirhams ($27.2 billion) package aiming to address the most acute concerns at the time. This support package offered 50 billion dirhams in a Zero-Cost Funding (ZCF) Support Facility and allowed banks to use their Capital Conservation Buffer, freeing up an additional capacity to respond of 50 billion dirhams. The ZCF funding is liquidity support to the banks in exchange for eligible collateral under the Collateralized Murabaha Facility (CMF).

In order to be eligible for the ZCF facility, banks must offer a full payment pause (principal plus profit), called a Targeted Economic Support Scheme (TESS) for customers for 6 months (later extended through the end of 2020). The Higher Shariah Authority reviewed and approved the conditions of the TESS for Islamic banks at the end of April, including the operational guidance for how to postpone payments for different transaction structures. This payment pause will have a negative impact on banks by reducing their income, which will lower their capital levels. The combination of these effects motivated the CBUAE to allow banks to use of the Capital Conservation Buffer (CBB) to avoid creating retrenchment in new financing at a time when demand for it is heightened. The CCB is an  added capital requirement of 2.5% of risk-weighted assets that is in addition to their 12% minimum capital levels. The UAE Central Bank’s action allowed all banks to draw up to 60% of the buffer with additional flexibility for Domestic Systemically-Important Banks (D-SIBs) that are able to draw down 100% of their CCB buffer.

On April 5, the CBUAE extended these policies with the aforementioned extension of the payment pause for customers through the end of 2020.7 In addition, the second phase of support measures for banks includes additional support for bank liquidity. The CBUAE relaxed the reserve requirement for demand deposits from 14% to 7%, freeing up. 61 billion dirhams ($16.6 billion).

The central bank also allowed banks to draw down their liquidity by another 95 billion dirhams ($25.9 billion) such that their liquidity coverage ratio drops to 70% and their Eligible Liquid Asset Ratio (ELAR) falls to 7%. The former measures High Quality Liquid Assets (HQLA) to projected net 30-day outflows, while the latter reflects a range of assets deemed to be liquid by the CBUAE relative to the bank’s total assets.

Apart from the measures to expand the capital and liquidity, the Central Bank eased requirements for funding real estate and SMEs. For real estate, the requirements allowed for higher loan-to-value by 5% for first-time home buyers, and banks have their real estate exposure cap relaxed from 20% to 30%, but they must hold more capital. To encourage SME financing, the CBUAE reduced the risk-weighting on SME financing from 25% to 15%.

In total, these measures accounted for 256 billion dirhams ($69.7 billion), which was about 17% of estimated GDP in 2019, and they provide a backdrop of stability for the financial system, including the Islamic banks in the UAE. They also pass through some of the relief to consumers and businesses through the TESS, although there are notable gaps because the debt relief will be of limited help for those who have lost their jobs who will struggle to meet their financial obligations even with their debt repayments paused.

In addition to the capital and liquidity relief offered to banks in the UAE, the central bank, together in coordination with the Dubai Financial Services Authority (DFSA) and Abu Dhabi Global Market (ADGM) issued guidance on how the banks should treat their financing impairments to give banks  more flexibility during the pandemic.9 In short, the banks were given an extended time to update macroeconomic models to calculate the expected credit loss (ECL) of their assets.

Each bank participating in TESS will report about the total volume of financing for which repayment is paused and indicate how significantly their financing portfolio has been affected using a two-group classification system. One classification indicates that customers’ business is likely to be mildly and temporarily affected while the other indicates a more significant and lasting impact from the coronavirus crisis. The status of financing for clients making use of TESS would be unchanged in how they are classified for the purpose of measuring expected credit loss under IFRS 9. The exception to this policy comes anytime the bank actually incurs a credit loss (such as if the customer faces insolvency). This reverts treatment to pre-IFRS 9 requirements and treats the impact of the lockdown as purely a liquidity issue, and not an impairment of the creditworthiness of the customer. As a part of this change, banks were able to avoid late payment triggering a negative impact based on changes to expected credit loss (ECL) that change based on the number of days for which a payment is due. This trigger would otherwise increase the level of losses required to be counted against financing asset value.

As outlined above, the response within the UAE to the coronavirus crisis from the perspective of Islamic banks is likely sufficient for the time being to stabilize the financing sector. Islamic banks may find some elements more difficult than conventional banks as a result of having a different mix of financing assets. To take one example, there may be greater haircuts involved in the ZCF funding because Islamic banks have less financing to the government and government-related entities than conventional banks.

As of the end of February, their assets included 50% financing assets to the private sector compared with 34% for conventional banks. The corresponding asset share for government and GRE financing assets was 3.1% and 5.5% for Islamic banks, respectively, and 8.4% and 6.1% for conventional banks. At the same time, their liquid asset position is healthier, with 12.8% of assets in cash and central bank deposits, plus 2.6% with other UAE banks. The corresponding liquid asset position for conventional banks is 10.2% in cash and central bank deposits and 1.4% due from other UAE banks. From the perspective of stability, the Islamic banks are likely to be in at least as strong a position as their conventional counterparts.

How can banks mitigate the impacts of COVID-19 and lockdowns used to curb its spread?

The current central bank policies are largely defensive. It is focused on easing the acute pain facing those currently affected by the COVID-19 lockdown. Providing financial stability, as the CBUAE’s actions are likely to do, is a necessary but not sufficient outcome for the banks. As their customers face significant economic damage, they face an opportunity to support their customers now that the central bank has provided them with support. For Islamic finance in particular, the ethical principles that guide the industry would both offer them a framework to implement support for their customers as the economy rebuilds following the crisis and also increases reputational risk that they would face if customers believe their efforts were insufficient. The Higher Shariah Authority reiterated this sentiment as it urged Islamic financial institutions to support the most affected customers and economic sectors. The efforts to think about rebuilding damaged economic sectors is important because the duration and severity of the economic contraction that has already begun is only partially within banks’ control. Continuing to maintain a robust response to the coronavirus will influence the epidemiological progression of the coronavirus, but there are significant unknowns about treatment and vaccines, as well as the form that social preferences change as the economy is reopened. This phase of the recovery could last as long as through 2022 under conditions that require moderate or severe physical distancing.

In addition to the financing needed for the immediate response, the economic transformation that is required to recover from this crisis needs new investment. Postponement of existing financing is a useful short-term tool, but it needs to be supplemented with new financing as well. As banks work to extend this new financing, it will be especially important for them to make their risk management process robust.

One element that will be critical is to recognize the heightened importance of environmental, social and governance (ESG) issues as a tool to understand and evaluate the material financial risks that they face. These risks have always existed, and have sometimes been evaluated, but not in the systematic way that is required today and into the future.

The world has been transformed by the coronavirus. The environmental, social and governance – especially social issues – will be pivotal for how well businesses are able to re-engage employees and  customers or lose them to their competitors. From the perspective of a bank extending new financing to businesses that have been disrupted so much, an analysis of their ESG issues will be as important as their pre-crisis financials in understanding how resilient they will be.

Operationalizing ESG will benefit from digitization, and be amplified by the digitization trends within the financial industry that are being accelerated by COVID-19. One of the most common ways that these trends are interacting in the UAE’s banks to date is with promotion of greater social inclusion through digital financial inclusion. For example, Emirates NBD launched a digital bank Liv in 2017 which allowed for financial inclusion for those living in remote areas and supported the bank’s corporate social responsibility efforts promoting inclusion of people with disabilities.

These types of digital services provided accessibility for some types of financially excluded people while also reaching out to younger consumers, but also had the side benefit of preparing the bank better for unprecedented changes that are occurring today. As a new normal develops during and after the lockdown as the economy continues to rely on physical distancing, this technology will support the banks’ effort to support businesses that are reliant on some degree of physical interaction as they become contactless. Having already made the technological development and invested in the infrastructure needed to operate digitally can enable these banks to more effective in understanding and responding to changing customer expectations.

Islamic banking represents a sizeable share of the market in the UAE, particularly banks with Islamic banking services (‘Islamic windows’) and their share of the market has increased during the recent consolidation of the banking sector in the UAE. These Islamic windows are at a relative advantage compared with standalone Islamic banks when it comes to adopting new technology. For example, Islamic windows connected to conventional banks that have developed their own neo bank, that offers services without any branch network, will be in the strongest position for growth by adapting their offering for the Islamic windows.

The Islamic windows will be able to leverage on their parent banks’ neo bank infrastructure already offering non-interest-bearing deposits. Using this as a starting point, they will be able to integrate their existing Islamic financing products, with minimal additional effort to automate processes compared to banks starting from scratch. The neo bank infrastructure being used to offer existing Islamic financing products could be leveraged to deliver services ‘at speed’ to market compared to standalone Islamic banks.

Standalone Islamic banks will need to respond quickly in order to maintain their competitive positioning, which could have further impacts on the UAE banking sector post-COVID-19. The natural alignment that standalone Islamic banks could otherwise use to their benefit in the post-COVID world between ethical underpinnings and broader ESG trends could be eroded. For example, if their focus is consumed by the shift to digital banking to meet current realities while the Islamic windows and conventional banks are able to use their digitization lead to implement ESG, including with the use of digital tools which follow the UAE’s Guiding Principles on Sustainable Finance, it would put standalone Islamic banks at a significant competitive disadvantage in a market where they otherwise could have an advantage.


The UAE’s response to the coronavirus crisis has been well designed with the objective of containing the spread of the virus. It has also now deployed the type of infrastructure that will allow to test and trace the level of infections and support the gradual reopening of businesses and the economy. The UAE has expanded its testing and healthcare response while also introducing measures to support its banking sector, including Islamic banks.

These banks are facing customers’ repayment worries that stresses both capital and liquidity and the central bank’s response to the financial strain has been effective in stabilizing interbank rates, which often provide indications of financial strain. Within the Islamic banking market, there will also be challenges facing individual banks, such as competitive pressures caused by accelerating trends in digitization, that they will need to address simultaneously.

Although governments and Islamic banks each require financial stability in order to act, they each have a duty to do more, and can benefit themselves in the process. The development of ESG practices in banking provides a better way for these banks to understand risks and opportunity. By becoming more resilient, they are able to unlock more resources to support to businesses that can thrive post-COVID but are facing severe constraints in the current environment. In addition to contributing to solid risk management in a time when traditional methods may be less effective, an ESG approach can provide Shariah-compliant financial institutions with more data to enable them to support the recovery of the real economy for the benefit of all of their stakeholders including customers, employees, regulators, and society at large.These stakeholders will want to know how Islamic banks are able to be creative while working within their regulatory framework to prudently direct financing to those who need it to support the recovery from the coronavirus crisis. It will provide a tangible example for how Islamic finance can maintain a focus on its own commercial objectives while at the same time also support a positive impact, particularly in relation to social impacts. This is a critical element to support society during a time of acute need on a scale when the needs of society are far larger than what can be addressed by governments or philanthropic activities.

The full e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" is available as a pdf download from HERE. The e-book is published by Indonesia's Islamic Finance and Economy Committee (KNEKS) in partnership with DinarStandard and Salaam Gateway. It was launched on May 27, 2020. The 12 countries covered are: Bahrain, Bangladesh, Brunei, Indonesia, Iran, Malaysia, Nigeria, Oman, Pakistan, Saudi Arabia, Turkey, and UAE. 


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Blake Goud, Sayd Farook and Hanife Ymer