The Islamic finance industry has been bracing for a new world since COVID-19

Mustafa Adil, Head of Islamic Finance for Refinitiv

2020 has been branded as one of the most challenging years economically given the widespread impact of pandemic-imposed measures, such as lockdowns which manifested unevenly around the globe. 

For Islamic finance, uncertainty prevailed, and risks included technological disruption potentially caused by the hacking outages, foreign exchange volatility and geopolitical risks. This is apart from operational risks caused by employees working remotely and changing customer behaviors that are impacting the financial institutions’ response towards these behaviors. These add to the woes caused by oil price volatility and the real estate sector slump in some Islamic finance markets. 

On the other hand, support measures by regulators in the leading Islamic finance markets allowed financial institutions to mitigate any issues they have faced and helped them ease their financial conditions.

Despite hardships and some Islamic financial institutions making lower profits or even losses, the Islamic finance industry saw double-digit growth of 14% to reach $3.4 trillion in 2020, according to Refinitiv’s Islamic Finance Development Indicator.

Double-digit growth seen in most Islamic finance sectors in 2020 despite hardships

Almost all Islamic finance sectors experienced double-digit growth during this period. The strong growth in total Islamic finance assets was driven by the largest Islamic banks in the GCC, Iran and Malaysia. A similar level of development was seen in these banks’ total liabilities as some of them increased their sukuk issues in 2020, taking advantage of the low interest rate environment to meet their capital adequacy requirements.

Sukuk also played a large part in such growth and proved to be resilient despite the uncertainty posed by the pandemic after it recovered from the initial shock in the first quarter of 2020. Sukuk’s robust growth was noticed in the GCC region, Turkey and Southeast Asia. It also received huge demand, as indicated by the significant oversubscription rate for some sukuk issues during 2021, such as Saudi’s Aramco sukuk, which received 10 times oversubscription.

Both Islamic banking and sukuk contributed a large sum of the total Islamic finance assets in 2020, amounting to $2.3 trillion and $631 billion, respectively. 

The impact of smaller asset classes cannot be ignored either. Although Islamic funds’ growth slowed down compared to the previous period, it still has the highest growth among the Islamic finance sectors, with a rate of 22%, reaching $178 billion in 2020. The solid increase was driven by its large markets, such as Malaysia and Saudi Arabia. Among recurring trends are exchange-traded funds, which are expanding geographically and even by the type of invested assets such as REITs.

Other Islamic financial institutions (other than Islamic banks and takaful operators) witnessed a single-digit growth to hit $154 billion. This is because some specialized Islamic financial institutions in certain markets are reeling from volatility in oil prices and the real estate sector. 

Meanwhile, takaful grew into the double digits to $62 billion in 2020, and this is largely attributed to the takaful growth in Turkey, Iran, Saudi Arabia and Southeast Asia. It is also gaining interest in other regions like North Africa, with Algeria’s government approving takaful regulations back in February 2021 and Moroccan consumers demanding takaful coverage for certain financing products such as property financing. 

The markets which experienced the fastest growth in Islamic finance assets during 2020 are Australia, Tajikistan, Morocco, Afghanistan, Egypt and Ethiopia.

Digitization, consolidation and sustainability remain as coping mechanisms

2020 was mostly spent managing the impact of COVID-19 for Islamic financial institutions, especially Islamic banks. Therefore, some institutions tried to stay ahead in the digital game by introducing new digital services. 

Another area of the industry that grew in prominence is Islamic FinTechs, which are challenging traditional Islamic banks. By looking at conventional Islamic banks, asset managers and takaful operators, many of these institutions oscillated towards partnering with FinTech companies to widen their target markets. Some countries are even working towards developing a supporting ecosystem for it, such as Malaysia.

The Islamic finance industry also saw sustained consolidation activity among its Islamic banks and takaful operators, mainly in the GCC. Another active market in this is Indonesia which saw a three-way merger of its Islamic banks in early 2021, while Turkey is considering a similar move by its publicly owned Islamic banks.

Sustainable Islamic finance continues to flourish. Since last year, many Islamic banks have been ramping up their green finance offerings. Meanwhile, more sustainability-driven Islamic capital market products such as sukuk and Islamic funds were launched in 2020 and so far in 2021, such as transition, sustainability and green sukuk along with ESG and waqf funds. Some markets are also prepping up for this. For instance, Oman is revising its debt market regulation by adding a set of detailed clauses that include sustainable and responsible investment (SRI) sukuk such as green, social and waqf sukuk.

Islamic finance support ecosystem reshaped by the pandemic

The impact of the pandemic can also be noted in the industry’s ecosystem, which encompasses Islamic finance regulations, education, events, etc. 

In terms of Islamic finance governance, 47 countries have at least one type of Islamic finance related regulation. Out of these regulations, sukuk has either been recently introduced in new markets such as Egypt and Uzbekistan or revised, such as the UAE and Oman. This given that sukuk is gaining traction and needs proper regulatory oversight in case non-payment occurs, as seen by some sukuk defaulting or restructuring during the pandemic. 

Shariah governance is gaining an increased focus. Kuwait formed its Higher Committee of Shariah Supervision in October 2020, while the Shariah Governance Framework for Local Banks Operating in the Kingdom was released in February 2020. Moreover, Turkey’s Banking Regulation and Supervision Agency created a legal infrastructure in October 2020 in which each Islamic bank should have its own Shariah board. 

Shariah governance also played a role in addressing issues posed by the pandemic, such as payment moratorium and how to deal with it based on the type of transactions and Shariah contracts. The industry is supported by 1,235 Shariah scholars.

As for the industry’s corporate social responsibility (CSR), many Islamic financial institutions reported their charitable activities in response to the pandemic, some of which are part of government initiatives to support health professionals or sectors impacted heavily by the pandemic. The total CSR funds that were distributed throughout 2020 amounted to $1.28 billion. There was also an increased emphasis on employees’ welfare and par excellence customer service to mitigate the impact of the pandemic on them.

When it comes to knowledge and awareness of Islamic finance, COVID-19 became a leading theme in Islamic finance research and events, totaling over 2,800 and 800, respectively. For events, seminars saw a notable rise as 93% of the events in 2020 were held virtually to cope with lockdown requirements and travel restrictions. Conferences, on the other hand, dropped because of this.

Given past developments and the trends so far in 2021, the Islamic finance industry is expected to grow to $4.8 trillion by 2025 in total assets, an average growth of 8% per year. We are already seeing some of the largest markets in Islamic finance with a potential for high growth, such as Saudi Arabia, Turkey and Indonesia, which will all drive the industry forward.