The Growth of Islamic Finance

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BY TEA IVANOVIC

Islamic finance has become, in only a matter of years, a financial market phenomenon, with growth expected at astonishing double-digit rates of roughly 19 percent until 2019, showing tremendous capability for growth and a potential to become a new mainstream global market. The Western world is already adapting to customers investing in Islamic Finance by making available some sharia-law compliant assets, but it could do more to understand the rules of Islamic finance to ensure it can capitalize on the industry’s growth.

While many in the non-financial world are unaware of a financial industry entirely compliant to sharia law, this is a rapidly evolving market and one that could potentially become a market leader in adapting to new technologies. Managing Director of the International Monetary Fund, Christine Lagarde, stated at a recent conference in Kuwait that Islamic assets have crossed the $2 trillion mark and have the potential to grow even larger. About 40 million of the world’s 1.6 billion Muslims are clients of the Islamic finance industry, which has surged in popularity since its niche market days of the early 1970s. Islamic banking has become important for financial systems in more than 10 countries, accounting for over 15 percent of total financial assets there. Non-Muslim countries such as the United Kingdom and Luxembourg have begun to issue Islamic bonds as well, indicating a global future for this type of finance. The head of the Bank of London and the Middle East, Humphrey Percy, believes that most of his customers come not out of fierce piety, but “purely as a value proposition”. Officials and experts, however, acknowledged that the industry still faces tough hurdles, mainly in setting consistent regulations for all markets. Nevertheless, this industry is appealing to those seeking new markets because it has the potential to promote financial stability, since its risk-sharing feature reduces leverage and its financing is asset-backed and thus fully collateralized. Lagarde made clear that the IMF will increase its involvement in the Islamic finance industry by providing more bilateral surveillance and analytical help.

Across Islamic competitors, the initial emphasis of information technology investment to support Islamic banking will focus on core systems, particularly around product processing, accounting and reporting. Enhancing or developing core systems to support Islamic products is a prerequisite for banks to be able to launch an Islamic banking proposition, and development strategies will vary by country type. Indeed, in the Western world there is also interest in this new market strategy, albeit one that has yet to materialize; Goldman Sachs’ previous attempt to enter the market, foundered amid claims that its proposed sharia-compliant bonds, known as sukuk, did not actually comply with sharia law. Indonesia has also scaled back its issuance of one type of sukuk due to similar complaints. The vast majority of issues are found in the fact that many Western investors do not comply with Islamic banking regulations, simply because they are not trained in doing so. Such rows have led to calls for greater international standardization—hence the creation by national regulators of such entities as the Islamic Financial Services Board, which issues both religious and prudential guidance, playing the same role as the Basel Committee does for conventional banks. As this industry grows and develops, it will necessarily be more prone to increase and adapt its rules and regulations. The understanding of rules of conduct and regulation compliance by both Western financial institutions interested in Islamic banking, as well as sharia law-compliant banks, is fundamentally important for the successful global advancement of this industry.