Islamic Finance | Bank Negara’s decision to halt issuing shariah-compliant bonds has left a big hole in the Islamic debt market. Filling the void will take time.

Author: Darren Stubing

Statistics don’t always tell the whole story when defining trends, particularly trends in finance. But when it comes to the rapid, almost meteoric rise of global Islamic finance, the numbers pretty much tell the tale. As of 2010, Islamic finance assets stood at $1 trillion. Five years later, that number has shot up to $2.1 trillion. Media firm Thompson Reuters expects global Islamic finance assets to hit $3 trillion within five years.

Chilwan, Dubai Islamic Bank: Diversification, innovation and operational improvement are helping drive up profits.

Profits keep skyrocketing, too. The combined global earnings of Islamic banks now top $10 billion—and are projected by Thompson Reuters to increase by double digits to 2020. 

This is assuming, of course, there are no bumps in the road. The sukuk market hit a major pothole this year when officials at Malaysia’s Bank Negara—one of the largest issuers of sukuk worldwide—announced they were halting issuance of the Islamic bonds. At the time, officials at the central bank noted that the securities—typically, long-term bonds that adhere to the shariah code of conduct, including Islam’s prohibition on the payment of interest—didn’t meet its need for short-term funding.

Granted, bank holdings make up the bulk of Islamic assets, comprising three-quarters of the $2.1 trillion total. But observers have long been touting the sukuk market as the next big thing in Islamic finance, particularly given the capital needed for infrastructure projects in Africa, Asia and the Middle East.

To be sure, the volume of sukuk issuance has been rising dramatically. In 2009, Islamic bond offerings reached $23 billion. In 2013, the total was closer to $120 billion. But with oil prices roiling economies in nations with large Muslim populations, that amount fell to $116 billion last year. The pull back of Bank Negara is a much bigger blow. Ratings firm Standard & Poor’s estimates that global sukuk issuance will be cut in half this year.


Other issuers are expected to pick up the slack eventually. Two multilateral financial institutions, the Islamic Development Bank (IDB) and International Islamic Liquidity Management Corporation, top that list. The IDB recently increased the ceiling of its sukuk program to $25 billion from $10 billion in a bid to expand cross-border financing. Meanwhile, companies including Saudi Arabia-based Arab Petroleum Investments Corp., Barwa Bank and Malaysian mortgage lender Cagamas are looking at large issues to diversify their sources of capital.

Likewise, a number of sovereigns have announced plans to issue sukuk, although the exact timing remains unclear. Indonesia intends to offer about $1.4 billion worth of Islamic bonds to help fund infrastructure projects. Jordan, Egypt, Tunisia, the Ivory Coast, Kazakhstan and Pakistan’s Sindh province are all eyeing debut shariah-compliant bond issues.

Al Mahmoud, Abu Dhabi Islamic Bank: Enhancing customers’ banking experience is a top priority.

So, too, is Oman. “The sovereign sukuk is primarily aimed at addressing the need of the nascent but fast-growing Islamic financial sector in Oman,” says Tahir Salim Al Amry, the director general of budget & contracts at the country’s ministry of Finance. “The sukuk will serve as a domestic investment and liquidity management instrument to Islamic financial institutions in the country.” Governments in the Western hemisphere are wading into the sukuk market as well. Over the past eighteen months, the UK and Luxembourg, among others, launched shariah-based bond offerings for the first time. Perhaps more important, Islamic financial institutions have entered new markets. Kuwait Finance House, for one, has expanded well beyond its domestic market, including into the fast-growing Turkish market. The chairman of KFH and chairman of Kuwait Finance House-Turkey, Hamad Abdulmohsen Al-Marzouq, notes that KFH-Turkey aims to offer services through the participation banking model both in Turkey and abroad. Towards that, the bank recently opened KT Bank AG, the first Islamic bank in Germany. The bank already has branches in Frankfurt, Berlin and Mannheim.


This geographical spread in Islamic offerings and assets is a new development—one that could turn Islamic finance into a real force on the world financial stage. Indeed, the current concentration of Islamic financial assets—three quarters are held in the six member countries of the Gulf Cooperation Council and the nations in the Middle East and North Africa region—has held back the industry.

Other problems exist as well. Few liquidity management instruments exist. Neither do appropriate safety nets, such as shariah-compliant deposit insurance schemes and lender of last resort facilities.

Moreover, many Islamic banks do not have access to Islamic-based, tradable short-term treasury instruments to channel excess funds to other Islamic financial institutions. The gap restricts growth and forces banks to hold excessive reserves. Another issue: Islamic religious leaders need to agree on what makes a sharia-compliant financial instrument actually sharia compliant.

Consultancy EY says many Islamic banks also need to improve their trade finance operations. Certainly, the rebalancing of the global trade flows in favour of fast growing Muslim markets has put payment solutions at the core of Islamic finance. But these flows are concentrated in specific channels, and trade services are costly due to Basel III and KYC requirements. EY contends that Islamic banks must learn where to operate, and where to deploy trade platforms that simplify supply-chain process and reduce costs. At the present, trade finance and cross-border payment business generate only a small part of Islamic banks’ revenue.

Ashruff Jamall, partner, financial services and global Islamic finance leader at PricewaterhouseCoopers, believes that Islamic banks may also be missing a big opportunity within the Muslim population due to a perception problem. That perception? Some potential customers suspect that Islamic banks do not always adhere strictly to the shariah code—and thus, could lead them to inadvertently violate their religious beliefs. Services are not always up to par, either. Some Islamic banks have rated lower than conventional banks in terms of service provision such as ATMs, branch networks and Internet banking products.

To be more competitive, a number of Islamic banks are focusing on improving their products and services. Dr. Adnan Chilwan, group chief executive at Dubai Islamic Bank, which saw a 35% rise in profits in the first half of 2015, says that the bank’s growth strategy is being driven by diversification, innovation and operational improvement.

At Abu Dhabi Islamic Bank, CEO Tirad Al Mahmoud says management remains focused on its strategy of delivering value to shareholders and enhancing the banking experience for its customers. ADIB is embracing digital technology and will soon be remaking its branches and rolling out more mobile banking offerings.


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