articles Ratings /ratings/en/research/articles/220901-islamic-finance-in-the-u-k-is-still-learning-to-crawl-12488863 content esgSubNav
In This List
COMMENTS

Islamic Finance In The U.K. Is Still Learning To Crawl

COMMENTS

GCC Banks Return To Form, Can It Last?

COMMENTS

U.K. Banks Face The Weakening Macroeconomy From A Resilient Balance Sheet Position

COMMENTS

U.S. Financial Institutions CRE Asset Quality Is Resilient: Long-Term Risks Remain

COMMENTS

Nordic Banks: Robust Capital Provides Cushion Against Tougher Times


Islamic Finance In The U.K. Is Still Learning To Crawl

This report does not constitute a rating action.

Islamic finance is still a nascent segment in the U.K. This is despite the government having issued two sovereign sukuks and the listing of several sukuks on the London Stock Exchange (LSE). S&P Global Ratings believes that Islamic finance will likely remain a very minor player in the U.K. Routes emerging from the fintech space or even environmental, social, and governance (ESG) considerations could generate more attention, particularly among non-Muslim clients. However, we don't anticipate greater traction until the industry shows a real economic added-value compared with conventional banking solutions and beyond the compliance with Sharia principles.

Islamic Banking Has Found A Niche In Real Estate Financing

At end-2021, U.K.-based Islamic banks held total assets of £5.7 billion, representing less than 0.1% of the domestic assets. Globally, U.K. banks hold nearly 0.5% of total Islamic banking assets at end-December 2021, according to the Islamic Financial Services Board (IFSB). Sukuk issuances have not taken off either, with the two transactions issued by the U.K. government amounting to £750 million and one Islamic bank's residential mortgage-backed sukuk for £250 million. There are four Islamic banks in the U.K. now that one of the initial five banks converted its presence to a nonregulated branch of its parent group to focus on commercial real estate financings. There are no reports on the size of the Islamic assets of conventional banks providing Islamic financial services, but we understand that it is also marginal.

Table 1

U.K.-Based Islamic Banks And Their Shareholders
Bank Country of origin Shareholders

Abu Dhabi Islamic Bank PJSC*

United Arab Emirates Abu Dhabi Islamic Bank

Al Rayan Bank PLC

Qatar Masraf Al Rayan

Bank of London and the Middle East PLC

U.K. Boubyan Bank
Gatehouse Bank U.K. Shareholders from Kuwait among others
QIB UK Qatar Qatar Islamic Bank
*Converted to a non-regulated branch.

Most of the U.K.-based Islamic banks' business comprises lending and remains concentrated on real estate financing. The banks remain primarily deposit funded with an average loan to deposit of 97.5% at end-2021. Asset quality is still solid, with a nonperforming loans (NPLs) ratio of about 1.5%, according to the IFSB. Although this ratio has more than doubled since the start of the COVID-19 pandemic, the NPL coverage ratio of 30.3% at end-2021 suggests good backing by collateral. That said, considering these banks' material concentration on retail activities, alongside encroaching risks of recession and high inflation, we expect some pressure on Islamic banks' asset quality indicators.

High provisions and low margins are probably the main factors underpinning Islamic banks low profitability. At end-2021, the return on assets was 0.1% and return on equity reached 1.2%, despite a relatively good efficiency with a cost to income of 49.5% at the same date. It remains to be seen if the banks will benefit from an increase in interest rates. The current structure of their balance sheets, with mortgages on the asset sides and short-term deposits on the liabilities side, suggests that higher rates would likely have a negative impact, at least over the next few quarters.

A tier 1 ratio of 16.8% at end-2021 shows that Islamic banks in the U.K. are adequately capitalized. Their liquidity appears solid, with a liquidity coverage ratio at 4.4x. In December 2021, the Bank of England (BoE) opened the Alternative Liquidity Facility (ALF) to allow Islamic banks to deposit their excess liquidity with the BoE and receive a remuneration based on the performance of an underlying portfolio of high-quality sukuk. In its first iteration, the fund included sukuk issued by the Islamic Development Bank. We consider this to be a positive development for the Islamic finance industry since it offers the needed high-quality liquid assets for banks to comply with regulation.

Table 2

U.K.-Based Islamic Banks' Key Numbers
2017 2018 2019 2020 2021
Assets
Total assets (bil. £) 3.8 4.5 5.5 5.6 5.7
Total financings (bil. £) 3.0 3.8 4.8 5.1 5.3
Capital
Tier 1 capital ratio (%) 21.0 17.9 16.2 16.2 16.8
Total capital ratio (%) 22.3 19.3 17.3 17.6 18.3
Credit risk
Nonperforming financing ratio (%) 1.8 1.3 0.6 1.4 1.5
NPF coverage ratio (%) 31.9 49.0 37.7 19.8 30.3
Profitability
Return on assets (%) 0.6 0.4 0.3 0.3 0.1
Return on equity (%) 4.3 2.9 3.1 2.6 1.2
Cost to income ratio (%) 78.5 49.9 48.2 44.1 49.5
Funding and liquidity
Liquid assets/total assets (%) 14.8 11.8 7.1 5.2 6.8
Liquidity coverage catio (x) 3.9 3.2 4.0 2.5 4.4
Source: Islamic Financial Services Board, S&P Global Ratings.

Sukuks Are No Game Changer

More than a year after the repayment of the £200 million sukuk it issued in 2014, the U.K. returned to the sukuk market with a new £500 million Ijara sukuk in March 2021. However, market appetite for this sukuk was markedly lower than the for the first one; issuance of the Ijara sukuk closed with 1.25x oversubscription (order book of £625 million), while the first sukuk was oversubscribed by 10.0x. The pricing of the latest issuance was similar to that of conventional instruments, and its structure is similar to the sale/leaseback structure of the 2014 sukuk. The underlying assets of the latest issuance include several office properties owned by the government, which will then lease back the buildings for a rental amount that is expected to be equivalent to the periodic distribution amount. At the maturity of the sukuk, a purchase undertaking is expected to be executed to repay investors.

However, over the eight years since the U.K.'s debut sukuk, U.K. corporates or financial institutions have not ventured into Islamic finance, except for the one £250 million residential mortgage-backed sukuk. Despite significant exposure to real estate financings, we have not seen other banks tapping the market. This leads us to believe that private sector issuers in the U.K. see little added value for sukuks in their funding profile. We understand that some issuers have been deterred by the Islamic finance's complexity compared with conventional bonds. What's more, the adoption of some of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards seems to increase the perceived difficulties.

Where London continues to make a difference is in the listing of sukuk. The LSE continues to be one of the main destinations for listing sukuk, although competition from Luxembourg and Dubai has risen over the past few years. At the end of July 2022, 15 sukuks were listed on the LSE with a total nominal amount of about $13 billion. According to the LSE, a cumulative total of 68 sukuks (including matured transactions) have been listed over the past two decades, exceeding a nominal amount of $50 billion.

Fintech And ESG Alignment Could Spark Attention

We see a couple of avenues for the Islamic finance industry's growth in the U.K.: fintech and ESG. We have observed a few Islamic fintech entities, one of which is affiliated with a U.K.-based Islamic bank, with activity ranging from neo-banking to money management or crowdfunding. We believe that the presence of young, tech-savvy Muslim customers could yield some growth opportunities. On the other hand, ESG alignment may also attract interest from non-Muslims or other atypical clients. The use of sustainability sukuk or a stronger focus on the social responsibility of the industry could up Islamic finance's prominence for investors and other interested parties that are not participating purely for the Sharia-compliant nature of the transactions.

Primary Credit Analyst:Mohamed Damak, Dubai + 97143727153;
mohamed.damak@spglobal.com
Secondary Contact:Dhruv Roy, Dubai + 971(0)56 413 3480;
dhruv.roy@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.


Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back