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Islamic Finance 2023-2024: Growth Beyond Core Markets Remains Elusive

This report does not constitute a rating action.

The global Islamic finance industry continues its growth path. S&P Global Ratings expects around 10% growth across the industry in 2023-2024 after expanding by a similar number in 2022 (excluding Iran). The Gulf Cooperation Council (GCC) countries--notably Saudi Arabia and Kuwait--largely fueled this performance, supported by a large, one-off acquisition in the latter. Elsewhere, growth was either muted or held back by local currency depreciation. At the same time, sukuk issuance continued to spur the industry's expansion despite slowing issuance volumes overall. While we generally expect volumes to diminish in 2023, we still believe that new issuance will exceed maturing sukuk, resulting in another positive contribution of the sukuk market to industry growth in 2023. The Islamic funds and takaful sectors are also likely to continue to expand. We continue to exclude Iran from our calculations due to the lack of disclosure by Iranian banks.

Structural weaknesses still curb the industry's broader geographical and market appeal, though. As we've stated in previous reports, we believe that progress toward greater standardization--in part supported by the digitalization of sukuk issuance for example--could enhance the industry's structural growth potential. At the same time, the increasing focus on sustainability-related themes by core Islamic finance players will create new opportunities for the industry. We expect the contribution of sustainability-linked sukuk to continue increasing in the next 12-24 months, albeit from a low base.

Strong Growth Will Persist

The Islamic finance industry continued to expand in 2022, with assets up by 9.4% compared with 12.2% in 2021, supported by growth in banking assets and the sukuk industry (see chart 1).

Chart 1


Banking assets propel performance

GCC countries, mainly Saudi Arabia and Kuwait, spurred 92% of growth in Islamic banking assets. In Kuwait, this was mainly due to Kuwait Finance House (KFH's) acquisition of Ahli United Bank (AUB). Over the next couple of years, we expect the latter to convert its conventional activities to Sharia compliance in line with its acquisition plans. In Saudi Arabia, the implementation of Vision 2030 and continued growth in mortgage lending supported the 2022 performance. We expect a material slowdown in GCC economies' real GDP growth in 2023-2024, compared with 2022, largely based on lower oil production (see chart 2). However, we think that Saudi Arabia's banking system performance will continue to underpin a large portion of the expanding Islamic finance industry. In other GCC countries, growth of about 5% appears plausible in the absence of new major government investment cycles.

Chart 2


In South-East Asia, we expect the Islamic banking industry to grow at around 8% over the next couple of years, despite an economic slowdown in the major markets of Malaysia and Indonesia. Robust demand for Islamic products and services and low penetration, particularly in Indonesia, support this trend. In both markets, we expect Islamic banking to continue to gain market share as growth outpaces conventional banking. Meanwhile, in Turkiye, the depreciation of the lira has been a constraint. Pressure on the Egyptian pound is also unhelpful for the industry, although the contribution of Egypt and Turkiye to the industry's banking assets generally remains modest.

Declining sukuk issuance, but increasing stock

We believe that sukuk issuance volumes will continue to fall in 2023, albeit at a slower pace than in 2022. We expect lower and more expensive global liquidity, greater complexity related to structuring sukuk, and reduced financing needs for issuers (due to fiscal surpluses from higher oil prices) in some core Islamic finance countries to deter the market. Corporates are likely to contribute to issuance volumes, particularly in countries where governments have announced transformation plans. This is the case in Saudi Arabia, where the banking system will be limited in its capacity to finance multiple projects related to Vision 2030 implementation. Issuers with high financing needs, such as those in Egypt and Turkiye, are also likely to tap the sukuk market as part of their strategy to mobilize all available resources. For example, Egypt has established a $5 billion sukuk program and issued its first sukuk in early 2023 for a total of $1.5 billion. We understand that this attracted significant investor interest, with more than $6 billion demand and a 59% allocation to investors from the Middle East and North Africa. The profit rate of the three-year sukuk was set at 10.875%, which at the time was broadly in line with the yield on Egypt's conventional bond with a similar maturity date of 2026. Overall, we think that the volume of new issuances will continue to exceed maturing sukuk.

We note a significant decline in foreign currency-denominated sukuk issuance over the past 12 months, though, mainly on lower and more expensive global liquidity (see chart 3). In addition, the market continued to suffer from uncertainty around regulation and standardization. For example, challenges related to the adoption of AAOIFI Standard 59 in the United Arab Emirates resulted in a significant decline in foreign currency-denominated sukuk--from around $10 billion per year in 2018-2020 to around $4 billion per year in 2021-2022. Introducing mechanisms for the revaluation of underlying assets could be one of the next obstacles that the market may face. We will continue to consider any future developments relating to regulation and standardization and how they may affect future issuance volumes. If sukuk became an equity-like instrument, we believe that investor and issuer appetite, as well as and pricing mechanisms, would likely change significantly. Sustainability and digitalization could help the sukuk market to shore up future contributions to the Islamic finance industry.

Chart 3


Takaful and fund industries still play their role

Despite their small contribution to the industry, we expect the takaful and fund sectors to continue to grow. We expect takaful to expand at an annual rate of around 10%, supported by continued nominal GDP growth, the expansion of infrastructure investment and medical insurance covers, and some inflation-related tariff adjustments. Fund growth will hinge on the performance of the capital markets, given its structure--around one-quarter equity funds and another 60% money market or sukuk funds.

Overall, we believe a growth rate of about 10% is achievable for the industry over the next two years. We continue to exclude Iran from our calculations due to the lack of disclosure and volatility of the country's exchange rate.

The Industry Remains Highly Concentrated

We see the Islamic finance industry as a collection of local industries rather than a truly globalized sector. In 2022, Saudi Arabia and Kuwait drove most of the growth in banking assets (see chart 4). Similarly, Malaysia and GCC countries accounted for a large portion of the sukuk market during the same period. Interest in tapping the sukuk market from players beyond the industry's original boundaries seems to be limited to countries in need to open all available financing options. The industry is therefore looking at ways to enhance its competitiveness and appeal to distinguish itself from the conventional fixed-income market. Streamlining products and processes to make them more appealing to new issuers is one of these methods. We believe that measures taken by stakeholders--particularly standard setters--and increased digitalization could also help. On the other hand, we note the potentially conflicting views of Sharia scholars, who favor more equity-like characteristics for sukuk, and investors that prefer more debt-like features. We see this as a factor that could disrupt the market.

Chart 4


We believe that digitalization could help alleviate this issue as it would require a set of standard legal documentation that would be used for digital sukuk issuance. However, having adequate physical and nonphysical infrastructure in place, along with the necessary supervision and regulatory framework, would be prerequisites for success in this area. In addition, a regulatory environment for digital sukuk and a monetary bridge between the physical and digital ecosystems could enhance market access.

Sustainability-Linked Themes Could Support Future Growth

Despite the natural alignment of Islamic and sustainable finance, sustainability-linked sukuk issuance remains limited (see chart 5). We believe that this will change, and we expect to see higher volumes of sustainability-linked sukuk as issuers try to meet investor demand and core Islamic finance countries seek to reduce their carbon footprint and support the global energy transition.

Chart 5


Many Islamic finance countries are pursuing strategies to help them transition to greener economies. We believe this indicates growth potential for green sukuk issuance and expect to see greater activity in this space as issuers tap global investor interest. Although less visible, we believe that the social aspect behind Islamic finance holds appeal as the economic impact of various political and geopolitical shocks continues to thwart populations in certain countries.

Banks are also likely to unlock growth opportunities related to their sustainability agenda. Over the past three years, many banks in core Islamic finance countries have publicly commented on their sustainability plans. While some have been more ambitious than others, this shows their public commitment to certain levels of sustainability-related financing or a certain percentage of their overall financing. We therefore expect green products and services for corporate and retail customers will contribute to the growth of Islamic banking assets.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Mohamed Damak, Dubai + 97143727153;
Secondary Contacts:Dhruv Roy, Dubai + 971(0)56 413 3480;
Samira Mensah, Johannesburg + 27 11 214 4869;
Nikita Anand, Singapore + 65 6216 1050;

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