growth, however, accelerated decades later in the
early 1990s, bolstered in large part by liquidity in
the Gulf from one crucial source: oil.
Some analysts estimate that the rise of the oil
industry helped to propel Islamic finance’s growth
rate to about 10 percent a year, while others say
the rate reached as high as 20 percent during the
past five years.
The influx of capital generated by rising oil prices
has spurred massive investment in infrastructure and real estate development projects in the
Gulf Cooperation Council (GCC) states of Bahrain,
Kuwait, Oman, Qatar, Saudi Arabia and the United
Arab Emirates, driving demand for sukuks (Islamic
bonds) and loans. The liquidity has also led to
significant wealth accumulation among individuals,
prompting the need for Islamic asset management
services. GCC leaders have announced plans to
boost domestic investment in the hopes of diversifying the area’s economies beyond oil, generating
jobs and building new cities.
Already, their vision is impacting investors. An estimated 25 percent of the portfolios of GCC states’
wealthy private investors is held in local financial
products—an increase from 15 percent in 2002.
By the end of 2009, the number of Islamic mutual
funds could rise to 925, representing an annualized
growth rate of 28 percent since 2000. The GCC’s
foreign investment choices will ultimately influence interest rates, liquidity and financial markets
Malaysia: A Pioneer
Oil has not been the only catalyst for growth in
Islamic finance. The industry found a powerful
ally across the Pacific in Muslim Asia, led by the
pioneering country of Malaysia. The country has
made significant strides in liberalizing its market
to promote greater financial integration with the
global Islamic financial system, and to increase
foreign entry and participation. As an example,
Malaysia has issued new licenses to foreign fund
managers and stock brokers, and has increased the
issuance of licenses in Islamic banks and takaful
(Islamic insurance) companies.
After three decades of nurturing the Islamic finance
industry, Malaysia has succeeded in developing a
system that operates in parallel with conventional
finance. Islamic banking assets now comprise
16 percent of the Malaysian market, while the
takaful sector oversees 7 percent. The country also
accounts for about two-thirds of global Islamic
bonds outstanding, representing the largest
sukuk market in terms of amount outstanding and
number of issues.
Since the 1990s, Islamic banks in the Gulf and
Muslim Asia have made significant inroads in
attracting retail customers. In those regions today,
an estimated 20 percent of banking customers
would likely choose an Islamic financial product
over a conventional one with a similar risk-return
Islamic financial institutions are now expanding
to non-Muslim countries by focusing first on the
retail segment. Among countries in Europe, the
UK has expressed a leading interest in expanding
its Islamic financial base. Standard & Poor’s (S&P)
estimates that as many as 300,000 retail customers
in that country may be interested in Shariah-compliant banking services.
In August 2004, the UK’s Financial Services
Authority (FSA) approved a banking license for
the Islamic Bank of Britain, the country’s first
Islamic bank to serve the consumer market with
Shariah-compliant products. The licensing of the
European Islamic Investment Bank, the UK’s first
independent bank for Shariah-compliant investments, followed in March 2006. Licensing a takaful
company or allowing conventional issuers to offer
takaful products may be next in the UK’s strategy
to enhance its position in the industry.
London recently became the only non-Muslim
competitor to join the major financial hubs to
handle Islamic transactions, which had previously
been dominated by Dubai, Kuala Lumpur and
Bahrain. London offers some distinct competitive
advantages: its large size and reach, the liquidity in
its secondary market, considerable human resource
capacity and expertise, as well as its already deep
and efficient markets where investors can switch
from one asset class to another, including sukuk.
London also benefits from a strong legal environment. Notable among initiatives related to
Islamic finance was a sukuk-friendly amendment
to the country’s tax law announced in 2007. The
tax regime applied to sukuk coupons makes them
deductible, which means that they are now equivalent to interest and no longer viewed as rental
The UK may consider issuing sukuk notes, which
would make it the third sovereign outside of the
Middle East to issue Shariah-compliant paper after
Malaysia in 2002 and Germany’s state of Saxony-Anhalt, which issued a five-year sukuk in 2004.
The largest sukuks to date were those issued by
Nakheel Group of Dubai for $3.52 billion in the
first quarter of 2007, which were listed in both
Dubai and London.
Also among non-Muslim countries experiencing
growth in Islamic finance is the US, where an
estimated 5 to 7 million Muslim residents are
calling for more Islamic financial opportunities—
particularly in the wake of the subprime lending
crisis. Shariah-compliant financing in the US mainly
exists for personal home mortgages. Shariah-compliant mutual funds are also offered, as are
Shariah-compliant transactions in private equity
and real estate.
The Drive for New
While the selection of products at large Islamic
financial institutions remains relatively narrow,
Shariah-compliant instruments are beginning to
rival those of conventional banks.
These instruments include profit-sharing investment accounts (PSIAs), which give depositors the
right to share in Islamic banks’ profits and losses, as
well as several money market, equity, real estate,
private equity and infrastructure funds.
As capital markets and legal frameworks develop,
a structured finance market may be established in
the Middle East. Originators are examining how it
may be possible to securitize assets as confidence
in this form of financing increases. Legal issues,
high liquidity and a lack of benchmarks pose challenges. Still, legal developments, including new
mortgage legislation being introduced in Saudi
Arabia and the introduction of foreign ownership
laws in Dubai and Saudi Arabia, indicate a willingness to try to facilitate some securitization.
Also, the need to diversify the region’s investor
base and reduce dependence on the performance
of oil markets may be a significant incentive for
securitization, which shares an important feature
with Shariah compliance: asset-driven returns.
Financial derivatives and hedging instruments may
prove more difficult to develop, mainly because
of Shariah’s prohibition of interest and activities
that have a high risk of uncertainty. The industry,
however, is moving forward to try to find new
avenues. The Islamic Development Bank’s Shariah
Committee approved a Shariah-compliant concept
for hedging against risks associated with currency
and profit rates structures. The committee also
approved a contract to consummate hedging operations with one of the counterparties.
It is reviewing other proposals for hedging mechanisms that include the use of diminishing partnerships as a mode of financing in the construction and
development of highways, Shariah rules related to
liquidity management and rules governing third-party guarantees.