Several emerging markets with large Muslim populations combine low bank penetration and a high return on assets with a relatively small market share for Islamic banking, and thus provide further opportunities for growth in the Islamic finance sector.

In a speech in the US at the end of September 2011, Islamic Development Bank president Ahmad Mohamed Ali restated the theme he has emphasised ever since the financial crisis took hold in 2008. “The principles of Islamic finance are capable of minimising the severity and frequency of financial crises by introducing greater discipline into the global financial system and requiring the financier to bear or share in the risk,” he told his audience.

A glance at the headline figures for Islamic finance suggests this assessment is accurate. Islamic assets grew almost 21.5% in The Banker's 2011 survey, surpassing $1000bn for the first time. By contrast, assets in The Banker’s Top 1000 World Banks survey in July 2011 had risen just 6.4% year on year – and that after a decline of almost 1% the year before.

But while sharia-compliant banking may in theory embrace a more sustainable model that resists the build-up of debt in the financial system, it is still subject to the same limitations as conventional finance. The size and wealth of the economies and populations where it operates, and the penetration of banking services in those markets, are likely to determine the headroom for further growth.

The Banker has taken a look at some of the major markets for Islamic finance, together with some of the countries with the largest Muslim populations, to identify where the opportunities might lie. This compares data from the Top 500 Islamic Financial Institutions survey against the comprehensive banking data available in thebankerdatabase.com, specifically for banks where data for financial years ending in 2010 or 2011 is available. The general banking data includes both locally owned and foreign-owned subsidiary banks, to provide as full a picture as possible of the banking sector in each country.

islamic finance penetration, 2010

Bahrain overbanked

The status of Bahrain as a major international financial centre for both Islamic and conventional banking is very clear from its stand-out position in terms of bank penetration. Banking assets are more than 520% of gross domestic product (GDP), and even sharia-compliant assets are almost 260% of GDP.

This is a mature market, where prospects are likely to reflect broader trends in the global financial sector – banking assets overall grew by just 2.2% in 2010. However, Islamic asset growth far outstripped that, at just under 29%. The question is whether rapid growth rates in such a competitive market are sustainable.

The profitability of Islamic financial institutions in Bahrain would suggest the answer is no. In 2010, aggregate return on assets (ROA) for fully sharia-compliant banks in the country was negative, whereas that for the banking sector as a whole just crept into positive territory, at 0.29%.

Two other major centres for Islamic finance, Malaysia and the United Arab Emirates, also have very mature banking sectors where assets surpass 100% of GDP. However, sharia-compliant assets in both countries remain less than 30% of the total. This suggests that there might still be room to gain market share, even if the overall market size is unlikely to expand rapidly.

Islamic_opp_2

Bangladeshi potential

At the other end of the scale, Bangladesh, with a population of more than 160 million, is deeply underbanked, with total banking assets of less than 20% of GDP based on the latest available bank results. Interestingly, the country has the highest proportion of Islamic assets in this group, at 66% of total assets. Only countries where sharia compliance is obligatory for the banking sector, such as Iran, tend to have higher ratios than this. Part of the reason is poor data disclosure, which means the conventional banking sector in Bangladesh may be under-represented in our sample.

Even so, the country’s second largest bank, Islami Bank Bangladesh, is fully sharia-compliant, and accounts for almost 20% of the country’s banking assets on its own. While the high ratio of Islamic banking means the potential to capture market share from conventional banks in Bangladesh is limited, the low overall penetration of financial services suggests there is plenty of room for all banks in the country to grow if economic conditions are stable.

There should be promise also for Islamic banks in countries where they retain only a low share of overall assets. In several Muslim-majority countries with large populations, including Indonesia, Turkey, Egypt and Pakistan, Islamic financial assets account for less than 10% of total banking assets.

Of these, Indonesia, Pakistan and Egypt could be particularly interesting, as all three have relatively small financial sectors overall. The Turkish banking sector is more mature, but certainly not less profitable – ROA for the sector as a whole was among the highest worldwide in 2010. 

Islamic underperformers

Even in countries where Islamic finance has a small market share, however, expansion is not necessarily straightforward. Islamic bank CEOs generally report that while customers might have a moral preference for sharia-compliant products, they will still compare returns against conventional bank products.

That means Islamic banks must offer products with good rates of return, potentially absorbing the extra costs of sharia-compliant structuring and monitoring, rather than passing them through to customers. Moreover, sharia-compliant institutions have a smaller universe of assets in which to invest. This reduces diversification, although in theory the extra concentration risk should be offset by the lower debt levels inherent in investments that are permissible under Islamic law.

Overall, the challenges faced by Islamic banks are clear from the ROA in the countries examined here. Unfortunately, segregated financial reporting for Islamic windows is relatively limited.

Islamic_opp_3

Calculation limitations

Even global banks that emphasise high standards of disclosure in their conventional banking operations, such as HSBC and Standard Chartered, do not provide up-to-date figures for their Islamic brands – Amanah and Saadiq, respectively – except in jurisdictions such as Malaysia, where regulators require separate accounts. The Banker will continue to urge more transparent reporting by Islamic windows, which is fairer for customers, and more in keeping with the industry’s stated principles of discipline and integrity.

Until more Islamic windows supply separate profitability data, any calculations for return on assets must be based on fully sharia-compliant institutions. Using the figures for exclusively Islamic financial institutions in this way, it appears that the sector tends to underperform relative to conventional banking in terms of profits.

Of the countries considered here, only Islamic financial institutions in Saudi Arabia and Bangladesh achieved a higher ROA than the banking sector as a whole. And only Bangladeshi Islamic banks achieve a higher ROA than the top-performing conventional banking markets, Turkey and Indonesia. In Pakistan, where ROA for the whole banking sector is high at almost 2%, Islamic banks are only just breaking even.

In fact, two of the countries with the worst Islamic ROA, Pakistan and Bahrain, also had some of the highest growth rates for Islamic assets in the past year, pushing 30%. This suggests Islamic banks in these countries may be eating into margins in a bid to expand aggressively. By contrast, Saudi Arabia’s excellent ROA of 2.64% for sharia-compliant institutions corresponds to a relatively low Islamic asset growth rate of 9.2%. However, this rate still means that the Islamic financial sector in Saudi Arabia is gaining market share, as the banking sector in general only grew by about 3.7%.

The remarkably high growth rate in Indonesia – Islamic assets are up almost 46% in this year’s survey – partly reflects the dynamism of the Indonesian banking sector as a whole, where assets grew by 26.8% in 2010. But a further factor could be the regulatory encouragement for banks to spin off Islamic windows into independent sharia-compliant subsidiaries. Some Islamic assets may be transferred to the subsidiary, and the creation of a separate Islamic bank would require economies of scale to be profitable, driving asset growth.

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