Islamic finance has vital role to play in virus recovery

At its core, Islamic finance, which is enshrined in the basic tenets of sharia (Islamic law), has the principles of sustainability, fairness and equality. These intrinsic attributes mean Islamic financing is well-placed for funding global development projects – including the protection of the environment, the prohibition of economic and social injustice, accountability at every level of organisations, and the promotion of sustainability for future generations.

Social cohesion, co-operation and solidarity – the qualities that are grounded in the spirit of Islam – mean that the innovative vehicles of Islamic financing can contribute significantly towards global social development.

Unique moment

The need for governments, financial institutions and the private sector to focus on social development has never been of greater importance. September 2020 marks a unique moment for the world: five years since the UN’s Sustainable Development Goals (SDGs) were agreed by 193 countries, and 10 years until the 2030 deadline. But it is important to remember that a $2.5tn annual financing gap stands in the way of the SDGs, which has been further exacerbated by the coronavirus pandemic. The global community must take this moment – with this impending deadline – to reassess the right financing tools that can help us achieve these goals.

The Islamic Development Bank’s (IsDB’s) new business model, which I launched after becoming president of the bank in 2016, calls for leveraging innovative Islamic financing to enhance the capacity of our member countries in the pursuit of the SDGs. I have put the SDGs at the core of the bank’s operations, in line with the principles of global green bonds, principles of social development bonds, and principles of sustainability bonds prepared by the International Capital Market Association.

This model is vitally important, and the foundation upon which our issuances of sustainability bonds, green bonds and social development bonds rely, along with other instruments to mobilise funds for specific projects that support the SDGs.

Islamic finance has a rich set of social financing methods which cater to different segments of society. Arguably, the most visible Islamic financial instrument in the world is sukuk, which is growing in international recognition. Outside the traditional Islamic financial markets of Gulf Co-operation Council and south-east Asia, there has been a growing interest from bond issuers – both sovereign and corporate – to establish a sukuk framework and add sukuk to their array of products for investors who would like to deploy their liquidity in a sharia-compliant manner.

The IsDB is proud to be a pioneer of the sukuk market, issuing the first-ever AAA-rated ‘green sukuk’ at our Sukuk Summit in Luxembourg in November 2019. The proceeds of the issuance, worth €1bn, are exclusively allocated to projects for renewable energy, clean transportation, energy efficiency, pollution prevention and control, environmentally sustainable management of natural living resources and land use, and sustainable water and sanitation projects across our 57 member countries.

Waqf’s potential

However, sukuk is not alone as an innovative financial tool. A further underused area where Islamic finance could play a greater role in social development is waqf, which is, in essence, a ‘charitable endowment’ and similar to the concept of a trust. Waqf has a long history in Muslim civilisation with several success stories in countries such as Turkey and Malaysia, where it played an important role in economic development and alleviating poverty.

An asset is endowed into a trust, irrevocably and perpetually, and the returns generated are used to finance social projects such as health, education and poverty alleviation, thereby strengthening domestic resource mobilisation and ultimately improving the socio-economic status of communities. The significance of the perpetual nature of waqf is that it helps to create wealth for societal needs not just in the short term, but for generations to come. Crowdfunding for waqf projects is also a complementary structure that has great potential for channelling investments into social, as well as environmental and climate-friendly, finance.

Economic empowerment is a key focus when it comes to addressing the most vulnerable communities, in terms of social development. Islamic finance structures such as ijarah (lease financing), istisna’a (construction financing) or mudharabah (enterprise financing for small and medium-sized enterprises) can be used to help equip and empower communities and ultimately strengthen their resilience. The approach can be customised to leverage high-potential value chains, boost technical capacity, identify climate risks and devise mitigation measures, build partnerships and improve access to markets for as many beneficiaries as possible.

Of course, the Covid-19 pandemic has presented a global crisis that is forcing us to confront new challenges in a rapidly developing environment. It has led to unprecedented impacts on all our member countries, not just economically, but on a social, health and infrastructure level too.

In June 2020, the IsDB launched the first sustainability bonds to raise $1.5bn, from a wide range of investors, to finance social projects in affected countries. These were the first sukuk of their kind related to the pandemic in the global capital market. The proceeds of these ‘sustainability sukuk’ will be used in social projects that improve healthcare facilities, equipment and critical staffing in member countries to mitigate the effects of Covid-19, as well as support smaller businesses and promote employment as countries recover from the effects of the disease. We believe that focusing on healthcare (SDG3) and job creation (SDG8) should be key focus areas for countries in the aftermath of the pandemic.

The investor diversification we achieved for the sustainability sukuk shows that the IsDB sustainable finance story is gaining traction in new markets and we hope to maintain this momentum for future issuances. We’ve already seen global financial centres, such as the UK and Luxembourg, issue their own sukuk and undertaken significant regulatory measures in order to become an Islamic finance hub. These are promising steps towards demonstrating the opportunities for Islamic financing tools to play a key role in social and sustainable development.

Raising awareness

Despite the many benefits of Islamic finance in social development, there is still work to be done in raising awareness among the global investors of programmes such as the sustainability sukuk. Like other multilateral development banks, the IsDB continues to engage and educate investors in various parts of the world, targeting central banks and investment agencies interested in investing in AAA instruments.

The IsDB’s first issuance of sukuk was 17 years ago in 2003, with a standalone issuance in which $400m was raised. Since 2009, we’ve sought to expand our investor base through entering new markets, targeting new currencies and creating tools that keep pace with development in the capital markets, especially those related to SDGs.

Investors are increasingly focusing on environmental, social and governance considerations for their decisions, and financial institutions are hard-pressed to serve this segment, which they ignore at their peril.

In this global context of working towards the deadline of the SDGs and recovery from the pandemic, I firmly believe that Islamic finance will prove the notion that ethical investments and attractive financial returns are not mutually exclusive.

Dr Bandar Hajjar is the president of the Islamic Development Bank.