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Middle EastSeptember 3 2018

Mohammad Y Al-Hashel: Unlocking Islamic finance’s true potential

Modern Islamic finance is a niche. However, its core principles of benefiting the wider community should have global appeal, says central bank governor of Kuwait Mohammad Y Al-Hashel.
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Mohammed Y Al-Hashel

Financial intermediation has a critical role to play in supporting communities so that they can achieve their ultimate objective. As Thomas Jefferson put it: “The care of human life and happiness… is the first and only object of good government.” And banking, being the dominant segment of financial intermediation, is the greatest contributor towards achieving this objective. 

The conventional banking industry is already playing a major role in this regard. It is a mature and long-established industry, with adequate depth and sophistication. It has the ability to effectively contribute to the global economy, given that it employs proper corporate governance and ethics.

A universal value proposition

On the other hand, modern Islamic finance, including Islamic banking, is at an early stage of its development. Yet the Islamic finance industry provides a universal value proposition for all. Its core values include profit and loss sharing, transactions linked to real assets, a focus on responsible and ethical investments, and prohibitions on speculative transactions, synthetic instruments and industries that do not benefit the community. 

These core principles have universal appeal among governments, corporates and consumers, among developed and emerging markets, and for Muslims and non-Muslims alike. Through these core principles, the industry has the potential to support inclusive growth across the value chain, increasing productivity and providing economic and social benefits to the entire society.

Here in Kuwait, we have experienced these benefits first hand. Kuwait has always been a pioneer when it comes to Islamic finance. Looking back, it is impossible to appreciate the birth of the Islamic finance industry without recognising the tremendous contributions of their late Highnesses, the amirs Sheikh Sabah Al-Salim Al-Sabah and Sheikh Jaber Al-Ahmad Al-Sabah, for providing a legal environment for Islamic finance in Kuwait. 

It was their late Highnesses who supported the late Sheikh Ahmed Al-Yasin to realise his vision of establishing an Islamic bank in the mid-1970s, when there was virtually no Islamic finance model to emulate or learn from.

Despite this challenge, Sheikh Al-Yasin persisted, with the support of other like-minded individuals, to establish Kuwait Finance House (KFH) – not only the first Islamic bank in Kuwait, but also one of the first to be established anywhere in the world. He described the challenge of establishing an Islamic bank as being “like swimming against the tide”. The seeds he sowed for the industry have blossomed, and the Islamic finance industry in Kuwait, which started with a single branch and four employees in 1978, has grown today to comprise up to 40% of the country’s banking sector, with five Islamic banks, Kd29bn ($96bn) in assets, 600 branches and more than 12,000 employees.

Leveraging the examples of Kuwait and other pioneering markets, the global Islamic finance industry has grown exponentially over the past four decades. According to most estimates, the industry now accounts for $2200bn in assets. Today there are more than 10 countries operating a dual-banking model, where Islamic banks hold more than 20% of banking sector assets, reflecting their systemic importance. In addition, 44 countries to date have introduced some form of legislation or regulations to support the development of their domestic Islamic finance industries.

Addressing today's challenges

Although the growth of Islamic finance has been impressive over the past four decades, its penetration is still only about 2% of the global finance industry. While more than 80 countries are implementing some form of Islamic finance, the industry remains small outside of a handful of core markets in the Middle East, north Africa, and south and south-east Asia. Still, the Islamic finance industry, with its universal value proposition of inclusiveness, can help address many of today’s economic, social and financial challenges, subject to necessary conditions such as the implementation of relevant Islamic finance standards, corporate governance, ethics and proper risk management.

First, for economic diversification, Islamic financial instruments can play an important role. One Islamic financial instrument used extensively for this purpose is sukuk. In the past four years alone, sukuk have been used by more than 20 sovereign governments from around the world, Muslim and non-Muslim alike, to raise more than $100bn of funding for various projects and initiatives across Africa, Asia, Europe and the Middle East. 

Sukuk not only help institutions raise funding and deepen capital markets but also help governments build infrastructure and provide support in achieving the UN Sustainable Development Goals.

Second, we have the impact of Islamic banking on the overall financial stability of a country. Islamic finance can have a positive impact on financial stability through the implementation of its core values, such as profit and loss sharing, connectivity of financial transactions with real assets, and the prohibition of speculative transactions, synthetic financial tools and investments in harmful industries. Numerous studies from the World Bank and the International Monetary Fund (IMF) have highlighted that Islamic finance offers an inclusive and stable operating model, provided it remains true to its core values and is built on a solid foundation.

Last, social development is another area where the core principles of Islamic finance can be leveraged. For instance, governments can use Islamic finance for financial inclusion. Many countries introduced Islamic finance during the 1980s and 1990s with the primary motivation of promoting financial inclusion for people who would otherwise have been excluded from the financial system

In recent years, international institutions such as the World Bank and the IMF have increasingly identified Islamic finance as a critical industry to address the issue of financial exclusion across the world. A recent study from Ernst & Young on banking in emerging markets shows that sharia-compliant products – through leveraging the support of appropriate technology infrastructure – could bring up to 150 million unbanked customers into the financial system in the next three years.

SME aid

The core principles of Islamic finance mentioned earlier are also naturally aligned to the needs of the small and medium-sized enterprise (SME) segment. This link has been substantiated by research from various institutions, including the World Bank, which published a study in 2014 that found that the greater the number of Islamic banks per 100,000 adults in a country, the lower the proportion of SME firms that identified access to finance as a major constraint. Given the salient features I have discussed, we have to ask ourselves: “What would be the impact, globally, if the industry was able to reach its full potential?”

Our empirical analysis indicates that if developed globally, Islamic finance assets could grow to about $7000bn in the next decade, based on the best-case scenario. This growth would mean the industry nearly triples in size in 10 years, contributing an additional $4000bn per annum to the global economy, and creating an additional 150 million jobs. But the industry would still remain a fraction of the global finance industry, at about 3%. 

We have to ask ourselves if we are happy to represent a niche segment, or if we are willing to take the appropriate actions to unlock the true potential of the industry.

Mohammad Y Al-Hashel is the central bank governor of Kuwait.

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