The large unbanked Muslim populations of Indonesia and Africa present a huge opportunity for Islamic financial institutions, with Africa's infrastructural shortfall providing a particularly fertile ground for the sukuk market.

The frontiers of the global Islamic finance industry are expanding. From competitive home markets such as Malaysia and the countries that make up the Gulf Co-operation Council (GCC), sharia-compliant financial institutions are now pushing outwards to tap into the higher growth opportunities on offer elsewhere in the Islamic world. This has come as global demand for sharia-compliant financing options is on the rise. With massive Muslim majority markets, including Indonesia, lacking significant sharia-compliant financial coverage the opportunities for growth are substantial. 

Encouragingly, national governments in these underserved markets are increasingly aware of the benefits of Islamic finance. This awakening has emerged in the form of new sovereign sukuk issuance, positive regulatory reforms as well as training initiatives for regulatory agencies. As a consequence, momentum is now building behind the development of a truly globalised industry.

Indonesia's rise 

Nowhere is this dual trend of commercial interest and positive regulatory reform more evident than in Indonesia the Islamic world’s most populous country. “Indonesia is a sleeping giant in the Islamic finance marketplace. We believe that if Indonesia does get all the infrastructure in place, it can really emerge as a genuine heavyweight in the Islamic finance industry,” says Mohamad Safri Shaul Hamid, senior managing director and deputy chief executive of CIMB Islamic. 

Yet, Indonesia’s potential has been touted for some time. Banking sector penetration in the country currently sits at about 30% of the population, according to local consulting firm Cekindo. This lack of financial inclusion on the part of both conventional and Islamic lenders is partially a result of the low levels of financial literacy in the country. This is particularly the case when it comes to sharia-compliant finance, according to research conducted by the country’s financial services authority Otoritas Jasa Keuangan (OJK). 

To address these issues – and others – the OJK released a roadmap in June 2015 to chart a course for Islamic banks to hold about 15% of system wide assets in Indonesia by 2023. The fact that Islamic lenders currently have about a 5% market share in the country means that reaching this target will be difficult. But it nevertheless provides a strong indication that Indonesia is now taking Islamic finance seriously. 

Indeed, most lenders operating in the country, both domestic and local, are enjoying strong levels of profit and asset growth. “CIMB Niaga Shariah currently has close to 30 branches in Indonesia and we see huge growth potential there. With a population of about 250 million, where more than 90% are Muslims, the scope for retail Islamic finance is enormous,” says Mr Safri. 

Despite exchange rate challenges around the rupiah, total sharia-compliant assets in Indonesia increased from $19.1bn last year’s Top Islamic Financial Institutions report to $21.04bn this year. And it is more than just Malaysian banks – traditionally the most active in Indonesia – that are looking to tap into this growth opportunity. A number of the Gulf region’s sharia-compliant banks are now paying greater attention to the country. 

Dubai Islamic Bank received regulatory approval from OJK in October 2015 to increase its stake in PT Bank Panin Syariah Tbk to 40%, up from 25%. Meanwhile, according to a number of Indonesian press reports, as well as statements from the OJK, Dubai’s Emirates NBD is considering a move into the country through the establishment of a new sharia-compliant lender. 

And in a growing sign of cross-border developments between Indonesia and the markets of the GCC, Indonesia issued four sovereign sukuk at a value of $6bn on Nasdaq Dubai in September 2015. Not only was this the largest sovereign sukuk transaction executed in Dubai, it also points to a much-needed process of convergence between the Islamic finance markets of south-east Asia and the Gulf, as well as Dubai’s growing status as a global centre of Islamic finance.

Into Africa 

Beyond Indonesia, Africa is seen by many as a natural growth opportunity. With the likes of Abu Dhabi Islamic Bank already operating in Egypt and Sudan, many Islamic banks are now looking to gain a foothold in key markets across the continent. For Islamic institutions, this advance offers huge potential in terms of Africa’s demographic potential. The International Monetary Fund estimates that about half of the population of the sub-Saharan Africa region is unbanked. Moreover, the Muslim population in this area is expected to increase from its current 250 million people to about 386 million by 2030. 

As Africa’s economic growth develops in conjunction with these demographic changes, demand for financial services is expected to spike. Here, the opportunities for Islamic lenders are expected to be vast. “Over the longer term, I think Africa can become a source of massive growth for the Islamic finance sector. The opportunities are considerable and Standard Chartered Saadiq could one day transfer some of our expertise and knowledge to assist in the development of sharia-compliant finance across the continent,” says Adhha Abdullah, CEO of Standard Chartered Saadiq.

Filling gaps 

Yet, it is clear that sharia-compliant finance can also deliver real benefits to Africa’s economic and social growth trajectory. Even in markets with large Muslim populations, the number of Islamic financial service providers remains limited. An increasing number of Islamic banks will therefore improve financial inclusion across the continent, both for Muslims and non-Muslims. This is particularly true when it comes to small and medium-sized enterprise financing by increasing the options on offer. 

Just as significant is the potential for Islamic finance to address Africa’s yawning infrastructure funding gap. The African Development Bank estimates that the continent’s annual infrastructure investment deficit is $50bn. Increased sukuk issuance is seen as one way of addressing this problem. Not only do sukuk provide a natural fit for infrastructure and project financing, by virtue of the fact that they are asset backed, but they are also an excellent means of attracting surplus liquidity from Islamic investors in the Middle East and Asia. 

Encouragingly, a number of African sovereigns are now turning to the sukuk market. In 2014, both Senegal and South Africa debuted sovereign issuances, while Nigeria, Côte d'Ivoire and Niger are all actively exploring a transaction. In doing so, these countries will effectively broaden their traditional investor base. Moreover, this wave of sovereign issuances could potentially ease the way for further transactions from African corporates, state-owned companies, financial institutions and others, to benefit from a new funding source.

Support needed 

What is required moving forward is greater regulatory and political support for the development of Islamic finance in Africa. Here, things seem to be moving in the right direction. In June 2015, Uganda introduced amended financial institution legislation that will open the country up to Islamic banking. In Nigeria, the central bank issued guidelines for the creation of a centralised sharia authority in February, while in late 2014 the Moroccan parliament approved an Islamic finance bill permitting the operation of sharia-compliant banks. 

As the regulatory environment incrementally improves, so are the regulators’ understandings of Islamic finance. Kenya recently signed a memorandum of understanding with the Qatari government to support the development of the Nairobi International Financial Centre, of which Islamic finance will be a key component. Meanwhile, the Kenyan School of Monetary Studies, part of the country’s central bank, has partnered with Malaysia’s International Centre for Education in Islamic Finance (INCEIF) to deliver training programmes on Islamic finance. 

Similar training arrangements involving INCEIF and the governments of Tanzania and Uganda have also been agreed, while the central bank of the West African Monetary Union is also developing a francophone Islamic finance education body with the Malaysian institution. 

These developments and others point to the growing momentum behind Islamic finance in Africa. An improving regulatory environment and rising demand are playing their part in driving change across the continent. As this process gathers pace in the larger African markets, as well as jurisdictions such as Indonesia, the prospects for unlocking another period of sustained growth for the industry appear ever brighter. For sharia-compliant banks across the GCC and Malaysia, these dynamics are undoubtedly promising and point to the potential for a new phase of global expansion. 


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