Despite a fall in total assets, The Banker's 2015 survey of the Top Islamic Financial Institutions indicates that the market is continuing to move in the right direction, with sharia-compliant institutions improving access to and delivery of services, developing microfinance services, and forming stronger strategic partnerships across Asia.

The year 2014 was a defining one for Islamic finance. For the first time since The Banker's Top Islamic Financial Institutions survey began nine years ago, the industry’s total assets moved into negative growth territory. After years of double-digit growth from the 2007 rankings to year end 2013 (with a compound annual growth rate [CAGR] of 15.73%) and single-digit growth in the 2014 ranking of 9.81%, in the 2015 ranking total banking assets fell 8.48%.

That said, the Islamic finance market still commands an asset CAGR of 12.68% across the nine years of The Banker rankings. And an in-depth analysis of Islamic finance over the past year reveals that this decline can be attributed to a consolidation in some markets, new regulatory changes, market saturation in highly banked economies and the exchange rate differential of several local currencies.

Change in direction

The Banker survey data for our 2015 ranking reflects a change in the direction of the market for sharia-compliant finance, as total assets for the industry contracted from $1.391bn in 2014 to $1.273bn. The single most significant contributor to the reduction in global assets can be attributed to Iran’s 38.79% drop due to exchange rate changes against the US dollar. Government agencies and regulators continued to make headway in increasing the transparency of the market and in playing a significant role in issuance in both volume and product offerings.

The Banker’s survey indicates that banks and financial institutions offering sharia-compliant services are adapting their business models to a new set of market conditions. In our 2014 ranking, 360 institutions reported sharia-compliant activities. Although 33 institutions were dropped from our survey as they do not report their financial positions, an almost equal number of new institutions came into the market to bring the total to 360 for the 2015 ranking.

Of these 360 institutions, 111 are conventional banks operating semi-separated sharia windows, while 248 are wholly compliant independent organisations. A review of this year’s ranking shows that 198 institutions are commercial banks, 32 are foreign-owned subsidiaries and 90 are insurance companies. For the 2015 survey, a small number of adjustments were made in compiling the financial information to increase the quality of reporting. These changes in our tabulation of the industry are detailed in the methodology article.

In this year’s survey, 282 (78.55%) institutions reporting financial activity disclosed a rise in assets while only 77 (21.44%) reported declines in total assets. Ranking the profitability of the industry indicates that 294 institutions reported positive profits while 52 institutions reported a decline in profits from the previous year. In addition, 151 institutions increased their Tier 1 capital while 42 reduced their Tier 1 capital. 

Room for expansion

This decline of assets in several markets tells only part of the story. When taking into consideration the geographic areas where declines occurred and contrasting them with the resident Muslim populations of the regions, The Banker's research shows that more than 75.12% of the world’s Muslim population is still vastly underbanked, or lacks access to financial institutions.

A number of sharia-compliant banks are in the early stages of addressing this imbalance by making significant investments in retail banking delivery technologies. These investments, designed to make banking services more accessible to Muslims in the lower section of the financial pyramid, have not yet had an impact on many banks’ balance sheets and income statements. These are early days for what has been labelled 'financial inclusion' in many markets where bank density is still relatively low by Western standards. Within this context, it can be concluded that there are significant growth prospects for sharia-compliant institutions in the years to come.

Moving into the mainstream

Islamic finance is still making great strides into mainstream banking. In 2014, sharia-compliant banks such as Islamic Bank of Britain, which became Al Rayan Bank, were rebranded. Dubai-based Noor Islamic Bank renamed itself Noor Bank to appeal to a wider customer base. Sharia-compliant institutions are trying to engage their customer base in new ways and in new markets. The Middle East and north Africa region is no exception; as much as 50% of the population is considered by banks as the 'youth market'. Upgrading the brand image of a bank and the underlying technologies to enable transactions, and educating customers on how sharia-compliant products can be used to facilitate their lifestyles, are all items on senior management's agenda.

Another event in 2014 that helped to move Islamic finance closer to the mainstream and acted to shape the rankings was the issuance of sovereign sukuk by the UK, Hong Kong and Luxembourg governments. These were the first non-Muslim countries to issue sharia-compliant AAA rated government bonds, and in doing so they created a higher level of confidence in the market as it matured.

Malaysia’s Islamic Financial Services Act of 2013 – intended to move Islamic finance further into the mainstream – started to impact banks in 2014. Designed to add a level of customer protection and financial inclusion, as well as promote more transparency in risk sharing, Malaysia’s move is working to shift public perception of sharia-compliant products. It is reported that sharia-compliant products are beginning to be seen less as copies of their traditional counterparts, and more as authentically Islamic and based on a higher ethical degree.

This poses opportunities for the exportation of sharia-compliant finance in other Asian countries with vastly underbanked populations. Meanwhile, a growing number of international development agencies are exploring the sukuk market in order to diversify sources to fund their operations. For example, the International Financial Corporation, the World Bank’s private sector lending division, plans to issue its third sukuk in the Middle East. Last December, the International Finance Facility for Immunisation issued an inaugural sukuk to raise $500m.

External challenges, internal shifts

Sharia-compliant financial services continue to develop in various parts of the world at different rates of growth. This is due in part to variations in viewpoints of sharia interpretations, which can be regarded as the strength of Islamic finance and sharia scholars’ ability to adapt it. However, much of the variability in market growth can be attributed to a handful of factors: emerging market complexities combined with political instabilities, economic slowdowns, varying levels of technological financial infrastructure and a wide range of regulatory regimes. These have all contributed to changes in how the market for Islamic finance is maturing.

The Banker's survey of sharia-compliant institutions looked at eight key forces shaping the industry. Various events, actions and trends are moving Islamic finance in a two-dimensional trajectory. Macroeconomic fluctuations, regulatory variations, the emergence of non-traditional providers of financial services, geopolitics and the advance of technology are influencing the direction of Islamic finance, the depth of the banks' product portfolio and the levels of customer service competence.

Other influences, such as how quickly traditional competitors react to market conditions, the rate that customer service expectations are rising due to new technology, and the technological revolution in a bank’s distribution channels are also affecting the pace at which sharia-compliant institutions are developing and executing their strategic intentions. The direction of sharia-compliant banks and the speed at which they react to market conditions are the key to the development of the industry. 

The China effect

China’s ambitious infrastructure programme 'One Belt, One Road' is beginning to have an impact on the Islamic finance industry as China has signed currency swap agreements with Indonesia, Kazakhstan, Malaysia, Pakistan, Qatar, Turkey and the United Arab Emirates. Combined these countries represent 30% of the world’s Muslim population. The newly emerging links between financial markets across Asia is now reaching Islamic finance markets. A number of Chinese banks such as Bank of China, Industrial and Commercial Bank of China and Agricultural Bank of China have moved into the southern Asia and the Gulf regions. Also, the Hong Kong Monetary Authority has issued two government sukuk, receiving orders from 49 global institutions.

The extension of relations with China may open a new door for Islamic finance. This could be leveraged to increase the depth and breadth of the industry’s product offerings. Qatar International Islamic Bank and QNB Capital have also signed a strategic partnership with China’s Southwest Securities to develop opportunities for the establishment of sharia-compliant financing in China. Further evidence of changes in regional capital flows can be seen in discussions in the Ningxia Hui Autonomous Region to establish an Islamic financial centre to develop economic co-operation between China and the Arab States.

Management agenda

Once again costs appear firmly on the senior management agenda, along with continued gaps in customer service levels and a prevailing focus on providing services to the small and medium-sized enterprises (SMEs) sector. What sharia-compliant banks are learning is that as customers become acquainted with the idiosyncrasies of Islamic finance products, and feel more comfortable in applying them to their lifestyles, they in turn demand higher levels of customer service. Moreover, they become more conscious of fees charged for those services.

Therefore, there is a growing gap between the costs of providing services, the fees customers are charged, and their expectations in service delivery. In the past, customers pondered why Islamic finance appeared to be more expensive or carried a higher cost when compared with conventional banking. Typically, Islamic financial institutions reported that higher fees were a result of higher costs in meeting local regulations and sharia compliance requirements. This fee differential was labelled by the industry as the 'faith penalty'. Customers are now questioning these fees as more banks are offering products that are competitively priced, which is causing sharia-compliant organisations to revisit their cost structures and business models.

The quality of customer service is also still an issue, but the nature of the issue is changing. During the past few years, senior-level people with knowledge of sharia-compliant instruments, the fundamentals of Islamic finance and knowledge of conventional products were in short supply. Now the focus of knowledge acquisition is the resourcing of front-line branch personnel, who often lack an in-depth understanding of the products needed to communicate the service offering to customers.

SME financing, microfinancing and social financial inclusion are also increasingly on the senior management agenda as governments in emerging markets encourage financial institutions to do more in these areas. The vastly underserved SME market suffers from three key challenges: a lack of credit information on SME borrowers, a lack of socially indexed credit models to arbitrate domestic lending criteria, and a lack of lending rules to apply sharia-based principles to advanced credit scoring techniques. Pioneers in this field include Abu Dhabi Commercial Bank’s Islamic banking services for SMEs, which has open six dedicated SME centres, and SME Bank in Malaysia, which recently celebrated its 10th year with the launching of the Women's Entrepreneur Financing Programme.

Microfinance is another issue for the senior management team’s strategy, as numerous non-governmental organisations and other non-banking financial service providers are moving into this area. There is a noticeable lack of sharia-compliant services in most countries. And yet Islamic banks such as Ghana Islamic Microfinance are rising to the challenge, with its new 'Halal Livestock Mudarabah' offering. However, much more capacity in these areas is needed to enhance the reach of Islamic finance.

As The Banker survey on Top Islamic Financial Institutions completes nine years of measuring the industry’s performance, we must once again acknowledge a striking improvement in the data provided by institutions. The level of reporting of financial data and transaction details is becoming increasingly transparent. This has led to a higher degree of accuracy in the survey's numbers, as well as improving the quality of trends analysis. The Banker’s survey of financial institutions that offer sharia-compliant services has become a benchmark for the Islamic finance industry. Our intent continues to be to provide data that can be used to drive strategic decision-making by financial institutions.

Joseph DiVanna is the managing director of Maris Strategies and co-author of The Banker’s survey on Top Islamic Financial Institutions ranking since 2007. James King is the Middle East editor of The Banker.



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