Asia: the Future of Islamic Finance?

Islamic Genenric

Last month, Britain became the first government outside the Islamic world to issue sovereign sukuk, otherwise known as Islamic bonds, declaring its intention to become the western capital for Islamic finance. Attracting more than £2 billion in orders, the bond sale was met with enthusiastic demand from investors worldwide, from both within and without the Muslim world.

Later this year, Hong Kong is expected to join the rank of countries venturing into Islamic finance, putting up its first offering of sukuk, believed to be between US$500 million and US$1 billion. Earlier in March, the financial hub had passed a tax bill allowing sukuk sales and levelling the playing field between Islamic bonds and conventional financing.

Islamic banking and finance are governed by several Islamic principles, collectively known as Sharia. Under Islamic law, speculative transactions that are akin to gambling are prohibited. Money is also regarded as having no intrinsic value, and is purely a means of exchange. As such, profit from interest, called riba, is prohibited. Instead, all returns must be earned through commercial risks undertaken by the investor in real assets, such as property.

Sukuk, the most common form of Islamic financing and its fastest growing segment, is a financial certificate in which the investor owns a pro-rated interest in a real asset, bearing the risk in and deriving the profit from the underlying asset. For example, a financer who invests in a property obtains returns in the form of rental payment. Effectively functioning as a loan, the lessee may gradually pay off the property in installments, and the proportion of returns to the investor correspondingly falls.

With global Muslim population standing at about 1.6 billion, almost a quarter of the world’s population, the market for Islamic finance is vast. Globally, the assets of Islamic banks averaged 17 percent growth in the past few years, according to the World Islamic Banking Competitiveness Report 2014 by Ernst & Young.

In its State of the Global Islamic Economy 2013 report, Thomson Reuters found that the current Islamic finance market stands at about US$985 billion in assets, less than one percent of global banking assets. At full potential, the market could expand up to US$4,095 billion.

Asia, home to more than 60 percent of the world’s Muslims, lies at the heart of this rapidly growing market. Indonesia has the world’s largest Muslim population and Malaysia the world’s leading Islamic finance market at US$412 billion in 2012.

A combination of strong political support, large investor base and generous tax incentives that make Islamic finance comparatively cheaper for investors has propelled the Southeast Asian nation into the world’s most developed market for Sharia-friendly investments, commanding more than 60 percent of global sukuk issuance. Although the largest Islamic bank in terms of assets is Saudi Arabia’s Al Rahji Bank, Malaysia has the largest number – 21 – of Islamic finance banks within a country.

This month, three of the country’s top Islamic banks began early talks of a merger, which analysts predict will form a “mega Islamic bank” with assets capable of challenging the dominance of traditional Western banks.

Currently, the sukuk market is largely dominated by established global banks such as HSBC and Standard Chartered, which issue sukuk via an Islamic window. Local Islamic banks struggle to compete against the cost efficiencies and vast global networks that these banks can leverage. If this merger goes through, the combined entity of CIMB, RHB Capital and Malaysia Building Society (MBSB) will have assets of about US$188 billion, making it the fourth largest bank in the Association of South East Asian Nations. Some analysts believe the potential for cross-border Islamic financing will pave the way for the internationalization of Malaysia’s Islamic banking model.

The potential for the Islamic financing market is immense – 10 of the world’s 25 rapid growth markets have a large Muslim population, EY analysts report. Indonesia, with about 250 million people, is likely to be the next major market for Islamic financing, with its young Islamic banking sector forecast to grow fivefold from 2011 to 2015. In Malaysia, Islamic financing assets are forecast to account for 40 percent of the banking sector by 2020.

Hong Kong, which has been working to become the center for international financial intermediation between China and the Middle East, is preparing to issue its first sovereign sukuk in September. With the Chinese dimsum market continuing on its rise, Hong Kong is situated as the ideal gateway to channel renminbi into the Islamic banking sector, an area with immense potential.

Since the global financial crisis in 2008, there has been growing interest in ethical financing, an image that analysts believe closely align with the principals of Islamic finance. Globally, sukuk demand continues to far outstrip supply, creating an attractive alternative for cheaper financing.

*This article was originally published on The Amilin Post on 27 August 2014. Read the original article here.

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