Moody's reports: Islamic finance industry records high growth rates but remains fragmented

Modern Islamic finance is a recent phenomenon. Only 30 years have passed since the first fully fledged Islamic financial institutions (IFIs) emerged, and the market for Sukuk (Islamic bonds) was virtually inexistent as recently as the beginning of this century. Today, estimations tend to value the Islamic financial industry -- which comprises about 300 Shari'ah-compliant banks, takaful (or Islamic mutual insurance) companies and mutual funds in line with the principles of Islamic finance -- at more than $700bn in terms of assets.

"The market for Sukuk alone, accounting for around $100bn at year-end 2007, has exceeded the
GDP of a country the size of Morocco," says Anouar Hassoune, a Moody's analyst and author of the report.

Moody's notes that current excess liquidity prevailing in Gulf economies since 11 September 2001 has fuelled both sustained demand for the products supplied by IFIs and the booming expansion of the market for Sukuk, while contributing to creating a very close link between Islamic banks and what remains to date a relatively illiquid compartment of the bond market. Nevertheless, the rating agency expects liquidity in the Sukuk market to improve gradually as the variety of Sukuk issuances widens. Not only are volumes expected to exceed $150bn by the end of the current decade, but the nature, geographic location and credit quality of future issuers are also expected to considerably evolve and diversify.

At this stage, the Islamic financial industry remains very much intermediated -- or, in other words, more widely dominated by financial intermediaries capturing deposits to recycle them into on-balance-sheet asset portfolios than by disincarnated, de-territorialised and virtual capital markets. Moody's notes that some 90%
of Shari'ah-compliant assets are concentrated on IFIs' balance sheets and on those of conventional banks offering Islamic financial services and products through "Islamic windows". Islamic finance is becoming increasingly "internationalised", but essentially remains a collection of disseminated and still weakly coordinated local operations.

"A number of forces within the Islamic financial universe tend to contribute to its fragmentation. The core principles underlying Islamic financial products, although subject to vast consensus as to their formal content, remain differently interpreted and differently weighted in practice," says Mr. Hassoune.

In Moody's opinion, the lack of technical and contractual standardisation impedes the capacity of Islamic finance, as an alternative financing and investment model, to enhance its globalisation process, without necessarily forbidding its internationalisation. Initiatives aiming at either introducing Islamic finance or strengthening its position are mushrooming across a wider range of countries, whether home to majority Muslim populations or not, but these remain country specific and weakly co-ordinated, despite the sustained endeavour of several cross-border organisations to bring some consistency to the concept.

"Building in prospective views is not an easy task in such a young industry. Nevertheless, we expect the Sukuk market to become more complex, more structured, larger, more diversified and more liquid as it evolves over time,"

adds Mr. Hassoune.

Equally, IFIs are expected to explore new geographic horizons as well as new business lines, become more competitive and (paradoxically) contribute to the gradual emergence of a more disintermediated Islamic financial industry -- one with a reduced presence of Islamic banks.