Despite the recent gloomy economic environment globally, the Islamic finance industry's total assets scaled new heights in 2009, rising to $950bn. Moody's estimates that the market's potential is worth at least $5 trillion and the industry is continuing to expand globally.
"In this context, IFIs are continuing to deliver Shari'ah-compliant returns whilst, at the same time, focusing on efficiently mitigating the associated risks through a new risk management approach, including the use of derivatives,"
says Anouar Hassoune, a Moody's Vice President - Senior Credit Officer and author of the report.
"If employed with care, derivatives can enhance efficiency in IFIs through risk mitigation, thereby making them more competitive as well as appealing to customers. However, their application in Islamic finance is highly controversial for reasons of speculation and uncertainty, two practices forbidden under Shari'ah," explains Mr Hassoune. The varying scholarly opinions in the world of Islamic jurisprudence on the legitimacy of derivatives has so far translated into a total ban on these instruments in some countries and actual implementation -- albeit on a limited scale -- in others.
"IFIs aim to utilise derivative instruments to hedge against risk and to improve risk monitoring practices. However, they are keen to do so in a Shari'ah-compliant manner, rather than imitating conventional derivative instruments -- in order to avoid losing their special status as Shari'ah-compliant banks, which makes them very attractive to a large population of Muslims. For this reason, a new innovation phase in the industry is critical," Mr Hassoune notes.
Moody's currently rates eleven IFIs in the GCC region and Turkey. Although their financial profiles display strengths, they are offset by weaker qualitative characteristics including their risk management.