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The global outlook of the
Islamic financial services industry
An Economist Corporate Network management brief

Supported by

The global outlook of the Islamic financial services industry

Contents

Preface 2

1. Introduction 3

2. The scale of the opportunity 4

3. Stresses and strains 7

4. Regulatory requirements 9

5. Building the talent pool 12

6. Priorities for action 14

© Economist Corporate Network 2010 1


Preface
The global outlook of the Islamic financial services industry is an Economist Corporate Network (ECN)
report. The ECN wrote the report based on a roundtable event staged at the Global Islamic Finance Forum
held in Kuala Lumpur in October 2010. The findings and views expressed here are those of the ECN alone.
Rajiv Biswas and Jane Kinninmont were the authors of the report. Gaddi Tam was responsible for design.
The cover image is by Corbis.

November 2010

Participants at the Economist Corporate Network roundtable on Islamic finance:
Zukri Samat, managing director, Bank Islam
Steven Choy, president and CEO, Cagamas
Noripah Kamso, CEO, CIMB Principal Islamic Asset Management
Daud Vicary, global leader of the Islamic Finance Group, Deloitte
Aamir Rehman, managing director, Fajr Capital
Richard Thomas, CEO, Gatehouse Bank
Rafe Haneef, managing director, HSBC Amanah
Agil Natt, president, INCEIF
Mushtak Parker, editor, Islamic Banker
Mohammed Rashdan Yusof, executive director, investments, Khazanah Nasional
Mohd Safri Shahul Hamid, deputy CEO, MIDF Amanah Investment Bank
Takuya Furuya, chairman, Nomura—Middle East and Africa
Dr Nik Norzrul Thani, chairman, Zaid Ibrahim & Co

To learn more about the roundtable, visit: www.ecn-asia.com/mifc

© 2010 The Economist Corporate Network. All rights reserved. All information in this report is verified to
the best of the authors’ and the publisher’s ability. However, the Economist Corporate Network does not
accept responsibility for any loss arising from reliance on it. Neither this publication nor any part of it
may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior permission of the Economist
Corporate Network.

2 © Economist Corporate Network 2010


1. Introduction
More than 1,000 participants from 50 countries gathered at the Global Islamic Finance Forum (GIFF)
held in Malaysia in October this year. The wide spread of delegates—from countries as varied as the
Gulf states, the UK, France, Switzerland, Russia and Australia—is testament to the industry’s global
spread beyond what is normally thought of as the “Muslim world”. To understand this growing appeal,
as well as to debate the industry’s pressing challenges, the Economist Corporate Network staged a
roundtable discussion with some of the leading figures at GIFF.

I slamic finance has won increasing attention in both Muslim and non-Muslim countries in the past
decade. From its small beginnings in the 1970s, the industry has expanded rapidly. Bank Negara
Malaysia, the Malaysian central bank, has estimated that the industry’s financial assets may already
exceed US$1trn. And the growth looks set to continue. By some forecasts, the industry’s assets are on
track to double over the next five years. The sector’s rapid growth will inevitably bring challenges as well
as opportunities, and much of the discussion at GIFF centred on avoiding self- congratulation and pushing
forward with efforts to develop the industry.
Islamic finance practitioners favour an approach to investment that avoids excessive leverage and
is based on real, tangible assets. Such principles are finding more resonance following the global
financial crisis, which was sparked by excessively complex financial instruments involving levels of risk
and borrowing that investors did not understand. But perceptions that the Islamic finance industry
was immune to the global crisis are over-optimistic. Notably, some of the Gulf-based Islamic banks
that invested heavily in regional property markets made substantial losses when the real estate market
turned, and there have been defaults on a small number of sukuk (Islamic bonds).
The Islamic finance industry remains closely linked to the conventional financial sector and one of
the key questions for its future development is how it will differentiate itself more clearly. The industry
also needs to demystify itself. Many potential investors remain unclear about what Islamic finance really
means. Risk management and risk assessment still need to be developed further. And almost everyone in
the industry acknowledges that more investment needs to be made in human capital. Creative thinking is
also needed to push ahead with innovation without simply mimicking conventional finance.



2. The scale of the opportunity

A t an Economist Corporate Network roundtable on Islamic finance1 held at GIFF, Aamir Rehman,
1 This roundtable was held
on 28th October 2010 as part
of the Global Islamic Finance managing director of Fajr Capital, a Dubai-based Islamic investment firm, and author of a book on
Forum in Kuala Lumpur,
Malaysia.
Islamic finance, identified four key factors driving the growth—and globalisation—of Islamic finance.
First, he said, is the increased importance of capital from the countries that belong to the Organisation of
the Islamic Conference (OIC), an association of 56 Muslim-majority countries. “The economies of the OIC
are a crucial source of capital-generating surpluses, growth and wealth while many of the world’s largest
economies face deficits and capital constraints,” he noted.
What’s more, Mr Rehman added, OIC-based companies “with sharia sensitivities” are becoming
increasingly important global players. Thirdly, the industry is becoming increasingly sophisticated and is
developing new products to attract customers. Finally, there is increasing demand on the retail side, “the
core of the market and the soul of the industry”. For instance, he said, there are now calls in the Gulf to
set up more sharia-compliant pension funds.
In some countries, Islamic finance has already reached a significant share of activity. In Malaysia,
which operates a dual financial system, Islamic finance accounts for 21% of the financial sector, and is
2 Bank Negara Malaysia
growing rapidly. In the first seven months of 2010, Islamic banking assets grew by 21% compared to the
previous year.2 Islamic banking assets have also been expanding in neighbouring Indonesia in 2009
and 2010 after years of sluggish growth. In Saudi Arabia, bottom-up demand for Islamic banking has led
many of the conventional banks—which dominate the Saudi market—to switch to sharia-compliant retail
operations.
The potential Muslim market is huge and growing: Islam is the second largest religion worldwide, with
3 Mapping the Global Muslim
1.57bn followers, or 23% of the global population3. Many of the world’s Muslims live in rapidly-growing
Population: A Report on the
Size and Distribution of the emerging markets such as Indonesia and India. However, there are some important caveats. Muslims do
World’s Muslim Population,
2009, Pew Research Centre
not necessarily choose Islamic financial services—especially in cases where these are more expensive
than conventional equivalents. Many are skeptical or unaware of modern Islamic finance and the industry
still needs to do much more to make its case to the large pool of potential customers.
Furthermore, many Muslim countries, or countries with large Muslim populations, have not put the



legal framework in place to develop Islamic finance, often because of political and social sensitivities.
Government support is critical to the successful development of the industry in any given market. The
industry has been slow to grow in North Africa because of an absence of political support. Moreover,
India, which has the world’s largest Muslim population but is not a Muslim-majority country, does not yet
licence or regulate Islamic banks, despite attempts in 2009 by the Kerala State Industrial Development
Corporation to set up the country’s first sharia-compliant financial institution.
Several participants in the roundtable said that Islamic finance needs to demystify itself and to
emphasise its links with other forms of alternative finance, from modern “ethical finance” which prohibits
certain forms of investment—such as in gambling companies—to traditional banking practices that
avoided excessive leverage. Some argued that the industry should even lose the label “Islamic”. For
instance, Muslim banks in Turkey are normally called “participation banks” to avoid offending secularist
sensibilities. One participant suggested the industry should adopt English terminology instead of using
the traditional Arabic words which are unfamiliar to most people.

Not just for Muslims
On the other hand, Islamic finance has had some success in attracting non-Muslim investors and
borrowers, encouraging a number of non-Muslim countries to support the industry. In Europe, the UK,
France and Luxembourg have all passed laws to ensure tax neutrality for Islamic finance, both to develop
their international competitiveness as financial centres and to offer a wider range of services to European
Muslims. Ireland is now pressing ahead with similar legal changes.
From an issuer’s point of view, Islamic instruments represent an opportunity to reach a new pool of
investors. In a notable development earlier this year, Nomura, a Japanese bank, tapped the Islamic
markets twice. In July, it raised US$70m through a murabaha facility issued in Bahrain and US$100m
through ijara certificates issued in Kuala Lumpur.
“Islamic finance represents an important alternative channel to move money and diversify our funding
sources,” said Takuya Furuya, chairman of Nomura for Middle East and Africa, speaking at the ECN
roundtable. Cagamas, Malaysia’s national mortgage company and securitisation house, issued its first
sukuk al-Amanah Li al-Istithmar in August, having worked with Al-Rajhi Bank in Saudi Arabia to ensure its
sharia provisions were acceptable to Middle Eastern investors. Its president and CEO, Steven Choy, said
that 43% of investors were new investors in Cagamas—and that one-third of them were buying sukuk for
the first time.
Most issuers have been cautious this year, with many companies placing expansion plans on hold.
Meanwhile, “demand for sukuk is outstripping supply,” said Zukri Samat, CEO of Bank Islam in Malaysia,
and many investors are non-Muslims attracted by the returns on sukuk. Mohammed Rashdan Mohammed
Yusof, the executive director of Investments at Khazanah Nasional, the Malaysian government’s
investment holding arm, which issued its debut Singaporean-dollar sukuk this year out of Malaysia, sees a
great appetite for alternative investments and believes that international private equity funds are ready
to embrace Islamic finance.



Liquidity boost
The financial framework that underpins the industry is strengthening too. Liquidity management
has proven a challenge, but an international taskforce has developed a solution. On October 25th
2010, 12 central banks and monetary authorities, and two multilateral organisations—the Islamic
Development Bank (IDB) and the Islamic Corporation for the Development of the Private Sector—set up
the International Islamic Liquidity Management Corporation (IILM). Based in Kuala Lumpur, and with an
authorised capital of US$1bn, its aim is to add resilience to global Islamic finance by facilitating cross-
border capital and investment flows. The provision of enhanced liquidity to Islamic financial instruments
will generate greater confidence in the products across financial centres.
Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia, said the new institution will “enable more
effective liquidity management not only for Islamic financial institutions but also for the management of
Islamic financial portfolios.” She added that the development is also significant because “it demonstrates
an international collaboration among the central banks.”
Some have called for OIC sovereign wealth funds (SWFs) to dedicate even a small part of their portfolios
to sharia-compliant investments. A recent research paper by Kuwait Finance House Research asked why
there are no sharia-compliant SWFs when some of the largest such funds are owned by Muslim countries.
This remains a sensitive issue as many SWFs have invested heavily in areas not deemed sharia-compliant,
notably conventional banks but also hotels. Perhaps a more likely next step is increased issuance of
sovereign sukuk to further strengthen liquidity management.



3. Stresses and strains

N onetheless, despite all the progress and growth of recent years, significant challenges remain for the
industry. Many of these challenges were highlighted during the stresses of the recent global financial
crisis.
Some observers had assumed that Islamic finance would be insulated from the types of shock that
create turmoil in conventional financial services. Partly that’s because Islamic finance is much more
asset-based—it is built around real-world projects and investments rather than abstract risks—and
involves greater risk-sharing than conventional finance, since both the client and the financial institution
must assume some of the risk. Equally, it’s because the industry is less exposed to some forms of financial
innovation, especially in the field of derivatives, given Islamic restrictions on trading in financial risk.
Those perceptions were put to the test in 2009 and in some cases found to be misplaced. During the
financial crisis, a number of issuers of sukuk, defaulted, including Investment DAR, a Kuwait-based
finance and real estate group, and fellow Kuwaiti firm, International Investment Group. Fears also
circulated widely of a large-scale sukuk default by Nakheel, a Dubai-based property developer. Such fears
were only allayed following a US$10bn bailout by Abu Dhabi to Dubai World, Nakheel’s parent company.
In other respects, the financial crisis also demonstrated the resilience of Islamic finance. Notably,
a comparison of the performance of the ten largest conventional banks with the largest Islamic banks
shows a stark contrast during the crisis4. While aggregate profits of conventional banks fell from 4 Islamic Finance and Global
Financial Stability, IFSB and
US$116bn in 2006 to a net loss of US$42bn in 2008, profits at Islamic banks rose by 9% from US$4.2bn to IDB, April 2010
US$4.6bn.
Professor Dr Abbas Mirakhor, first holder of the chair of Islamic finance at the International Centre
for Education in Islamic Finance (INCEIF) in Malaysia, believes the sukuk defaults can have a positive
effect. “If the economy is suffering, you want that to be reflected in the balance sheets of banks. It shows
that the banking sector is tied to what is happening in the real economy and is not removed from it,” he
said. In contrast, much of the activity of conventional finance became highly esoteric and removed from
the real economy over the past decade. Likewise, Noripah Kamso, CEO of CIMB-Principal Islamic Asset
Management, told the roundtable that the sukuk defaults in the Gulf will force people in the industry to
improve transparency and to address legal reforms.



Nonetheless, the unnerving experiences in Dubai, Kuwait and other places suggest that many issues
need addressing. In the case of Nakheel, protracted discussions with creditors about restructuring
the firm’s debt highlight the need for formalised processes and mechanisms to resolve default issues.
Questions have also been asked about the valuation of underlying assets during the Gulf property boom.
“Really, the issue is poor credit, not the sukuk structure,” said Rafe Haneef, managing director of HSBC
Amanah, the Islamic finance arm of HSBC bank. Some of the participants argued that the defaults and
near-defaults in the Gulf had more to do with weaknesses in the Gulf legal systems than with sukuk
structures themselves.
Among the other key issues raised were questions of regulation, risk management, and the
development of human capital—all of which were the subject of heated debate.



4. Regulatory requirements

T he rapid growth of the industry has increased the focus of regulators on appropriate regulatory
standards and risk management systems. When the Bank for International Settlements (BIS) in
Switzerland released its Basel II guidelines for capital adequacy, the Islamic Financial Services Board
(IFSB), the international prudential standard setting body, followed with its own guidelines for Islamic
banks. The subsequent agreement reached for a Basel III Accord in September 2010 sets higher minimum
capital standards for banks, and will trigger further changes from the IFSB too.
As the key global standards setting body for regulatory capital in the global banking industry, BIS has only
recently widened its representation to include developing countries. In mid-2009, it invited developing country
members of the G-20 forum to join its standard-setting committee. Among the countries joining the committee
were Indonesia, Saudi Arabia and Turkey. In the past, Islamic countries had no voice in setting global banking
standards. But the inclusion of these three nations has changed that.
Of course, the IFSB has been developing prudential standards specifically for Islamic banking for many
years, and promoting greater co-operation across different jurisdictions. And its activities have been
growing. In April this year, for example, it set up the Islamic Financial Stability Forum (IFSF) to build
international co-operation in crisis prevention, management and resolution.
In some ways, the IFSB has been path-breaking in its approach. For example, uniquely among
international financial regulators, it not only oversees Islamic banking, it also sets standards for Islamic
insurance (Takaful), and also the activities of capital market intermediaries. “We recognize the strong
linkages between different branches of finance and the need to have a regulatory approach that can
manage those linkages,” says Dr Zeti of Bank Negara Malaysia.
However, many in the industry feel that standards have room for improvement. Earlier this year,
Deloitte’s Islamic Finance Knowledge Center surveyed the industry and found that two-thirds believe
Islamic banking is under-regulated. And more than 60% feel that regulations are needed to strengthen
systems of risk management. (See Charts 1 and 2, overleaf.)
5 “Islamic Banks and Financial
A recent IMF research paper on Islamic banks5 argued that, while small Islamic banks tend to be Stability: An Empirical Analy-
financially stronger than both small and large conventional commercial banks, large Islamic banks tend sis” by Martin Cihak and Heiko
Hesse, IMF Working Paper
not to be as financially strong as large conventional commercial banks. The reason, the authors argued, 09/16



Chart 1
Do you think the Islamic finance industry is properly regulated?
(% of total respondents)
Under-regulated
66
Appropriately regulated
31
Over-regulated
3
Source: Deloitte Consulting Islamic Finance Knowledge Center

Chart 2
Which of the following areas require new regulatory measures to ensure compliance of regulation and best practice in Islamic
finance?
(% of total respondents)
Islamic accounting standards
62
Risk management
62
Corporate governance
58
Shariah standards
55
Bank credit exposures
45
Business conduct
42
Source: Deloitte Consulting Islamic Finance Knowledge Center

is that it is significantly more complex for Islamic banks to adjust their credit monitoring system as they
become larger.
Daud Vicary Abdullah, global leader of the Islamic Finance Group at Deloitte, noted at the roundtable
that there is a particular need to focus on strengthening risk management “in operational risk control
and in sharia-compliance for product structures”.
The concept of “sharia risk” has become an issue, especially since early 2008, when the Auditing
and Accounting Organisation for Islamic Financial Institutions (AAOIFI), an internationally recognised
industry standards board based in Bahrain, ruled that many sukuk in the market were not sharia-
compliant as they were structured in a way that failed to share risk between the borrower and the lender.
In an attempt to address this, there is increasing dialogue between scholars from different countries.
According to Dr Zeti, there is now a scholarly consensus on some 80% of issues pertaining to Islamic
finance, while there are still a few product structures that are accepted only in some jurisdictions.
Scholarly differences are unlikely to disappear altogether. In a religion where there is no single
centralised clerical authority, such differences are a normal part of theological debate and, arguably,
religious freedom. Yet, when it comes to practical application for companies, Mr Choy of Cagamas says it
is simply “not that difficult” to find a structure that is acceptable globally, adding that it took Cagamas 14
months to develop its sukuk alim, but that this was “time well spent”.



Other regulations also vary from country to country depending on the legal and political environment
of each market. Dr Nik Norzrul Thani, chairman of Zaid Ibrahim & Co, a Malaysian law firm working across
Asia and the Middle East, argued that three things are needed for Islamic finance to flourish in any given
country: a good enabling environment in terms of tax neutrality and the laws governing the sector; the
wider enforceability of contracts within the country’s judicial system; and the availability of dispute
resolution mechanisms.



5. Building the talent pool

A nother key issue for Islamic finance is human capital. For years, industry participants have said that
there is not enough investment in training the next generation of Islamic finance professionals,
who need to be well-versed in a combination of Islamic principles, finance, and legal and regulatory
standards.
Training is needed at all levels. “We need more training, not just within the industry itself, but right
across the spectrum of governance—training for the regulators, the tax authorities, and even the
parliament,” argued Richard Thomas, the CEO of Gatehouse Bank, a UK-based sharia-compliant wholesale
bank.
Some progress has been made in developing professional qualifications for accountants, auditors and
finance professionals. However, Mr Thomas identified a particular gap in training: “The industry needs
to spend a lot more money in training risk professionals. Risk is a completely different model in Islamic
finance; it’s more fundamental.” Mr Thomas added that, “In the past, Islamic finance has been held back
because conventional banks have been underpricing risk.”
To date, efforts to build up professional training certifications and higher degrees have been patchy.
At present, each Islamic financial centre pursues its own path in human capital development, without
internationally agreed curricula and codes of conduct. This issue will become ever more prominent as the
industry becomes increasingly international, and skilled personnel move to different jurisdictions during
their careers.
Participants in the roundtable emphasised a need for greater coordination across the industry,
involving regulatory bodies, educational institutions and financial firms in developing professional
standards. “The record on quality control is mixed and there is a risk that students can spend their money
wrongly,” said Mushtak Parker, editor of Islamic Banker, an industry magazine. Mr Parker suggested that
the IFSB and the Islamic Development Bank (IDB) should now set up a taskforce on Islamic finance talent
development, just as they set up a taskforce to deal with liquidity management, which eventually led to
the creation of the IILM.
One of the bodies actively developing education standards for the industry is the Malaysia-based
International Centre for Education in Islamic Finance (INCEIF), a university specialising in Islamic finance



that was set up in 2006 by Bank Negara Malaysia. International co-operation projects are underway
with institutions including the University of Reading in the UK, the University of Bahrain, Universitas
Indonesia and Abu Dhabi University in the UAE.
Agil Natt, president and CEO of INCEIF, believes a key priority is for greater international co-operation
in education and training. “There is now an urgent need for a professional association that will group
Shariah scholars together and establish a code of conduct,” he says. “There is also a need for greater
sharing of research and materials in a common international language, English, to ensure that all
jurisdictions have access to research that may have originally been done in other languages, notably
Arabic. Greater transparency of relevant fatwas [Shariah pronouncement] and research will also be an
essential part of wider education and outreach efforts to help address skepticism about the industry.”
Several participants also called on Islamic banks to invest more in universities. “Larger Islamic
financial institutions should come up with graduate programmes,” said Mohamad Safri Shahul Hamid, a
former Deutsche Bank executive who is now deputy CEO of MIDF Amanah Investment Bank. “These banks
don’t yet have the same [graduate training] offering as the Goldman Sachs and Merrill Lynches of this
world.”



6. Priorities for action

T he global outlook of the Islamic financial services industry remains strong, driven by a combination
of macroeconomic factors, Muslim population demographics and growing demand from non-Muslim
institutions for Shariah-compliant products. But this rapid growth does create challenges for the
industry.
At a policy level, there is a need for greater engagement by governments with the industry, including
representation on global decision-making bodies such as the IMF and World Bank. In some cases,
governments in Islamic countries have been sluggish in promulgating legislation to allow the further
development of Islamic finance. Despite progress by some governments, most have a long way to go to
address legal and tax impediments.
In terms of industry standards, there is still a lack of a clear regulatory framework and guidelines.
Importantly, standards need to be as simple and transparent as possible.
Among financial leaders in the industry, a strong consensus exists that risk management and
regulatory standards need to be strengthened and that Islamic financial institutions are lagging in their
implementation of risk management systems. The experience of the recent financial crisis highlights
the need for improved risk management in relation to capital markets product structures, as well
as greater regulatory efforts by capital markets authorities to enforce high standards of disclosure
and transparency. Strengthening credit risk management systems in large Islamic entities is also an
important priority.
To that end, improving the development of human capital and establishing best-practice international
standards for the industry, remain important priorities. Many in the industry are calling for greater
international co-operation among academic institutions to establish common standards, as well as a code
of conduct across financial centres. Meanwhile the industry itself needs to offer more support to up-and-
coming students. More research will also be needed to promote innovation, from new risk management
systems to a greater and more inclusive range of products and services, to maximise the opportunities for
further growth.


Whilst every effort has been taken to verify the accuracy
of this information, neither The Economist Intelligence
Unit Ltd, nor the sponsor of this report can accept any
responsibility or liability for reliance by any person on this
white paper or any of the information, opinions or conclu-
sions set out in the white paper.

Cover image - Corbis/Pascal Deloche

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