Saudi Arabia set to strengthen lead as world's biggest Islamic finance market

Demand for government sukuk and Shariah-compliant mortgages is helping to drive asset growth in the kingdom

King Abdullah Financial District in Riyadh, Saudi Arabia. Saudi Arabia is the world's biggest Islamic finance market, with assets of $339bn as of March 2020. Reuters

Saudi Arabia is set to strengthen its position as the world’s biggest market for Islamic finance as more customers switch from conventional to Shariah-compliant products, according to Moody’s Investors Service.

Despite the short-term challenges presented by a pandemic-induced economic recession and a decline in oil prices, the shift by companies and individuals towards Islamic finance products will mean they make up about 80 per cent of system-wide loans within the next 12-18 months, up from 78 per cent last year and 70 per cent in 2013.

The industry is also set to benefit from the government’s sukuk debt issuance programme, a deepening of the kingdom’s capital markets and the easing of some restrictions on foreign investment, the ratings agency said.

“A comprehensive set of Islamic finance regulations have spurred Saudi [Arabian] banks to issue sukuk, Islamic products are now listed on the main market, and an Islamic mortgage refinancing business has been established,” Ashraf Madani, a senior analyst at Moody’s, said.

Saudi Arabia is already the world’s largest Islamic finance market, with assets of $339 billion as of March 2020, the ratings agency said. Malaysia is a distant second with $145bn of Islamic assets.

Mirroring a global trend, Saudi Arabia's economy has been impacted by the coronavirus pandemic this year, with gross domestic product in the second quarter declining by 7 per cent, according to official government data.

Moody’s expects the kingdom's government to run a budget deficit of 12 per cent of gross domestic product this year and for its external financing needs to increase by the same amount, the ratings agency's sovereign and sub-sovereign senior analyst Alexander Perjessy said during an online conference on Wednesday.

However, rather than tapping reserves or international debt markets by raising foreign currency-denominated bonds as it has in the past, "the government has really taken advantage of the very strong domestic demand for sukuk and significantly increased the size of its borrowing in the sukuk market this year", Mr Perjessy said.

"Based on the issuance we have seen in the first nine months of the year, we now expect total 2020 sukuk issuance by the government will reach around $40bn-equivalent, which is nearly double last year’s sukuk issuance, taking the stock of government sukuk to more than $100bn, which would be more than Malaysia’s stock of outstanding sukuk," Mr Perjessy said.

Buyers of sukuk in the domestic market have come from several sources. Banks now hold about 400bn riyals ($106.67bn) of government sukuk instruments, Mr Madani said, while two state-run entities –  the Public Pension Agency and the General Organisation for Social Insurance – have also bought about $12bn worth through private placement deals this year, Mr Perjessy said.

Retail investors in Saudi Arabia have also been major buyers since a rule change last year reduced the minimum subscription size to 1,000 riyals, from one million riyals previously.

This "makes it easier for retail investors to participate in the market and for mutual funds to be able to set up dedicated sukuk investment funds", the ratings agency said.

The volume of sukuk now traded on the kingdom's main bourse, Tadawul, has increased to about 70bn riyals on an annualised basis for the first eight months of this year, Mr Perjessy said, compared to less than 1bn riyals in 2018.

Other significant drivers of growth in the market will be the mergers between major Saudi Arabian banks, which favour Islamic finance because "Islamic banks are playing a leading role", according to Moody's.

The booming local mortgage market, assisted by government programmes to increase home ownership, will be a "key driver in asset growth", Mr Madani said.

"These are largely done in a shariah-compliant form and hence we expect this product to be a key support for the continued penetration for Islamic finance in the Saudi [Arabian] banking system," he said.