Islamic finance growth to slow due to oil fall and reforms

The growth of the US$2 trillion Islamic finance industry is set to slow as the weak oil price and regulatory reforms take their toll on the sector.

Growth is expected to slow to the single digits next year after expanding by as much as 15 per cent over the past decade, Standard & Poor’s said yesterday.

The industry, nonetheless, will grow by 50 per cent to $3tn in the next decade, the credit rating agency said in a report.

“The decline in oil prices and its implications for core market economies, the rapid changes in the global regulatory framework for banks and insurance companies, and the industry’s fragmented nature are the main contributors to the expected slowdown,” S&P said.

The decline in oil prices is taking a toll on the public finances of oil-exporting countries governments, the agency said, adding that most of these countries are core markets for Islamic finance.

All six energy-exporting Arabian Gulf states are likely to continue to spend to support growth, but if oil prices fall further they may rethink their investment policies, which would affect Islamic finance.

“The rapid changes in the global regulatory environment for banks and insurance companies are also affecting Islamic finance,” said S&P. “In particular, Basel III for banks and Solvency II [risk-based capital requirements for insurance companies], and the implementation of bank resolution regimes in major EU countries are raising the bar for Islamic financial institutions to keep pace with developments in conventional finance.”

The Islamic finance sector also remains very fragmented, stunting its growth.

S&P, though, expects growth to pick up in the next decade. Iran could be a key market for growth as it emerges out of decades-old sanctions thanks to the nuclear deal with the West struck this year.

Regional governments could also look upon Islamic finance as an avenue to finance their budget deficits as they maintain their spending momentum in a low oil price environment.

“Apart from Iran, governments in the GCC countries will likely try to maintain their capital spending,” said S&P. “Consequently, they may look for alternative financing sources, such as the domestic or international capital markets, support economic growth, build debt capital markets, and slow the depletion of their asset positions.”

This month, S&P said it expected Gulf Islamic bond or sukuk issuance to grow in single figures next year – after a run of double-digit growth between 2008 and 2014 – as Gulf governments trim spending amid weaker oil revenue.​

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