Islamic finance industry ‘must diversify to boost growth’

Islamic finance, which prohibits charging interest, is set to double in size in five years, but the one-trillion-dollar industry must diversify and regulate to realise its full potential, analysts and economic reports say.

Diversification into new territories is also necessary to reduce the risk of exposure and utilise their full potential, they add.

Islamic law not only forbids charging or paying interest, but also bans speculation and investment in sectors deemed haram (prohibited), such as pornography, gambling, arms, alcohol and pork products.

Perhaps the most popular product is Murabaha, which is used to finance consumer purchases from cars to houses. Sukuk is the equivalent of bonds to raise funds for large-scale investments.

Under a product called Musharaka, which means partnership, the bank provides funds to enable the customer to buy an asset, with the two parties agreeing a profit or equity sharing ratio for that asset. Losses are shared on a similar basis.

The broader principle of Islamic finance is based on sharing risk and profit.

Despite the number of products offered, Amrith Mukkamala, director of asset allocation at Kuwait and Middle East Financial Investment Company, believes they are still limited.

“The products (of Islamic finance) for investors are still very limited … compared to high demand,” he said, adding that the field of derivatives should be explored seriously.

Kuwaiti economist Hajjaj Bukhdur believes there are enough products, and even greater expansion has been subdued by a lack of sufficient regulation and management skills.

“Islamic finance has around 30 types of products and instruments, giving it a large degree of flexibility to meet investors’ demand and continue to expand rapidly,” he said.

“But it has two major shortcomings: there are different regulatory systems and managements have been less competent to realise the full potential.”

Assets of Islamic financial institutions increased five-fold to around $1trn between 2003 and last year, but Moody’s Investors Service believes the full potential is at least $5trn. But it only makes up around five per cent of the global financial industry.

In May, speakers at a forum on challenges facing the sector, said it took 40 years to reach $1trn in assets, but now it will take just five years to double.

The number of Islamic financial institutions and banks have grown from just a few in the mid-1970s to several hundred, operating in more than 50 countries, and with leading global banks getting into the business.

In April, Moody’s urged the Islamic finance industry to innovate, particularly in risk-hedging, if it is to thrive. The combined use of securitisation and derivatives “offers considerable scope for reducing the risk exposures of Islamic financial institutions and thus improve their overall creditworthiness,” it said.

source : gulf daily news