Following financial crises in the US and Europe, investors are increasingly attracted to raising funds for investments through Islamic bonds called “sukuk.”
Sukuk are an alternative to conventional bonds that governments and companies sell regularly to raise funds. They comply with sharia law, the moral code of conduct based on the Quran, which prohibits charging interest and trading in debt.
Ernst & Young’s Global Islamic Banking Centre of Excellence projects that global demand for sukuk is likely to triple to $900 billion in 2017. Here are a few reasons for the surge:
The world’s Muslim population is growing at about twice the rate of the non-Muslim population, the Pew Research Center estimates, driving the growth of the Islamic banking industry.
Banks in the Middle East are flush with cash because of high oil prices. Islamic banks, particularly those that were not hard hit by the financial crises in the US and Europe, are looking for opportunities to park their cash. Worldwide, Islamic assets held by banks account for an estimated $1.1 trillion, according to Ernst & Young’s Islamic banking report. Their share of all commercial bank assets varies from country to country. In the Middle East and North Africa, Islamic assets constitute an average 14% of banks’ assets.
Muslim countries have increased government spending to stimulate, develop and sustain economic activity since the beginning of the Arab Spring.
Investors worldwide are seeking safer investments following global financial crises. Sukuk are unsecured, asset-based loans. Unlike asset-backed loans, which use buildings, land or patents as collateral, sukuk must be based at least 51% on an asset that generates rent, such as a building. The sukuk issuer can make amortised payments or a bullet payment at the end to pay off the sukuk. While the majority of the payments must come from the rent, a smaller portion can come from profits that a business generated.
“Would the growth be the same if the US and the European market weren’t in crisis? Perhaps yes, but not at the rate you see now,” said Rizwan Kanji, a lawyer who specialises in sukuk transactions in the Dubai office of the law firm King & Spalding. “… The growth of sukuk will continue while the Western markets recover.”
Establishing a global standardised sukuk trading platform that is open to all financial institutions would go a long way toward spurring more supply, according to Ashar Nazim, E&Y’s MENA Islamic finance services leader.
“There is an urgent need for a new direction in the market to be led by leading Islamic financial institutions and multinational institutions in a collaborative manner,” he said in a statement. “Globally, at least 14 Islamic banks today have the financial muscles to venture into [the] international sukuk capital market. Prerequisites are international connectivity, sukuk structuring and trading expertise, and balance-sheet strength.”
—Sabine Vollmer (email@example.com) is a CGMA Magazine senior editor.