Islamic banking set to change financial markets

Sharia-compliant banking is growing in many regions, and not just in Islamic nations. The UK recently announced a £200m Sukuk bond, and other countries are sure to follow


On October 29, 2013, British Prime Minister David Cameron announced that the UK would issue a £200m sovereign Sukuk in 2014, making the UK the first Western nation to do so. As if to say, “Why not?”, the UK, with this announcement, has given a much-needed sense of legitimacy to a small but growing sector of the banking industry with great potential. If one were listening carefully after that announcement, a small cheer might have been heard coming from the direction of Saudi Arabia, an epicentre of modern Islamic banking.

Although Malaysia, Indonesia and a number of other countries have long been players in Islamic banking and finance (see Fig. 1), the GCC – more specifically, Saudi Arabia – has been a critical region with regard to Islamic banking’s future. The kingdom, which is home to the birthplace of Islam as well as the first modern Islamic bank (the Islamic Development Bank, or IDB) and the world’s largest Islamic bank (Al-Rajhi Bank), had for the longest time relied on a conventional banking model. But with IDB’s launch in 1975 and the subsequent rise of the Al-Rajhi empire a decade later, a path was laid towards an Islamic banking future for all in the country.

Sharia leader
Saudi Arabia’s importance cannot be understated. Currently, it is the largest IDB shareholder with 26.5 percent of paid up capital. According to the Islamic Research and Training Institute, an IDB affiliate, the kingdom also represented 7.1 percent of the $1.6trn global Islamic banking market in 2011. However, more importantly, Islamic banking accounts for nearly half of the kingdom’s banking market. Oh, and liquidity abounds.

In Riyadh and Jeddah, where Saudi Arabia’s banks are headquartered, both Islamic and hybrid Islamic/conventional banks are tripping over themselves to present their sharia-compliance bona fides. Conventional operations have gone far beyond the opening of so-called ‘Islamic windows’ and are now launching fully Islamic branches, as is the case with Saudi Investment Bank. And new market entrants, such as the well capitalised, publically owned Alinma Bank, have the benefit of being founded as 100 percent sharia-compliant across all products, services and operations.

What does all this have to do with London? That question can be answered with three words: competition, standardisation, and growth.

Saudi Arabia has the potential to become the hub for international Islamic banking and finance. However, in order to fulfil this potential, issues related to competition, standardisation and growth need to be sorted out. In short, if London pushes for a foothold as an Islamic banking hub, this will force Saudi Arabia (and others for that matter), to address its current challenges. Additionally, rising waters lift all boats; if London can be a gateway for other Western nations to adopt Sukuk financing or other Islamic instruments and practices, Saudi will have greater opportunities.

Milestone Sukuk deals
In the short run, Sukuk seems the most likely avenue for Saudi growth and is the area in which the country can be most influential. Already in 2013, there have been a number of important Sukuk issuances, most notably the Sadara Chemical issuance at $2bn, and the government’s $4bn issuance for the General Authority of Civil Aviation. These deals are not insignificant and cannot be ignored. In fact, they will be analysed and scrutinised with regard to their structures, and if Saudi Arabia keeps up this pace, it will help shape the discourse on how such Sukuk deals should be handled.

In terms of industry growth, however, the line need not be drawn at project finance. If anything has been learned in the past decade, it is that Islamic retail banking can compete with conventional retail banking and can be profitable in doing so. And if London were to open the door to retail operations in the future, this would give Saudi Arabia another area in which to shape the discourse and create opportunity for itself.

The two newest banks in Saudi Arabia, Albilad and Alinma, already hold an advantage over many regional and even European retail banks thanks to technology. Unencumbered by legacy systems, their sharia-compliant offerings are often easier to deliver. Alinma, in particular, has leveraged technology to be first to the market with smart-chip cards, instant in-branch card issuance, services for the blind and automated safe deposit boxes.

In short, the line between conventional and Islamic products will continue to blur. Innovation in sharia-compliance will make it possible for Islamic banks to challenge nearly all conventional products. The market will grow, and Saudi, if it plays its cards right, could be leading the charge at the end of the day.