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Fintech, digital sukuk could spur Islamic finance growth in Middle East

The Gulf has seen a boom in funding for fintech startups, more than quadrupling from $200 million in 2020 to $885 million last year.
This photo shows the logo of the Saudi Stock Exchange Market (Tadawul) bourse in the capital Riyadh, Saudi Arabia, Dec. 12, 2019.

Fintech companies and digital sukuk could be two key growth drivers of the global Islamic finance industry in the Middle East and North Africa in the coming years, according to a senior executive at the Standard & Poor’s rating agency.

The Gulf has seen a boom in funding for fintech startups, increasing by more than fourfold from $200 million in 2020 to $885 million in 2022.

In an interview with Al-Monitor, S&P’s global head of Islamic finance, Mohamed Damak, said, “Fintech could help in the Gulf where we see most of the growth coming in the payment and money transfer business and that comes down to the structure of the population, the amount of money that is being sent back home every year.”

Damak added that some companies in the region had tried to develop their offering to push digital sukuk, a new type of Islamic bond, which a world of increasing automation and digitalization could benefit from. While with a conventional sukuk, much of the documentation is done on paper, with digital sukuk, it is all done digitally.

Traditional Sharia-compliant bonds, called sukuk, have been popular since the early 2000s. Sukuk was developed as an alternative to conventional bonds that are not considered permissible by many Muslims as the deals involve paying interest (riba). The global sukuk market was worth $193.2 billion in 2022, according to Refinitiv data, with the main issuers being Malaysia, Indonesia and Saudi Arabia.

Damak said that the increased use of digital sukuk, which gained more popularity during the coronavirus pandemic, would make the processing of issuance easier for investors and issuers. It could also resolve issues related to the standardization of deals, such as having consistent legal documents for the sukuk structure. The process will also be faster if its all done digitally.

Globally, S&P has seen some foreign currency-denominated sukuk over the past few years, and an increase in issuance driven by Saudi Arabia’s process of implementing the Vision 2030 agenda to diversify its economy away from oil. The rating agency also said it saw growth in green and sustainability-linked sukuk.

Industry challenges

Damak noted during the first half of 2023 some companies and investors were pushing to weaken the fixed income characteristics — when a bond pays a regular amount to investors until maturity — of sukuk, often to try and introduce a little more profit and loss sharing in the legal documents.

“That could be problematic for the industry because if sukuk were to become an equity-like instrument, you would be speaking to a completely different investor base, you will be speaking to completely different pricing mechanisms, etc.,” he added.

Although he sees that as a risk for the industry going forward, the overall outlook is positive. S&P expects the global Islamic finance sector to grow by about 10% year-on-year in 2023 and 2024 after expanding by a similar number in 2022, excluding Iran.

Another issue that the industry has been facing for the past decade is that Islamic finance is concentrated in too few countries and because of that, banks have not been able to price deals as competitively as conventional transactions, meaning that it is harder for the market to expand globally.

Take Britain for example, where Islamic finance began in the 1980s with the introduction of Murabaha transactions, which involve the seller and buyer agreeing to the cost and markup of an asset in line with Sharia principles. Today, only 0.1% of total banking assets in the United Kingdom are Islamic and there are only four active Islamic banks, Damak noted.

North African market

Despite having huge Muslim populations, Islamic issuance from North African countries has historically been low for similar reasons.

“The penetration of Islamic finance has not been that significant, and that's because there would be clients that would have a natural preference for Islamic finance — the vast majority, as we understand — if economically it would add value for them as well,” Damak said.

By that, he means whether the pricing is cheap and comparable to conventional bonds. Or the fact that sukuk allows access to some investors who are not prohibited from investing in bonds, unlike some Islamic investors.

Egypt raised $1.5 billion in February from its debut sale of Islamic bonds at a yield of 11%, Reuters reported at the time. It priced in a similar manner to conventional sovereign bonds. However, other new issuers are often deterred by the complexity of issuing Islamic bonds.

Conventional bonds have been popular for many years and the time needed to market them to investors is often short. “While for sukuk, you have to make sure that your regulatory environment is conducive for that and you have to make adjustments; if it's not the case, you have to identify structure, to identify underlying assets, to speak to the lawyers, the scholars, etc., to structure a product in order to be able to make it to the finish line,” Damak noted.

“And that process is much longer and much more complex than a conventional bond. That's why we think that if we were to see a simplification of the process — say for example through digital sukuk — we could see many more countries and many more issuers making it to the finish line and trying to double the opportunities of the sukuk market,” Damak concluded.

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