Muhammad Hammad

The Islamic Financial Services Industry (IFSI) assets saw a global growth of 4% year-on-year (YoY) to reach USD3.38 trillion in 2023, despite a challenging macroeconomic environment characterized by inflationary pressures, geopolitical tensions, and banking sector stresses.

Islamic banking continues to be the largest segment of the IFSI, constituting 70.21% of the total global IFSI assets in 2023, while Sukuk outstanding and Islamic funds collectively represented 29.08%, and the Islamic insurance segment represented 0.71%.

The regional distribution of global Islamic finance assets reveals a pronounced concentration in the Gulf Cooperation Council (GCC), which accounts for 52.50%.

The East Asia and Pacific region holds the second-largest share at 21.80%, trailed by the Middle East and North Africa (excluding GCC) at 12.70%. Further breakdown is as follows: Europe and Central Asia (8.30%), South Asia (3.10%), Sub-Saharan Africa (0.70%), and others (0.90%).

Financial Stability of the Islamic Financial Services Industry

Islamic banking segment

The Islamic banking segment demonstrated continued resilience across the key soundness indicators. Islamic banking assets saw a YoY growth of 7.21%, reaching USD 2.37 trillion by Q4 2023. The growth was driven by increases in deposits and financing of 7.92% and 5.97%, respectively.

The continued expansion of the global Islamic banking segment was also reflected in robust profitability indicators across most jurisdictions, against a lower or moderate cost to income, which positively affected Islamic banks‘ net income.

The improvement in profitability was backed by a decline in Non-Performing Financing (NPF) ratios across most regions with one exception and an increase in financing across all regions, mainly in the household, real estate, construction, and manufacturing sectors. Islamic banks remain well-capitalized.

The overall capital structure of the global Islamic banking segment across all regions continued to be robust and within regulatory requirements, with the average capital adequacy and Tier 1 capital ratios at around 19.10% and 17.83%, respectively.

The global leverage ratio for Islamic banks remains above the 3% regulatory requirements for all regions.

However, challenges remain due to the scarcity of Islamic liquidity management instruments. Islamic banks often rely heavily on cash as part of their high-quality liquid assets to meet regulatory requirements, highlighting the need for expanded investment opportunities and the development of more diversified Shari‘ah-compliant financial products.

Islamic capital markets

Sukuk outstanding reached USD 850 billion, reflecting a 2.45% YoY growth, with the continued strong demand for Sukuk reflected by oversubscription of major issuances during the year. Sovereign issuances accounted for over half of total issuances, while corporate issuances saw a slight downturn, although corporate issuers‘ participation in the Sukuk market has significantly improved in recent years. Sustainability-related Sukuk issuances increased substantially in 2023, amounting to a total of USD11.94 billion, of which around 65% were green Sukuk.

Islamic AuM fell to $182.24 billion in 2023 due to macroeconomic and currency factors. Equity funds led allocations, followed by commodities. Islamic equity markets remained strong, outperforming conventional peers.

Islamic capital markets face liquidity challenges but have growth potential. Drivers include an improving global outlook, ethical investing, technology, government initiatives, and international integration.

Takaful

The global Islamic insurance industry demonstrated resilience in 2023, with contributions growing by 6.5% YoY to reach USD 24.05 billion in Q3 2023. This growth was primarily driven by the strong performance of the general segment, which saw an overall increase of 21% YoY globally. However, there were regional disparities in growth, with some regions reporting strong growth while others saw a slight decline, particularly in regions where the family segment is more dominant or those that experience a decline in USD terms due to the impact of currency depreciation.

Profitability differed by region, with some areas seeing significant gains. Factors driving growth included rising awareness, demand for savings and mortgage products, and regulatory efforts to consolidate the sector.

Underwriting performance was stable across most regions. Expense ratios decreased in the general segment, while the combined ratio slightly increased, signalling potential challenges.

Capacity constraints and increasing demand may cause market conditions to tighten further in 2024. Protection gaps are a key concern, exacerbated by rising natural catastrophes, climate risks, and geopolitical conflicts. Proactive regulatory actions are essential to address these potential challenges and ensure the segments‘ stability and resilience. These include strengthening regulatory frameworks, implementing stress testing requirements, enhancing risk modelling for climate risk management, and monitoring potential vulnerabilities and risks, including interlinkages between sectors.

Forecasting

The International Financial Services Industry (IFSI) is poised for sustained growth in 2024, driven by an enhanced outlook for near-term global financial stability and anticipated disinflation.

Robust resilience indicators underpin this positive trajectory. However, unforeseen tightening in global financial conditions may trigger capital outflows from emerging markets, potentially exerting downward pressure on currencies and other assets.

Thus, continued vigilance remains important, and regulatory and supervisory authorities should take steps to ensure institutions offering Islamic financial services (IIFS) can withstand potential global shocks and other risks through effective risk management and supervisory oversight using stress testing and early corrective measures. Where there are existing data gaps for the IFSI, reporting requirements should also be enhanced.

It is also important for regulators to prioritize full and consistent implementation of international prudential standards, notably complete the implementation of risk management, capital adequacy, and disclosure standards. Further progress on crisis management, particularly establishing adequate recovery and resolution frameworks, is also of critical importance to limit any impact in the case of failure of an IIFS.