What is the Future of Islamic Finance?

The Islamic finance industry has seen exceptional growth over the past decade and many optimistic predictions have been made regarding the enormous potential for future development. But Cedomir Nestorovic explains why in his opinion, Islamic finance will never be able to replace conventional finance.

Islamic finance has experienced continuous growth in the last 30 years. Year after year, there has been continuous expansion of total Islamic finance assets as well as a sophistication of products, together with an ever-growing number of countries, companies and institutions participating in the industry. Ernst & Young in its latest forecast puts the figure of total Islamic finance assets at US$1.8 trillion for 2013, a significant increase compared to US$1.3 trillion registered in 2011. At the same time, Islamic finance has proved its ability to be more resilient than conventional finance in spite of some drawbacks such as the Dubai real estate plunge in 2010 and sukuk posting an unusual loss in 2013. Many observers have jumped immediately to the conclusions that the future is bright, that Islamic finance is superior to conventional finance and that it will naturally replace conventional finance.

However, this cannot happen for several reasons.

Limited organic growth

Islamic finance today represents only 1% of conventional finance and the probability that shariah compliant products could replace interest-based products is close to zero. The pace of growth of Islamic finance is a bold one (at about 15 - 20% growth per year), much higher than conventional finance, but it is not sufficient to replace conventional finance. It is striking that the industry does not progress at a rhythm of 40 - 50% per year or more, given its novelty and supposed appeal to 1.6 billion Muslims worldwide.

Limited institutional and individual demand

Institutional investors, banks and companies in Muslim countries, especially in the GCC, still prefer to use conventional finance, while some important western institutions have already experienced backlashes in the domain. Goldman Sachs abandoned its landmark sukuk launch worth US$2 billion in 2011 and HSBC restructured its subsidiary, Amanah, in 2012 by closing its Islamic banking operations in the UK, the UAE, Bahrain, Bangladesh, Singapore and Mauritius. Since HSBC is a leading western institution engaged in Islamic finance, the decision sent gloomy signals about the possibility to expand Islamic finance in the western world.

The biggest financial hubs in the world (New York, London, Paris, Singapore and Tokyo) either do not deal with Islamic products, or if they do so, the amounts traded are in the range of a statistical error. Islamic banks are still at least 10 times smaller than big conventional banks, so there is no way that Islamic finance can replace conventional finance.

On the individual demand side, Booz & Company released a report on GCC private banking 2010 - 2011 showing that while 10 - 30% of private banking clients interviewed in the GCC said they would choose 100% conventional products in any case, only 10% of respondents said they would use 100% Islamic products.

Hypertrophy of the industry

Islamic assets rely very much on one country, namely Iran. According to figures coming from Kuwait Finance House-Research, total Islamic assets increased from US$1.1 trillion to US$1.3 trillion from 2011 - 2012, but at the same time, Iran accounted for from 41 - 42% of all these assets. The fact that Islamic assets rely heavily on just one country and that this country is becoming more and more of a castaway country with few possibilities to expand abroad, is putting the whole Islamic finance industry in jeopardy. S&P forecasted in 2012 that the Islamic finance industry would double between 2011 -2015. Since the industry is so dependent on Iran, it means that Islamic finance from Iran must also double in the same period, which is more than doubtful.

If we look at the sukuk side, it depends very much on another single country: namely Malaysia, which accounted for an astonishing 80% of all sukuk issuances in 2012. Malaysia participates actively to the international development of Islamic finance but Iran is rarely invited to join the effort. It is therefore difficult to imagine how Islamic finance can develop if its champion, Iran, does not participate. The development of Islamic finance is therefore hypertrophied and does not show the balanced growth that could be expected from an industry claiming to be universal. Many of the biggest economies in the Muslim world (such as for example Indonesia and Turkey) do not participate as fully as they could in the development of Islamic finance, nor have many of them reached their full potential, for example in the case of Saudi Arabia. Islamic assets represented about 50% of total assets in Saudi Arabia in 2011, while in Turkey and Indonesia they represented less than 10% in the same year.

So, what is the future?

Perspectives for Muslim countries Islamic banking started with a simple idea, providing Muslims with products which will satisfy their spiritual concerns. However, not all Muslims were convinced at that time about the necessity of Islamic finance, and still are not convinced today. If the pillars of Islam are well known to them, if Halal food as a dietary law is regarded as compulsory, it is not necessarily the case for Islamic finance. Educating Muslim consumers is the key issue because the room for growth in Muslim countries is still the most important and the most promising option for the industry.

The alternative to education is a political move. Muslim countries can decide to Islamise their financial sector as it has been done in Iran or in Sudan. Why not? If Muslim countries believe that Halal food is important, and that all food imported must go through Halal certification, it can also be done for Islamic finance.

In a great number of Muslim countries, Muslims cannot buy Haram products which are available only to non-Muslims. The same thing could be done for Islamic finance, making it compulsory for Muslims, if not for the whole country. According to the 2013 International Islamic Financial Market (IIFM) report on sukuk, 2011 and 2012 witnessed record sukuk issuance by sovereigns, quasi-sovereigns and corporates, in that order. This suggests that the political decision is the most important one when it comes to sukuk issuance.

Finally, Islamic finance can enter new areas, such as Waqf and Hajj savings products. This was after all the debut of Islamic finance in Malaysia, with the establishment of the pilgrimage fund Tabung Haji in 1963. Since all Muslims are concerned with Hajj, financial products associated with savings for the Hajj could be much more attractive to them than takaful or retail Islamic banking.

Perspectives for western countries

As for the western countries, there is a long way for Islamic finance to go before it can have a significant impact. Only a few western countries have authorised Islamic finance and provided similar conditions to those applied to conventional finance. There are serious political barriers preventing the development of Islamic finance. It is true that there were some remarkable examples of Islamic finance in western countries, but these examples are rather in the category of exceptions than the rule.

Many proponents of Islamic finance assume that should western countries accept Islamic finance, its success is guaranteed. This is wishful thinking because even if all regulatory and tax burdens disappear in the west, it is not certain that customers, Muslims or not, would embrace Islamic finance. Why should France, the UK or Germany be more ready to accept Islamic finance than some big Muslim countries? How can we expect Islamic finance to develop in France or the UK if it is not growing in Turkey or Algeria?

The future of Islamic finance is therefore first and foremost in Muslim countries, where room for growth still exists, provided education and political willingness are secured. It is a waste of money and time to insist on pushing the development of Islamic finance in western countries, where competition with conventional finance is fierce and merciless.


Cedomir Nestorovic is a professor at ESSEC Business School Asia Pacific.

This article first appeared in Islamic Finance News (24 July 2013, Volume 10, Issue 29, Page 14 - 15). For more information, please visit