Even as the world is headed for sluggish economic growth, the Islamic finance industry still has massive potential, a top Singapore central banker said on Tuesday.
But the sector will achieve this potential only if it can overcome its fragmented state, he added.
Speaking at the World Islamic Banking Conference: Asia Summit on Tuesday, Monetary Authority of Singapore managing director Ravi Menon noted that Islamic finance has shown remarkable resilience in the last five years.
The industry has grown by about 20 percent annually in this period to reach US$1.3 trillion in total assets last year.
However, the overall size of Islamic assets is still less than 1 percent of the global financial system, Menon said.
Islamic finance offers fewer product choices for consumers and less comprehensive risk management options for institutions.
Cross-border investment flows are also constrained by differing interpretations of what is permitted under sharia principles, Menon said.
“The isolated pools of Islamic liquidity in each market restrict opportunities for more efficient allocation of capital across consumers, industries and jurisdictions.”
To overcome this, Islamic financial institutions must strike roots in the major financial centers of the world, he said.
“The broad and deep investor pools in international financial centers offer an opportunity to channel non-traditional sources of funds into Islamic finance.”
In Singapore, for instance, several local and foreign issuers have successfully tapped the capital markets using Islamic instruments, he noted.
The demand for such products has come from investors across Asia and Europe, many of whom are simply attracted by the credit quality and yields offered.
Then there are opportunities for interaction and collaboration with other players in that international financial centre, he said.
He was speaking to a roomful of bankers from around the world gathered in Singapore for the two-day event.
While an escalation of the euro zone crisis could curtail the growth of the Middle East and thus affect many Islamic banking players, he noted that this period is also a window of opportunity for the industry.
“With its strict prohibition on excessive leverage, Islamic finance has been spared the worst of the financial crisis,” Menon said.
“Islamic banks are well positioned to reach out to new customers who are in need of financing, as many global institutions pull back on their lending due to the need to repair their balance sheets.”
Islamic finance should diversify into growth areas such as trade and infrastructure financing, he added, where demand is still strong, especially in emerging economies.
Another big challenge facing Islamic finance is one that all banks have to contend with regulatory reforms.
Like their conventional banking counterparts, Islamic financial institutions will have to devote considerable resources to meet the new international standards being rolled out, Menon said.
However, there are certain inherent characteristics of Islamic finance that will stand it in good stead in the new regulatory environment, he added.
Islamic banks have consistently held higher levels of capitalization than conventional banks, by some 2.5 percentage points on aggregate, according to research from the World Bank.
They also start off with a higher level of liquid assets than their conventional counterparts.
Islamic finance is also well placed to meet the increased “return-to-basics” investor demand, Menon said.
“Islamic finance, with its stronger emphasis on transparency, price certainty and risk-sharing, can benefit from this renewed demand for more basic investments, from Muslim and non-Muslim investors alike.”
The conference coincided with the board meeting of the International Islamic Financial Market, which was also held here.
The directors of this global standard-setting body, drawn from government bodies and the private sector, discussed the development of standards for new Islamic finance products.