Keynote Address: “Islamic Finance in the New Normal: Assessing Stability Risks in Turbulent Times” by Mr Jaseem Ahmed, Secretary-General of the IFSB at the “London Sukuk Summit 2016”
Date posted: 25 May 2016
||25 May 2016
|Event / Venue
||Sukūk Summit 2016 | London, UK
||Mr Jaseem Ahmed, Secretary-General, IFSB
Islamic Finance in the New Normal: Assessing Stability Risks in Turbulent Times
In my remarks today I will first share with you some of the principal findings of the IFSB Stability Report in terms of the growth of Islamic finance.
Second, I will briefly evaluate the issue of the stability and resilience of Islamic finance, drawing upon the framework and data that the IFSB has developed.
In the third part my presentation I will offer details on the performance of the Sukūk market not only in 2015, but also during the first quarter or so of 2016 in which there was considerable activity taking place.
I will conclude with some observations on Key Constraints and Issues, and will point to a new set of standards to be prepared by the IFSB to support Sukūk and Islamic Capital Markets.
A. RECENT INTERNATIONAL DEVELOPMENTS
Let me begin, however, with some brief observations about the context in which Islamic finance is currently operating, which is a global financial and economic environment of continued uncertainty and volatility.
We are all now familiar with the key challenges arising from a slowdown in the Chinese economy and its wide ranging ramifications globally in terms of its impact on commodity prices which are depressed, and on reduced growth prospects for emerging markets.
This and other developments in the Eurozone have also affected investor confidence globally and contributed to a heightened sense of risk which is aggravating volatility in cross-border financial flows.
Another source of concern is uncertainty over how markets would react in response to the expectation that central banks in systemically important economies would be raising their interest rates.
For Islamic finance, the underlying issue is that the cross border transmission of economic shocks is now a feature of the global economy that is impacting Islamic finance in view of its greater internationalisation.
An aspect of this transmission of shocks is the greater cross-sectoral links emerging within Islamic finance, in particular through the greater reliance being put on Sukūk by many Islamic finance institutions for both funding and asset side purposes.
This is a channel of inter-linkage that will require closer scrutiny by regulatory authorities in the interest of preserving and strengthening the stability and resilience of Islamic finance.
The IFSB is contributing to this task through the development of a Technical Note on Stress Testing, in which we provide some illustrative simulations of how the Sukūk market interlinkages can both strengthen Islamic financial institutions and systems, while also exposing them to greater vulnerability in the event of adverse economic shocks of a cross border nature.
B. ISLAMIC FINANCE: GROWTH PERFORMANCE
The strong and sustained double digit growth rates of Islamic finance since the global financial crises underwent a marked change in 2015.
In comparison to the 2015 IFSB Stability Report, the global Sukūk outstanding, based on par value at issuance, declined in 2015 by 1.4% to USD290.6 billion.
In contrast, the Takāful sector grew by 8.4% to USD23.2 billion, while the Islamic banking sector assets grew at 1.4% to USD1.5 trillion.
It is too early to draw reliable long term inferences from the evidence of a single year. However, macroeconomic developments and factors such as lower commodity prices, particularly of hydrocarbons, have impacted jurisdictions in which Islamic finance has a large presence.
Despite the modest growth of the banking sector, the cumulative growth rate has led to an increase in its systemic importance, with the number of countries that have more than 15% of banking sector assets in Islamic banking rising to 11.
We also see the emergence of a number of new jurisdictions which have come into the data coverage of the IFSB, with relatively large IF sectors, although still under that of the systemic importance threshold of 15%.
C. STABILITY AND RESILIENCE OF ISLAMIC FINANCE
I am going to draw upon the set of indicators that the IFSB has developed to assess resilience. This year, in addition to the data from our sample of financial institutions, we have also drawn upon the Prudential and Structural Islamic Finance Indicators (PSIFIs), which cover the banking sector and are provided by our member central banks from 17 major jurisdictions.
With growth slowing down, in terms of its stability and resilience, the ROA and ROE remain relatively stable in the banking sector compared to 2013, however at 0.95% (ROA) and 8.96% (ROE) in 2014, they are still short of the figures observed in 2008.
However there is some diversity in country and regional experience and it is notable that these figures have returned to their pre-crisis figures in the UAE.
Financing ratios are deteriorating in the banking sector, with both the Finance to Deposit ratio and the short-term asset to liability ratios moving into less favourable ranges. Again there is country and regional variation, with the GCC countries maintaining the F/D ratio below 100%, while this ratio is exceeding 100% in a number of Asian economies.
On a positive note, capitalisation of banks remains strong and the average Tier 1 ratio stands at 14.1% which is above regulatory requirements.
The Takāful sector remains in a relatively sound position, with the major issue being that the slowdown in global economic growth rates is likely to result in slower growth of ROA and ROE. A key development in the Takāful sector with cross sectoral implications is the significant shares of investment funds in Malaysia and Saudi Arabia being channelled into the Sukūk market.
Finally, the Sukūk sector has had the most adverse impact in terms of impact on growth of issuances and on profitability. This shows up principally in primary issuance markets where yields have been higher.
At the same time, Sukūk have done well in terms of stability and resilience as measured by the negligible ratio of defaults, which stand at 0.17 % of the total issuance volume to date.
D. SUKŪK MARKET DEVELOPMENTS IN 2015/16
Ladies and gentlemen, let me cite some recent developments that touch upon both challenges and opportunities in the Sukūk markets.
First, after three consecutive years of above $100 million of issuances per year, 2015 saw a sharp drop in new issuances to about $65 million, resulting in a decline in total Sukūk outstanding. This also curtails the cumulative growth rate of Sukūk outstanding which had been about 16% between 2010-15.
At the same time, the investor and issuer base remained wide in 2015, with the Sovereign Sukūk issuance base actually expanding with issuances by the Sultanate of Oman and Cote D’Ivoire. There was also a return issuance by the IFC.
Second, the first four months of 2016 saw a strong start with issuances of nearly $30 billion, or nearly 50% of the total figure for last year. These issuances were led by Sovereigns but have also included the corporate sector.
Amongst corporates, the GCC, Turkey and Malaysia were major issuers of regulatory compliance Sukūk, while Malaysia continued its strong performance in financing of infrastructure through Sukūk.
Third, as a result of the performance of this sector in 2016, there has been a reversal of the total stock of Sukūk outstanding which rose to $312 billion, which is higher than that observed in 2014, the previous peak for this number.
Fourth, there appear to a be set of strong underlying factors that is likely to support sustained growth of Sukūk over the medium term which include the need for Sukūk to meet Basel and IFSB regulatory capital requirements, as well as for liquidity in the form of HQLA.
There is also the possibility of countries facing funding challenges widening their access to funding sources through Sovereign Sukūk.
Infrastructure financing is likely to be another area of activity, especially through quasi-sovereign project financings.
Finally, Malaysia, the World Bank and others are developing approaches to innovative uses of Sukūk for SRI, climate change and other social and economic goals.
E. KEY CONSTRAINTS AND ISSUES
Divergences in Sharīʻah views on tradability and other factors continues to constrain liquidity.
At the same time, cross-border issuances are converging towards more harmonised and standardised Sukūk structures that are generally agreed upon globally.
For instance, most of the international Sukūk issued by sovereigns and MDBs are consistently structured as Sukūk al-Ijārah, given its generally agreed-upon structure and secondary market tradability. In 2007, more than 40% of the primary market volume was raised through Sukūk structured on Mushārakah and Mudārabah contracts; in the last three years, the share of these Sukūk has been less than 10%.
There has also been some progress made in terms of Sukūk market infrastructure and its ancillary services. Sukūk are now being rated by both international ratings agencies as well as domestic agencies in countries where available; this has enabled a better pricing mechanism for the investors.
However, in terms of benchmark pricing itself, there is a disparity in progress. Limited progress on Sukūk pricing benchmarks reflects a number of factors, in particular the absence of regular issuance programmes. This could be addressed through systematic efforts directed at the development of an active capital market where issuances are available across a wide range of tenures, including short-, medium- and long-term maturities.
This is particularly relevant for the GCC region, where capital market activities are limited and the banking channel is the main source of funding. The availability of Sukūk pricing benchmarks is critical, since these serve as initial price guidance for prospective issuers across a wide range of maturities.
In this regard, Malaysia has established a strong record through an active Sukūk issuance programme by the government across a wide range of tenures - ranging from three-month Treasury bills to the long-term 30-year government financing Sukūk. This has facilitated a pricing benchmark curve.1 In addition, Malaysia is one of the few countries that has benchmark curves for corporate Sukūk across different ratings and maturities.
Legal and resolution frameworks remain at widely different stages of development and robustness. It is important to strengthen legal frameworks in order to mitigate both issuers’ and investors’ possible unease on the resulting Sukūk resolution should a default occur in a foreign jurisdiction. This, in turn, should enable further confidence in cross-border Sukūk issuances and investments globally.
Ladies and Gentlemen:
IFSB Standards for Islamic Capital Markets (ICM): Before I conclude, I would like to turn to the standard-setting work of the IFSB, which is devoting greater effort and attention to the key issue of creating depth and breadth of cross border Islamic financial markets, and in particular Islamic capital markets and Sukūk.
In this context, the IFSB strongly believes that furthering cross-border linkages and achieving greater connectivity, within an appropriate framework for financial stability, will be facilitated by the adoption of common international standards for prudential safeguards and risk management capabilities in ICM.
In this respect, the IFSB has an enhanced programme of standards that are proposed for Sukūk and ICM during the current phase of our SPP 2016-18.
First, we are currently in the midst of the preparation of a standard for transparency and market disclosure that will provide an international benchmark for the regulation and supervision of ICM products, including for Sukūk instruments.
Second, in 2016 we will launch a standard for the preparation of Core Principles for Islamic Capital Markets.
And third, we envisage that in 2017 an additional standard will be launched on ICM that will address the key issue of consumer protection for this sector.
These three standards will contribute towards a common set of international standards for Sukūk and ICM and, will strengthen the basis for greater connectivity in both domestic and international ICM.
Ladies and Gentlemen:
The heightened turbulence and continued uncertainty in the global economy has impacted Islamic finance jurisdictions through its effects on the real economy, the financial sector, stock markets, exchange rates, Sukūk and capital markets. This is a reminder to us that while Islamic finance has its intrinsic strengths and appeal, it is not immune to the ups and downs in the international economy.
The task ahead is not to draw away from the international economy, but to prepare for its challenges and opportunities. In this respect, a key priority is to strengthen capabilities for effective supervision and regulation, and to build on the mechanisms for cross-border cooperation and knowledge-sharing that will lay the foundations for a resilient and stable Islamic finance.
In particular, it is important to distinguish between the immediate global economic turbulence, and the prospects and longer-term goals of Islamic finance.
Today, Islamic finance jurisdictions in the Middle East, Africa and Asia share a common challenge. This is to manage the spillovers from the global financial system, whilst developing robust risk management capabilities to strengthen long term resilience and stability.
The IFSB stands ready to work in collaboration with all its stakeholders towards the all important long-term goal of greater financial stability and resilience of Islamic finance.
1 However, the decision by BNM in 2015 to halt its short-term Sukūk programme likely removes an important component of the country’s benchmark Sukūk yield curve.
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