CJ DOHERTY: Welcome to the Lending Lowdown. I'm CJ Doherty, Director of Analysis at LSEG LPC. Today, for the first time, we're going to discuss Islamic financing.
It's a large market with around 5 trillion in assets. So I think it's well worth delving into and gaining an understanding of the workings of this market. In order to do this, I'm delighted to be joined by Mustafa Adil, Head of Islamic finance here at LSEG. Mustafa, thanks very much for joining me.
MUSTAFA ADIL: A pleasure to be here, CJ.
CJ DOHERTY: As usual, we want to hear a little bit about yourself first, in order to set the stage for our listeners. So Mustafa, if you could tell us a bit about yourself, your career background and your current position at LSEG?
MUSTAFA ADIL: Of course. So I've always been operating in the Islamic finance space. I was born and raised in Bahrain, which is a tiny little island off the coast of Saudi Arabia. Most people know us as being close to Dubai. And basically from when I completed my university, I started a career in consulting and I joined Ernst and Young. And they had a dedicated Islamic finance consulting team and I worked there for about 8 years and then this opportunity came up at Thomson Reuters who were looking to set up their Center for Islamic Finance in Bahrain. And I was initially hired about 11 years ago as the Head of Research and Product Development, and then I moved on to head the entire team. And now, since we've had the Refinitiv acquisition that was taken by LSEG, it creates tremendous new opportunities for us, with having, one, a listing venue which is a preeminent player in the Islamic finance space for listing sukuk and funds, and the FTSE Russell team who do extraordinary work on the
indices side for Sharia-compliant equity and fixed income indices.
CJ DOHERTY: Wait, now let's talk about the basics of Islamic financing. And can you give us an overview of the basic tenets of this type of financing? What are its unique characteristics and how does it differ from other forms of financing?
MUSTAFA ADIL: Sure. Islamic finance is relatively simple. Basically it is any kind of financing activity that aligns with the principles of Sharia, Sharia being Islamic finance. And essentially we have three main tenants when it comes to Islamic finance. One, you cannot engage in interest, so you cannot make money on lending money. You have to do some kind of economic activity in order to justify a return for yourself as a capital owner. The second is you cannot engage in any industry that is deemed to be harmful to society. So things like gambling, alcohol, pornography, weapons, manufacturing, tobacco, all of these industries were deemed to be prohibited when it comes to Islamic finance. And the third restriction is that you cannot engage in speculative or synthetic transactions. And what I mean by that is you can't engage in derivatives that are not being taken to hedge and on balance sheet position. You can't take very speculative positions because that is deemed to create unnecessary volatility in financial markets, and therefore it is deemed not to be for the broader benefit of society. So those are the essential key 3 restrictions that we have in Islamic finance. But other than that, everything else is permissible.
CJ DOHERTY: OK. So I just want to dig a bit deeper then and say, given what you've described, how do lenders make money in this market?
MUSTAFA ADIL: That's a great question and it's always the first one people ask when we tell them, well, you can't engage in speculation. You can't engage in interest.
The essential way is that you're still meeting a need, which is you're connecting those people that have capital with those institutions and individuals that need capital.
But what you do is you create a relationship that is not purely debt driven.
So you know, there's essentially three ways that you can make money through Islamic finance. The first is through through buying and selling an asset or a good. A typical example of that could be financing working capital for a corporate where you purchase the raw material and you sell it to them for a markup. Another example could be for consumer spending. If somebody wants to buy an asset like a laptop or something like that, the bank could purchase that asset and then sell it to them for a profit margin on a deferred payment basis. So that's the first way, through a transaction. The second is through buying and leasing an asset. So for example, if somebody needs an auto finance, then the bank can purchase the car and then lease it to them. If a business needs any machinery that is required for their business, then an institution can purchase that and lease it to them. And then the third way is through profit and loss sharing. And over there what happens is that essentially the capital owner participates in the risk and rewards of ownership of any particular venture. So for example, that is a typical way in which depositors make returns on their deposits. They deposit money with the bank as co-investors. The bank than utilizes those funds to invest in a portfolio of mortgages, a portfolio of auto finance or other financing initiatives, and the profit that is generated from those activities is then shared between the bank and the depositor. So those are essentially the three main ways that you would make money in Islamic finance, either through engaging in transactions or engaging in assets, the leasing of assets, or in engaging a type of profit and loss sharing arrangement.
CJ DOHERTY: Thanks for the clarification. That really helps. My next question then is what types of institutions are the main players in this market?
MUSTAFA ADIL: So the industry is pretty much dominated by Islamic banks, and Islamic banks are banking institutions that essentially operate in line with the rules and restrictions of Sharia principles and they make up about 70-75% of total Islamic finance assets. And within banks you have both fully fledged Islamic banks, that means the entire organization is Islamic, or you'll have Islamic banking windows. And windows are basically the Islamic banking arm of a conventional financial institution. So for example. Citibank, HSBC, Standard Chartered, Goldman Sachs, all of these institutions will have well developed Islamic banking windows that operate in the markets where Islamic finance is quite significant. So banking makes up the large portion of that, about 70 odd percent. And then the second biggest component is sukuk. And sukuk is essentially a Sharia-compliant bond instrument and sukuks make up about 18% of the industry.
CJ DOHERTY: Great. And let's talk about market dynamics now. Is the market growing? And if so, what are the drivers propelling this growth? And then on the flip side, does the Islamic financing market face any headwinds?
MUSTAFA ADIL: Sure, I think so. The market has been growing substantially in the core markets in in which it operates. So we've seen the industry grew by about 11% in 2023. We're still waiting for the year-end to see what the figures are here, but we're expecting similar 11-12% growth this year. Historically, the industry has been growing at double digit growth for the last decade and in most markets where Islamic finance operates, for example, the Gulf countries – Saudi Arabia, the UAE, Qatar, Kuwait, Oman, Bahrain - in Southeast Asia, for example, Malaysia, Indonesia in Turkey, the industry has been growing at twice the rate of the conventional finance industry. So the growth has been there. Initially Islamic finance was brought into play as a financial inclusion mechanism. So because you had a lot of consumers and businesses that didn't want to participate in conventional finance, because it conflicted with the with their faith and their values. So Islamic finance was brought in to incorporate them into the formal financial system, but since then it has grown very, very fast and in some markets like Saudi Arabia, more than 50% of banking assets are Sharia compliant. So it has grown tremendously. What we see today in terms of headwinds, one, is that a lot of new markets, what we would call frontier markets, are introducing Islamic finance. There are, I believe 57 countries that have introduced Islamic finance regulations and where governments are actively supporting the development of Islamic finance to support the broader financial ecosystem development. We are also seeing Islamic finance aligned with a number of broader themes that we see. So for example, sustainable finance, right? There is a lot of overlap between the principles and the motivations behind Islamic finance and sustainable finance. So we're seeing greater alignment in that area. We're seeing alignment between fintech and Islamic finance because fintech enables you to have the type of transparency and access to the type of structures and transactions that can simplify the Islamic finance tools and mechanisms. So we're seeing a lot of overlap there as well and that is all helping to drive the growth of Islamic finance.
CJ DOHERTY: Mustafa, we both work in different areas of LSEG, so a question from our company perspective, how does LSEG fit into the Islamic financing market? What role does it play?
MUSTAFA ADIL: So LSEG as a capital market institution plays a great role. We are one of the leading data providers when it comes to Islamic finance information, so if you think of our users, they require a lot of information to make financial decisions. Not only would they require all the typical conventional finance information, but they also need to know if are Sharia compliant, if things are investable, they need to understand what is their investable universe. They need to understand what is the underlying risk that they're taking if they engage in a Sharia-compliant contract as opposed to a conventional debt contract. So all of this information is being provided to them through Workspace. We also provide trading solutions for them, so a number of our trading platforms, we have Sharia-compliant variants of that to be able to support the trading and post-trade activities for our Sharia-sensitive users. Through FTSE Russell, we have a very, very strong presence in the indices space where we provide Sharia-compliant and Islamic indices covering equities, covering sukuk or fixed income and also covering thematic elements. So, for example, Sharia-compliant and ESG-compliant industries or Sharia-compliant and sustainable indices and then as a exchange itself, as LSE we are one of the largest listing venues for Sharia-compliant instruments like sukuk and funds. So a significant number of sukuks that are issued in Indonesia, in Saudi Arabia, in the UAE, in Kuwait and Qatar and other markets are listed in the LSE, and that gives the issuers access to international capital to be able to invest in their instruments.
CJ DOHERTY: Before we wrap up, it's always good to look ahead as best we can and so where do you think is the Islamic financing market headed in 2025 and beyond? What do you expect to see?
MUSTAFA ADIL: I expect to see a lot more adoption and a lot more growth. So we have seen a number of different jurisdictions that would not be traditional Islamic finance markets issue sukuk to tap into the Sharia-sensitive capital. So that includes the likes of the United Kingdom, includes the likes of Hong Kong, Philippines and various other markets. So I expect that to continue. I expect to see frontier markets. So we're seeing a lot of markets in Africa and a lot of markets in Central Asia like Kazakhstan and Azerbaijan and Uzbekistan and others, increasingly introduce and promote the Islamic finance ecosystem that they have, and we see greater collaboration between financial hubs. So the cooperation that's happening between Malaysia, the UAE, London, New York and others on Islamic finance is slowly breaking out the silos that have previously existed in individual countries and creating a truly global and interconnected Islamic finance market.
CJ DOHERTY: That's great and definitely something for us to monitor going forward. And with that, we will finish up for today. Mustafa, that was very informative. I learned a lot and I'm sure that many of our listeners will also have picked up a lot from this podcast. Thanks for sharing your insights.
MUSTAFA ADIL: Thank you very much, CJ.
CJ DOHERTY: Thank you all for tuning in. I invite you to check out coverage of the Islamic financing market on workspace and also on LSEG.com. I'm CJ Doherty, subscribe to the Lending Lowdown on your favorite podcast platform.
