Demand for Islamic finance is forecast to triple to US$900 billion within five years, presenting a golden opportunity for Asia's private banks.

Global demand for Islamic finance is forecast to triple to US$900 billion within five years, according to a new report, underlining a golden opportunity for private banks.

According to estimates by Ernst & Young's Global Islamic Banking Center of Excellence, the global demand for Sukuk is currently over US$300 billion and will grow three-fold by 2017, although it is unlikely that this demand will be met.

The exponential rise is primarily a result of double digit growth of the Islamic banking industry, and the increasing appetite for credible, Shari'a compliant, liquid securities, said the report.

The demand comes from Islamic financial institutions as well as fund managers and high net worth individuals. Conventional institutions are also showing renewed interest in investing in Sukuk after the euro-zone debt crisis primarily as these Islamic products are backed by real assets, the report showed.

"Sukuk continues to be in the spotlight, especially after the global economic meltdown, where we learnt that carrying excessively risky debt on the books can lead to financial collapse during black swan events. The intended differentiation is that sukuk securities are backed by real assets and projects. Major South East Asian and Middle Eastern companies are tapping into the international Sukuk market to raise Shari'a compliant funds. Global financial firms are also in the fray to raise money through Sukuk instruments and to offer Shari'a compliant products," said Ashar Nazim, Islamic finance services leader in the Middle East and North Africa at US accountantErnst & Young.

Challenges and opportunities

The fastest growing segment is the Ringgit denominated Sukuk, which accounts for more than two thirds of the total global issuance. Malaysia has successfully and regularly tapped into the sukuk market to support its infrastructure development program, a model that other markets are keen to replicate.

However, one of the foremost challenges faced by the Sukuk market is the supply side constraint as demand continues to outpace new issuance coming into the market. Further, "an absence of a global standardized Sukuk trading platform open for all Islamic and conventional financial institutions is a major factor hindering growth," said Ashar.

The unprecedented growth in demand is good news for governments and corporates seeking new avenues of funding. In 2011, approximately 86 per cent of total Sukuk issuances were from sovereign linked entities. In Saudi Arabia, the recent passage of mortgage law will drive billions of dollars of mortgage financing, and Sukuk capital market will be a primary beneficiary.

Similarly large natural markets like Malaysia, Indonesia and Turkey are set to benefit from the rising demand for Sharia compliant securities backed by quality, real assets.

Post global financial crisis, there was an upsurge in interest and eagerness amongst international conglomerates to explore avenues into the vastly liquid Islamic debt market. Even as the interest continues, the fact that Sukuk issuance platforms are proprietary to a few Islamic institutions also acts as a restriction to the growth potential of the industry. Ernst & Young Islamic Banking Center of Excellence believes that the industry is not yet ready to fully capitalize on this demand potential, and the supply of sukuks may fall well short of the US$900 billion demand over next five years. 

"There is an urgent need for a new direction in the market to be led by leading Islamic financial institutions and multilateral institutions in a collaborative manner. Globally, at least 14 Islamic banks today have the financial muscles to venture into international sukuk capital market. Prerequisites are international connectivity, Sukuk structuring and trading expertise and balance sheet strength," said Ashar.