A major international centre for Islamic finance, Dubai has more sukuk (Islamic bond) listings by value than anywhere else in the world. The emirate is also home to Dubai Islamic Bank (DIB), the oldest – and third-largest – fully fledged Islamic bank. The sector continues to develop rapidly, with local sharia-compliant banks registering faster growth than their conventional counterparts, although expansion could lose momentum in 2018. Efforts are under way to position Dubai as a centre for the halal economy generally, a leader in Islamic digital economy, and as a driver of standardisation, international dispute resolution for sharia-compliant institutions.
Current Market Snapshot
Islamic banks accounted for Dh522bn ($142.1bn) worth of assets, or 20% of the total in the UAE, at the end of March 2017, according to the IMF. The weight of the sector is somewhat stronger in Dubai than nationally: The emirate’s two standalone Islamic banks, DIB and Noor Bank, had combined assets of Dh215.4bn ($58.7bn) at the end of 2016, equivalent to 25.3% of emirate-level banking assets – based on local banks’ reported assets – up from 24.6% the year before. These calculations do not include the Islamic units of conventional banks operating in the emirate such as Emirates Islamic, the Islamic unit of Emirates NBD, which is also a significant player in the segment.
Islamic banks have become a force to be reckoned with in the UAE retail segment in particular. While corporate and government business dominates the books of conventional banks, with retail accounting for 24% of total lending, this figure rises to 40% at sharia-compliant lenders, according to data cited by Bashar Al Natoor, senior director and global head of Islamic finance at Fitch Ratings. He told OBG that the product offering of the Islamic banking industry had evolved rapidly and could now compete on an equal footing with conventional banks, helping to drive segment growth. “A decade ago, no Islamic banks offered sharia-compliant credit cards or car financing, for example, but now almost all do,” he said. “With a largely Muslim population and an equal product footing, the market is bound to see migration from conventional banks to Islamic institutions.”
Diversity & Flexibility
In addition, sophisticated financing models are helping to boost the popularity of corporate Islamic finance. “Previously, stricter Islamic banks had not been very active in the hotel financing market because many hotels serve non-halal food and beverage products such as pork and alcohol. However, now banks are increasingly able to structure deals to finance specific elements of a hotel rather than the entire operation, allowing them to avoid straying into areas that are not sharia-compliant,” Al Natoor told OBG. He added that sharia boards are now showing greater flexibility on such issues, for example, by allowing for a ceiling of revenues from non-halal products at companies financed by Islamic loans, rather than setting it at zero.
Factors such as greater sector expertise and more flexibility from sharia boards have allowed banks to undertake hedging activities. “Even two years ago, Islamic banks could rarely hedge, but now even the most conservative banks are doing so,” Al Natoor said, noting that Dubai was at the forefront of the trend. Redmond Ramsdale, senior director for financial institutions at Fitch, said he expected business at Islamic banks in the UAE to expand by approximately 10% in 2017, compared to growth of between 5% and 8% for the conventional segment.
In addition to such rapid growth, Islamic banks are also becoming increasingly profitable. Factors such as the higher cost of risk and operating base mean Islamic banks often tend to have lower profit margins than conventional banks. However, Nitish Bhojnagarwala, vice-president at Moody’s Investors Services’ Financial Institutions Group, told OBG that this had reversed in 2016 as a result of several sector developments. “Islamic banks’ cost of risk has improved as they have diversified away from real estate lending towards other sectors and their risk-management practices have improved,” Bhojnagarwala said. “Furthermore, Islamic banks have higher proportions of funding in the form of current and savings accounts, which is beneficial in the current environment of rising interest,” he added.
Investment options for Islamic banks have also improved. “In the past there was a limited range of investment options for Islamic banks, and everything was extremely oversubscribed,” Ramsdale told OBG. “However, we have seen an improvement in sharia-compliant offerings by central banks, including the recent launch of overnight sharia-compliant deposits from the Central Bank of the UAE, and there has also been an increased issuance of sukuk,” he added.
DIB, the first fully fledged Islamic bank in the world when it was launched in 1975, is the second-largest bank in the emirate by assets and the largest Islamic bank in the UAE, as well as the third-largest worldwide. The bank registered assets of Dh201.2bn ($54.8bn) at the end of September 2017, up 15% compared to Dh175bn ($47.6bn) at the end of 2016, representing a faster consolidated asset growth rate than any other banking group headquartered in the emirate. It also witnessed the emirate’s fastest banking asset growth in 2016 as a whole, at 16.6%.
In addition to its activities in Dubai, the bank operates several foreign units, including a wholly owned subsidiary in Pakistani, DIB Pakistan, which holds assets worth around Dh1.4bn ($381.1m) and operates a network of more than 200 branches. DIB is also a shareholder in the oldest and largest bank in Sudan, Bank of Khartoum, with a stake of 28.4%. The Sudanese bank holds assets worth $2bn, and operates 83 branches nationwide and six subsidiary units.
DIB is growing its presence in East Africa through a greenfield setup in Kenya. DIB Bank Kenya was granted a banking licence by the Central Bank of Kenya in April 2017 and launched operations the following month with the opening of three branches, two in Nairobi and one in Mombasa, making it the third Islamic bank to enter the market. In 2014 DIB also acquired a 24.9% stake in the Islamic subsidiary of Indonesia’s Bank Panin. It increased its holding in the institution to just under 40% the following year and rebranded it as Panin Dubai Syariah Bank in March 2017. To consolidate its efforts, DIB sold its 20.8% stake in Jordan Dubai Islamic bank in 2017.
The other standalone Islamic bank operating in the emirate is Noor Bank, which was established in 2008. The bank had assets worth Dh39.9bn ($10.9bn) by mid-2017, down 1.7% from Dh40.6bn ($11.1bn) at the end of 2016. Conventional banks in the emirate also operate Islamic units, including Emirates Islamic, the sharia-compliant wing of Emirates NBD, the largest Dubai-headquartered bank (see Banking chapter).
Since 2015 Dubai has been a leading destination for sukuk listings, with the value of Islamic bonds listed in the emirate climbing higher than any other market worldwide.
As of November 2017 the value of sukuk listings in the emirate stood at $52.96bn of which 96% were listed on Nasdaq Dubai, and the remaining on Dubai Financial Market (DFM). Nasdaq Dubai has become a centre for listings from around the world, with Islamic debt listings worth approximately $44bn at the end of 2016, while the DFM, by contrast, primarily lists domestic issues. By November 2017, 13 sukuk had sought listings on Nasdaq Dubai with outstanding face value of $10.25bn. There were 19 new sukuk listed on the exchange in 2016, with a combined market capitalisation of $11.5bn; down from $13.3bn the previous year, when 19 sukuk were also listed.
A number of factors are helping to support sukuk issuance in the UAE and the wider region, with positive implications for listings on both of Dubai’s exchanges. “Lower oil prices have given rise to a growing need for sukuk funding, and we have seen an increase in issuance in 2016 and the first half of 2017,” said Al Natoor, adding that funding requirements would persist in 2018 for both sovereigns and corporates. “An improvement in GDP in 2018 should also boost the need for bank financing, which means that banks will be issuing,” he said. According to the IMF, GDP growth in the UAE is expected to accelerate from 1.3% in 2017 to 3.4% in 2018.
Moves by UAE banks to apply Basel III standards – a framework aimed at supporting the banking sector’s ability to cope with economic and financial stress – and in particular the net stable funding ratios prescribed under it, (see Banking chapter) could encourage sukuk issuances.
To become Basel-compliant, banks have to issue. In the UAE half of deposits are term deposits, but not many have terms longer than 12 months, so banks will need sources of longer-term funding than deposits can offer and are likely to look at special purpose vehicles or sukuk to provide this,” Ramsdale told OBG.
The UAE and the wider international sukuk market hit something of a road bump in June 2017, when the Sharjah-headquartered, Abu Dhabi-listed energy firm Dana Gas – a unit of Abu Dhabi-based conglomerate Crescent Enterprises – announced it had received legal advice that, as a result of the evolution of the Islamic financial sector, the two sukuk it had issued could no longer be considered sharia-compliant, and were illegal under the UAE’s laws. It applied to have the bonds legally declared unenforceable, ahead of plans to restructure its obligations to holders of the instruments, which have a combined face value of $700m and were due to mature in October 2017. Dana Gas also said that bondholders could have to refund the firm all profit payments made on the bonds since their issue in 2008 should a court order the deal be unwound.
In November 2017 the company announced the English High Court of Justice had ruled that the purchase undertaking attached to the sukuk is enforceable under English law. The ruling, which was in line with the market’s expectation, is credit positive for Dana Gas sukuk investors because their claims are enforceable, according to Moody’s. Dana Gas said it would appeal the ruling to the Court of Appeal.
“The case has created noise that could affect issuers’ decisions when choosing between sukuk and conventional bonds,” said Michael Grifferty, president of the Gulf Bond and Sukuk Association. However, he told OBG he did not think the move would have a substantial impact on the choice of the UAE as a listing destination (see Capital Markets chapter).
The takaful (Islamic insurance) market remains underdeveloped in Dubai and the wider UAE, in part due to the limited expansion of insurance more generally. “Insurance is not really very well developed, and family (life) takaful is particularly underdeveloped, with most activity taking place in mandatory non-life areas such as motor and health insurance,” Al Natoor told OBG, adding that the sector needed a “quantum leap” as regards consumer education on the benefits of takaful before it could take off.
Takaful premiums in the country as a whole were worth Dh3.4bn ($925.5m) in 2015, according to the latest available figures from the UAE Insurance Authority. The figure was up 33% from Dh2.6bn ($707.7m) the year before, though this in turn was down on 2013 figures. General takaful premiums were worth Dh2.43bn ($661.4m), or 71% of the year’s total for the segment, while family takaful premiums stood at Dh983.3m ($267.6m). Despite accounting for a smaller share of the market, family takaful has been growing much more rapidly than general takaful, having stood at just Dh80.4m ($21.9m) in 2012.
There are 11 takaful companies operating in the UAE, out of 61 insurance firms. Rached Diab, executive director for business strategy at Dubai Islamic Insurance and Reinsurance Company, told OBG that conventional firms in the UAE have traditionally been more profitable than takaful firms, in part because conventional insurers are better established. However, he said sharia-complaint operators benefitted from a growing number of advantages. “Islamic banking activity is on the rise here, and for example, an Islamic bank offering a car loan will only accept car insurance from an Islamic insurance company, whereas the reverse is not true,” he told OBG. There are also disadvantages for firms in the segment, such as not being able to insure non-halal business, and more limited placement opportunities. “There is now a large number of Islamic banks and conventional banks with Islamic windows, which has improved the availability of products in which takaful firms can invest, but the number is still limited,” said Diab, adding that suggested plans for the launch of federal dirham-denominated bonds, which would likely include a sukuk element, would be a boost for the industry in this respect (see Capital Markets chapter).
The Dubai Islamic finance industry is witnessing innovation in different subsegments, in particular in relation to gold. In August 2017 the Dubai Gold and Commodities Exchange (DGCX), one of two derivatives exchanges operating in Dubai, and Saudi conglomerate Ayedh Dejem Group agreed to launch a sharia-compliant spot gold contract, the first in the region. This followed the launch in May 2017 of OneGram, a gold-backed cryptocurrency that is also sharia-compliant. Both developments were facilitated by the unveiling of a new sharia standard for gold by the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions, and the London-headquartered World Gold Council in late 2016. Prior to this, gold could only be used for payment or as jewellery under Islamic standards.
Various steps are being taken to increase standardisation, both within the UAE as well as in the wider international Islamic finance industry.
Domestically, a prominent step to this end was the Cabinet’s approval in May 2016 of the creation of a national sharia board for Islamic financial services (IFS), known as the Higher Sharia Board for Banking and Finance. Members of the board were appointed in May 2017. The Central Bank of the UAE is now responsible for implementing the project, the precise remit of which still has to be clarified. The wider objective is to ensure consistency in fatwas, especially those issued by sharia scholars acting for Islamic banks.
According to Al Natoor, the establishment of the body would have a positive impact on the development of IFS in the country. “The creation of the sharia board will lead to greater standardisation and will prevent future problems along the lines of the Dana Gas sukuk case from emerging, though its success will depend on its precise mandate,” he told OBG.
While some observers have expressed concern that the central board could limit the flexibility of institutions’ in-house sharia councils and lead to a reduction in innovation, Al Natoor said he believed the intention behind its creation was to standardise the market rather than introduce restrictions.
The emirate is home to the Dubai Islamic Economy Development Centre (DIEDC) established in 2013 by the Dubai royal family to develop the halal economy and promote Dubai as a world capital of sharia-compliant business. “Standardisation of the $3trn Islamic economy will lead to greater credibility and confidence in its sectors across the globe,” Khalid Al Janahi, advisor at the DIEDC, told OBG. “While independent organisations in different nations have developed standards and legislations to boost the standing of Islamic finance to suit their unique needs, the fact remains that there are no universally accepted standards in place today.”
Al Janahi added that given this context, and in line with the UAE government’s initiative to set up a global regulatory framework aligned with the DIEDC’s 2017-21 strategy, the centre is currently collaborating with a number of global, regional and local stakeholders. Efforts to develop a unified framework for Islamic finance to promote harmonised standards across different jurisdictions is expected to have the knock-on effect of increasing efficiencies at providers by streamlining a number of processes they use.
The emirate is also trying to position itself as an international centre for the resolution of disputes in the Islamic finance and business world, something Abdulla Mohammed Al Awar, CEO of the DIEDC, told OBG the centre was currently working on.
The Islamic banking sector appears set to continue to grow more rapidly than its conventional counterpart, driven by client migration as its product range expands and becomes more sophisticated. However, some reports suggest the sector could lose growth momentum in 2018, with S&P Global Ratings saying it could be affected by lower oil prices and slower economic growth. Meanwhile, the takaful industry is also showing signs of growth, in particular as regards family takaful, but remains small and will likely require efforts to encourage its development.
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