Dubai is growing as a financial centre that attracts investment and expertise from all points. Its Islamic banks are central to this economic narrative, as is the emirate’s participation in the international market for sukuks, a sharia-compliant alternative to bonds. Islamic finance has become a highly competitive market in Dubai and the emirate is angling to become a centre for sector studies and market development. Its banks look to improve their ability to thrive in an increasingly mature landscape, while exploring opportunities outside the UAE. Markets like Egypt, Turkey, Indonesia and sub-Saharan Africa may help banks capture higher returns. At home, an effort to increase the number of Islamic financial instruments available is under way within the emirate’s capital markets, and that should add options for portfolio investors as well as for Islamic banks looking to manage their liquidity.

New Instruments

Once a relatively new set of options, sharia-compliant market alternatives are now increasingly familiar, particularly in Dubai. As its earliest practitioners helped develop products and promote their availability, what has become clear now is that if presented with the option of Islamic finance alternatives many Muslims are likely to choose them, and even more so if they are priced to compete with conventional choices. As the assets of Islamic banks have grown, there has been an increased need to provide lenders with tools to manage their liquidity. Conventional banks use interbank lending, money markets and short-term bonds, and other options. Islamic banks are hoping that similar methods will grow to a scale sufficient to help them with the task of liquidity management, and Dubai has some home-grown options to do just that. Thus far, banks are keen to hold short-term sukuk for this purpose, and that is one reason why sukuk have been among the sector’s success stories.

Another factor that suggests continued growth for sukuk is demand from institutional and high-net-worth investors in the region, who have enjoyed a decade of high inflows thanks to oil prices and are looking for investment opportunities. Benchmark-sized sukuk sales offer some. High-growth stories have not yet emerged for other elements of the Islamic finance sector, like takaful, which is the alternative to conventional insurance, and an Islamic funds industry has not yet scaled up in the way that banks and sukuks have.

Legal Underpinning

Islamic finance in Dubai is governed at the federal level, by a 1985 law that allows licensed institutions to participate in commercial, industrial and trade activities; to acquire real estate; take deposits; and invest in funds. Institutions must have a sharia board with at least three members. Islamic banks are licensed and supervised by the Central Bank of the UAE (CBU) and takaful providers by the Insurance Authority of the UAE (IA). Because the practice is licensed on a federal level and banks and takaful firms can compete for business in any emirate rather than the one where they are based, the market Dubai exists in is a national one. The UAE has emerged as one of the world’s main hosts of Islamic finance activity – the NASDAQ Dubai securities exchange was the third-largest centre for sukuk trading by market capitalisation as of late 2013, for example, and the UAE was responsible for 5.9% of total sukuk issuance that year. The country has emerged as one of six crucial markets for Islamic finance worldwide, according to a sector report by EY, the consultancy formerly known as Ernst & Young. EY’s list includes Malaysia, Saudi Arabia, Qatar, Indonesia and Turkey, which together accounted for two-thirds of the 38m Islamic finance customers in 2013.

The six countries offer different markets with varying value propositions. Malaysia stands out for its relatively developed market for Islamic finance, while Indonesia and Turkey are considered strong prospects because of their large populations – 250m and 75m, respectively, making them the fifth and 17th most populous in the world. The UAE and the two other countries from the GCC region offer a mix of local wealth and already-thriving existing markets and actors. As of June 2013, UAE financiers held about $98bn in total sharia-compliant assets, 19% of the GCC total, according to the Islamic Financial Services Board (IFSB), a Kuala Lumpur-based body that seeks to establish sector standards. Global sharia-compliant assets were valued at $1.8trn at the end of 2013, according to IFSB, and were expected to surpass $2trn in 2014.

Retail Deposits

The UAE’s Islamic banks as a group hold about 7% of global Islamic banking assets, according to the IFSB. The list of Dubai-based lenders includes Dubai Islamic Bank (DIB), Emirates Islamic (EI), Noor Bank and others. DIB is the largest in the country by total assets. Overall, Islamic banks in the UAE have a market share of about 25%, but could reach 50% by 2020, according to the EI. Islamic banking grew at a compound annual growth rate of 19.1% from 2007 to 2012. Islamic funds have grown at a slower pace than banks and sukuk, at a compound annual rate of 9.4%.

As of November 2013 there was a total of $73.7bn in assets under management, about 1% of which was domiciled in UAE, according to the IFSB’s 2014 financial stability report. Of the sum total of 1052 existing funds, equities represented a third, and money market and sukuk funds 32%. Other common asset classes included commodities and real estate.

One of the main attributes of Islamic banks in the UAE is a strong base of retail deposits, according to a sector report from the Dubai-based investment firm Shuaa Capital. At the end of the second quarter of 2014, the two highest deposits-to-assets ratios among publicly traded lenders were DIB and Abu Dhabi Islamic Bank, at 77% and 75%, respectively. Islam forbids interest, so the cost of funds can be exceptionally low on a global basis for current and savings accounts (CASA), as consumers often do not expect any sort of return on these types of accounts.

As in the conventional sector, Islamic banks in recent years have been in a restructuring phase following the global downturn. When the effects spread to Dubai in 2009-10, domestic banks as a group were left to cope with a surge in loan defaults. Islamic banks have since been focused on reducing non-performing loans and remaking their balance sheets, as well as introducing greater diversification to their lines of business, in order to prevent a repeat of the problem.

At DIB, for example, preparing for the post-crisis era has meant seeking out new opportunities outside the lender’s traditional areas of focus. The bank is now increasingly targeting on retail customers. Commercial real estate has plunged from more than 40% of loans in 2008 to 24%, Adnan Chilwan, DIB’s CEO, told OBG. Consumer lending jumped from 14% of the total to 44%. “We undertook a two-phased strategy, the first of which was consolidation,” Chilwan said. “With the first phase complete, we initiated the next chapter built around focused expansion and growth.”

For Islamic banks overall, the challenge across the global landscape is to become more profitable – returns worldwide lag those of conventional lenders by 20%, according to EY, because of higher costs, the increased complexity of products and operational inefficiencies. One of the biggest obstacles is size: Islamic banks are typically younger and smaller than their counterparts, and therefore cannot benefit from economies of scale, to some extent, the report found. Scale could also mean a wider suite of products available to customers. EY’s survey found that on average customers of Islamic banks use 2.1 products, whereas for conventional banks the number is 4.9 products, indicating that the latter are doing a better job of providing options and selling customers on them. Chilwan said the average at DIB is 1.75 products, and the goal is to boost it to 2.25.

Commercial Lending

Credit growth across the banking sector is expected to be muted in 2015. An expansion in retail borrowing may be limited by the data available at end-2014 from the Al Etihad Credit Bureau, which began operations that year. The customer information available will shed light on consumers’ debt positions. A law mandating that banks consult the credit bureau could make it easier to enforce a regulation that banks cannot lend to consumers if they are spending at least half their income on repaying existing loans.

In the commercial segment of the market, further regulations will put a cap on the relationship between Dubai banks and the main borrowers of their recent past, the government-run enterprises (GREs). These concentration-risk rules cap the amount of credit any one bank can extend to a single customer to 25% of its capital. In the case of GREs, unless they meet specific thresholds tied to credit ratings (see Banking chapter), they will be grouped together as one entity that cannot exceed 25% of a bank’s capital. The expected impact is that GREs will be more reliant on bonds, sukuks, equities markets and other alternatives to borrowing from banks. For banks, this means protection from concentration risks and the need to seek out new business lines.

A chronically underserved market for bank lending that may be ripe for growth is small and medium-sized enterprises (SMEs), both in the UAE and across the MENA region. That is a territory Dubai banks frequently look to when considering international expansion. A recent study by the International Finance Corp. (IFC), the private-sector focused advisory arm of the World Bank, surveyed nine MENA countries and found a shortage of funding for SMEs that could be as much as $13.2bn. The results also showed that 36% of the region’s conventional banks have specific credit products designed for SMEs, whereas 17% of Islamic banks offered a competitive alternative.

In Dubai SMEs account for 95% of commercial establishments, 42% of the workforce and 40% of the total value added in the economy, according to Dubai SME, a government agency tasked with providing credit, subsidies, counselling and other support to SMEs. SMEs in the emirate are found mostly in trading, tourism and hospitality, and light industry. The latter are often firms working inside free zones like Jebel Ali.


Of insurers licensed by the IA, 10 out of 60 are sharia-compliant and eight are publicly traded on the Dubai Financial Market (DFM), the main securities exchange. Following regulations introduced in 2010 takaful providers in the UAE must be stand-alone firms that do not offer any other insurance, meaning conventional insurers cannot offer takaful products. Total takaful contributions reached $1.16bn in 2013, according to EY, up from $1.03bn in 2012. There has been annual growth in the amount since 2009, and the UAE has remained the second-largest takaful market in the GCC during that period. Saudi Arabia is the GCC’s largest. Its population is larger than the rest of the GCC combined and accounts for more takaful contributions than the rest of the GCC combined. The GCC total was $7.94bn in 2013, suggesting a 15% market share for the UAE.

In line with global trends, profits have been hard to come by in the emirate for takaful operators, in part because of the competition seen in the market recently. Insurance penetration remains low, at about 1%, so the many insurers currently in operation are all chasing after a small market. Competition is mainly centred on price, leaving little in the way of profit margins from underwriting, and in fact it quite often generates operational losses. “Despite intense competition, there is potential for growth, especially in the areas of family takaful and medical insurance, particularly in rapid-growth markets like the UAE,’’ according to EY’s report.

Several key legal and regulatory changes are on the horizon that will impact takaful providers. The year 2015 is the deadline for composite providers of insurance and takaful to separate their general and life lines of business into separate companies. That has been on the cards since the passing of an insurance law in 2007 that mandated an end to the composite approach. The original deadline was 2012. It is unclear whether implementation would entail divesting one of the two lines of business, or if they could be kept as separate companies under the same corporate structure. Finding buyers could be difficult because of the struggle to achieve profitability, and the latter could increase costs by duplicating administrative functions.

In addition, a package of fundamental changes is expected following the enactment of new solvency standards, which were legislated in January 2015. The new law increases minimum capital requirements, introduces risk-based solvency measures, institutes asset-allocation caps for investment accounts and mandates increased use of actuaries for life insurers. The law may also give the IA the ability to levy fines on insurers.


The UAE is one of the main sources of sukuk worldwide – it was the third-largest issuer in 2013, accounting for $7.12bn in sales, according to the annual sukuk review of Rasameel Structured Finance, an investment services firm based in Kuwait. That was 5.9% of the global total of $119.7bn and represented a drop in the value of issuance for the first time since 2008, when the financial crisis caused gridlock in international markets. This 8.9% decline was in large part in anticipation of the US Federal Reserve reducing its purchases of US bonds – a tapering of its quantitative easing method of providing economic stimulus.

The decline in sukuk issuance mirrored an overall turn toward bearish sentiment for emerging market securities, including bonds and equities as well, on the assumption that investors worldwide would be holding more US assets in their portfolios as a result. However the Fed ended up delaying the beginning of its tapering from September to December, and sukuk sales rebounded in October – the $36.7bn issued in the fourth quarter was the largest fourth quarter on record, according to Rasameel’s research.

Despite the influence of global market trends, the underlying fundamentals for sukuk are positive in Dubai, the UAE and overall. Domestically, the CBU’s regulations aimed at avoiding an overreliance on bank lending should provide steady sukuk issuance from GREs involved in development projects in preparation for Dubai to host Expo 2020. Globally, sukuk demand is being driven primarily by Islamic banks, which want sukuk to help manage their liquidity. The year 2014 stands out because a handful of non-Muslim-majority countries’ governments sold sukuk. They include the UK, Hong Kong, South Africa and Luxembourg. Three of these are global financial centres with a general interest in offering the widest possible array of financial instruments, but sukuk may also be appealing for the specific reason that the majority of investors in most sukuk come from the GCC, where investment opportunities are in high demand thanks to hydrocarbons wealth, and sharia-compliant investments are a good fit with local preferences. GCC investors often account for at least 40% of the buyers of international sukuk, and often far more than that, according to the research of the IFSB.

On an aggregate basis, dating from 1996 to September 2013, the UAE has been the world’s second-largest issuer behind Malaysia, according to data collected by Thomson Reuters. Malaysia is the source of most sukuk worldwide, having issued $324.58bn in the period, compared with $47.88bn from the UAE. Saudi Arabian sukuk from the period amounted to $39.3bn in issuance. No other country surpassed $20bn.

Recent Benchmarks

In Dubai, notable recent issues include Emirates Airlines, which sold a $1bn sukuk in March 2013 to be used for aircraft purchases. In the same month the Dubai Electricity and Water Authority (DEWA) and DIB sold the same amount. The government floated $750m in April 2014. The four issues were between five and 14 times oversubscribed, according to IFSB data and media reports, underscoring the huge demand worldwide for sukuk. “The tremendous expansion in the other sectors of the Islamic finance industry (banking, funds and Takaful) has warranted an increase in demand for sukuk instruments by institutions in these other sectors, outpacing the number of issuers tapping into the industry,’’ according to the IFSB’s 2014 financial stability report.

In November 2014, a $700m issuance from the Dubai International Financial Centre (DIFC), the financial free zone that hosts NASDAQ Dubai, booked orders worth $3bn. Sukuk traditionally cost more to issue and come with a slightly higher yield for investors in comparison to conventional bonds. In Dubai, for example, a government sukuk was issued at a 0.1033% premium to the yield of a comparable government bond, according to IFSB data. Similarly, in Malaysia the spread was 0.161%. Due to the shortage of sukuk and growing demand, yields are now sometimes below those of regular bonds, according to the institution’s data.


DIB’s sukuk was a perpetual issue, meaning that it does not have a maturity date, but continues to pay a profit rate to holders until they choose to cash it in. DIB was the second Islamic bank in the UAE to sell a perpetual sukuk, the first being Abu Dhabi Islamic Bank in 2012. These sukuk structures are in line with the rules of Basel III, so the capital they provide qualifies under the regime’s rules for solvency, but they also represent efforts to compete with the conventional sector. “Many conventional banks offer services that were once unique to Islamic financial institutions,” Ahmed Saad, the deputy CEO of Sharjah Islamic Bank, told OBG. “Thus, it is important that Islamic banks begin to develop their own roadmap, deviating from conventional and creating their own identity.”

With a new set of international standards, developed in response to the global financial crisis, bank capital is divided into two tiers. The first tier must be comprised of highly liquid assets – those that can be easily swapped for cash on short notice. Funds raised through perpetual sukuk qualify as this type of capital as long as investors cannot call on them for six years after the original sale. The profit rate on the sukuk is renegotiated after six years for those who do not exercise their call options. To qualify as Tier 1 capital under Basel III the debt must also be subordinated, meaning that in the event of insolvency holders would be paid only after owners of unsubordinated debt are paid.

In 2014, Almarai, a Saudi food conglomerate, became the first GCC non-financial issuer to use a perpetual sukuk. This issue is structured with a call option after five and a half years, but with a higher yield for those who choose not to. In addition to raising funds that could be used as Tier 1 capital, Islamic banks can also hold the sukuk of other low-risk issuers to accomplish the same goal, according to research from the global credit ratings agency Standard & Poor’s. “Basel III creates a window of opportunity for the industry to resolve long standing weaknesses related to the lack of liquidity management instruments,’’ Paris-based credit analyst Mohamed Damak wrote in August 2013.

Improvements could be made in two ways, he said. One would be central banks and other key Islamic institutions such as the Islamic Development Bank issuing sukuk on a regular basis that would count as safe liquid assets under Basel III’s Tier 1 category, making it easier for banks to hold these sukuk. Secondly, it could encourage secondary trading, as issuers with high credit quality would possibly seek to list their sukuk on capital markets to spur interest. NASDAQ Dubai could be a site for those listings, given it is already a centre of liquidity for sukuk and wants to grow in that area.


In the emirate, NASDAQ Dubai is a likely spot for market future innovations, and the effort being put into creating new instruments will dovetail with the emirate’s goal of becoming a leading centre for Islamic finance. In partnership with HSBC, Dubai introduced a sukuk index, in which yields on a basket of 52 dollar-denominated sukuk are tracked. The basket ended 2014 with a yield of just under 6.9%, having peaked in September at 8.44% and dropped to 5% in December.

In spring 2014 the bourse introduced an alternative to a method banks have developed that is reliant on commodity contracts on the London Metals Exchange. In the technical details of this process, called commodity murabaha, a bank that needs extra cash immediately agrees to acquire merchandise from another party for a deferred payment. It then resells the goods immediately to get the upfront cash it needs. Some in Islamic finance would like to develop other methods they are more certain would be sharia compliant, and with lower fees. Instead of using commodity contracts, asset-backed certificates are used in a similar structure: a bank buys from another party at a price to be paid later, and then sells immediately to get cash. The certificates have a fixed value of $10 and can be backed by real estate or other assets. NASDAQ Dubai announced the feature after completing a pilot phase in April.

That plan would help to create sharia-compliant liquidity on securities exchanges where there is little now. Secondary trading in sukuk is minimal worldwide, with most issues held to maturity. Growth in the secondary-trading market was up 17.5% in 2013, with a value of $269.4bn traded. Malaysia accounted for 58.7% of activity, Rasameel reported. However, if liquidity demand can be met by the sector and shorter-term government issues increased, it is easy to see a future in which sharia-compliant trading can flourish, adding depth to the existing Islamic exchange trading and complementing the growth already seen in both banking and sukuk.