Growth of Islamic Finance: Historical Perspective and Current Trends
According to Ernst & Young’s Report in 2013 the Islamic banking assets grew at an annual rate of 17.6% . This was sustained over the previous 4 years. The growth rate is expected to rise further to the level of 19.7% over the forecast period 2013-2018. This is an exceptional performance if put in the global context. Certainly, such growth phenomenon is beyond the reach of single countries, single institutions or even beyond assets of the conventional financial system taken as a whole.
Comparable growth rate was thought to be achieved prior to 2008. New financial instruments had been created, repackaged and resold on a global scale. For a prolonged period of time it indeed seemed like a success story. Then the asset prices plunged and chaos on the financial markets followed, in what has been called the mortgage crisis. What remained after that was the disappointment of bankers and governments, and the frustration of taxpayers who ended up paying for mistakes they have not made. The world is still struggling with its debris.
This is when the attention towards Islamic Finance shifted. The alternative, which it proposes, is conceptually striking. In contrast to the paradigms of conventional finance, it urges for financing of material assets and tangible projects, excluding the risks of speculation and asset inflation. It emphasises the need for investments, yet only those related to the real economy and aimed at the social well-being.
How Did It Start?
Although the prohibition of mechanisms such as riba (usury), gharar (uncertainty) and maysir (speculation) is well-defined conceptually, their application has been sporadic at best in attempts at Islamic Finance. Their history dates back not only to the foundations of Islam, in more of a religious-based framework, but also to the philosophical discussion and prevalence of concepts such as morality and social responsibility, defining what is ethical and what is not. The absence of their wide-scale application can be explained in terms of market inefficiencies, lack of funding opportunities, organisational problems but also, more recently, with regard to the dominance of the mainstream economics. It is the paradigm that stresses self-interests and puts rationality at its core, somehow unrelated to real societies and moral intentions of economic agents. Therefore, in the world of a profit-contingent trajectory path, it comes as no surprise that concepts such as lack of interest and loss-sharing did not find their way through.
However, the conceptual discourse is not the only matter that must be considered to explain why the Islamic Finance did not start its growth path earlier. The country-specific circumstances attached to the development of financial markets and services influenced the initial choice that, once made, could not be easily changed. An assumption that the Muslim countries should be the first to start-off with Shariah-compliant investments is a natural one, but it was not grounded empirically. As Bank of London and Middle East (BLME) explains ‘(…) the Middle Eastern and Asian regions became important trading partners for European companies such as the Dutch East India Company, European banks started to establish branches in these countries, which typically were interest-based. With the increasingly important role Western countries started to play in the world economy, conventional financial institutions became more dominant.’ 
Despite such influences, it is worth emphasising that Malaysia did succeeed in enacting the Islamic Banking Act in 1983. In the same year the first Islamic Bank, Bank Islam Malaysia Berhand (BIMB) was established. Regardless of the colonial background of Malaysia and the existence of a well-installed conventional financial system before 1990s, when the regulatory pre-conditions for the functioning of the Islamic Finance structures were laid, in two decades Malaysia became one of the most globally competitive markets in terms of financial development. What followed was a period of sustained growth that expanded the system in parallel with conventional finance. Critically, in 1993 the Malaysian government introduced an Interest-Free Banking Scheme that allowed other banks to engage in Islamic banking operations . This potential transition from one system to another provided conventional banks with a second thought about an alternative system of organisation. Today Malaysia is the world’s Islamic Finance hub . According to Islamic Finance Information Service (IFIS) database, out of a total of 8561 globally issued Sukuks 7236 were denominated in Malaysian Ringgit (MYR). This is a large number considering the outstanding value of these bonds (as reported by the IFIS) in excess of US$326 billion.
The most recent data (please refer to Figure 1 presented below) confirm that Malaysia keeps its position of the market leader but other countries follow its experience. During January-November 2014, the Malaysian share in the total outstanding Sukuk was over 50%, while group of the other big players included Saudi Arabia, Indonesia, United Arab Emirates, Qatar and Turkey with 16%, 8%, 7%, 5% and 4% respectivaly. Notably, there were also smaller players in the market with a total share of 7% over the period, with countries such as Bahrain, Pakistan, South Africa and United Kingdom to list only few. Both the latter and former countries yet have to prove the extent of their commitments but the way toward Islamic Finance alternative has been certainly paved.
Will Islamic Finance Grow Exponentially?
Increasingly many countries put forward their potential interest in Islamic Finance and declare that they might consider issuing some of Shariah-compliant instruments and integrate them into the regulatory framework of their own systems. At the same time the major international commercial banks enlarge the range of their offers to include some of Islamic Finance-based activities. By now also the individual customers can purchase these securities on the financial markets.
What do these decisions imply for Islamic Finance growth? Is there a direction the industry is tending to? What do the rough market data imply? These are only some of the questions that arise in terms of the past historical developments and the current stage of growth.
Restricting the analysis to the integrated data on the Sukuk market (since other types of securities are typically traded on the national markets, the data presented here includes both company and sovereign bonds) it follows that also the time horizon can be divided into subperiods with distinctive characteristics. Firstly, in the period 1996-2003 the market was defined by steadiness and was rather static, characterised by limited Sukuk value growth and small total number of underwritten Sukuks (Figure 2 and Figure 3). The situation changed with a sudden jump in 2004-2005 when the number of issued bonds exceeded 200 and reached 543 bonds by the end of 2005. In the same year also the value of Sukuks was rising and exceeded US$22 billion. From then on new Sukuks were flowing on the market, while holding the number of issuers within the range 100-150 (Figure 2). This implies that the same issuers were now either issuing more or were separating their capital into underwriting of smaller value denominations. To check for the latter hypothesis, we turn to Figure 3. The evidence is that while the bonds value was increasing until 2007, it suddenly plunged in 2008. By 2009 there were more bonds of a slightly higher value and the growth in value resumed at the previous levels only at the beginning of 2011. It reached a maximum in 2012. In 013 there were issued 894 Sukuks more at the total value in excess of US$109 billion and 142 issuers.
Figure 2: Number of Issued Sukuks and Sukuk Issuers in the period 1996-2014.
Figure 3: Value of Issued Sukuks in the period 1996-2014.
From these graphs the implication for the Sukuk market is that while the total number of obligations rises, the number of market players issuing them does not rise, yet the data somehow fluctuate without confidence. The initial decrease in value and a later increase following the mortgage crisis (though this said, it is certainly not the only factor behind such trend) provided a positive market expectation. This should be interpreted with caution and lead to a conclusive remark that the potential Sukuk boom in the future will depend on whether the current groth level is sustained or at least on whether it does not slow down.
On the returns-side and the relative attractiveness of investments in Sukuk, the Dow Jones Total Return Index is reported (Figure 4). It was launched November 30th, 2009 with the value of 114.3 and by October 31st, 2014 it stood at 152.31. The index is a composite measure of different types of bonds which were rated either AAA, AA, A or BBB with short-term maturities as well as long-term ones. Thus, the index shows the return performance of the top securities. Its value displayed periods of sustained increases and decreases but generally it performed very well.
Futhermore, in July 2013 S&P Dow Jones announced the lanuch of MENA Sukuk Index to trace the movements of bonds of the MENA region. Although its growth is more evident (Figure 4), its performance is actually inferior to the previous index, since its fluctuations are more irregular and its growth over the period lower. However, their similarity lies in the fact that they both exhibit a linear type of growth. A linear trendline is shown to approximate this relationship. Hence, the major conclusion is that the Total Return Index and the MENA Price Index as traced by S&P Dow Jones do not exhibit an exponentially-rising trend.
Figure 4: Dow Jones Sukuk Total Return Index (November 2009-October 2014).
Figure 5: S&P MENA Sukuk Index (July 2013-September 2014).
What Would Global Growth of Islamic Finance Mean?
While the ongoing debate about the essence of the Islamic Finance continues, the power of the system lies in the conceptual difference of bringing back the social relationships and recognising their potential positive influence through ethical and emphatic individuals, against the disembedded type of the law of the market.
Therefore, the modern Islamic Finance suggests a conceptual change (along giving up on tools such as interest charges) and reflects the state of the real economy. It should not come as a surprise to a careful reaser that the appeal to Islamic Finance and the question of what is moral came only in the aftermath of crisis.
Today Islamic Finance includes products such as partnership contracts (Shariah-complaint projects), financing arrangements (typically a deferred sale of goods at their cost), special leases, insurances and bond-type instruments (the most popular).
Notwithstanding this wide range of opportunities, there exist limits to growth that come from the internal part of the system. They lack of consistent regulatory framework, obligatory rating, consensus on univeral terms of contracts and trading of securities between different national markets (secondary markets) are only examples of such limits.
This paper attempted to trace the growth history and the current trends of one of the main Islamic Finance instrument, namely the Islamic bond. The presumption that Sukuk market grows exponentially was concluded not to hold. This might be proven differently in the future decade following the mortage crisis and the sentiments that shift the balance towards moral economy. Whereas Islamic Finance is a world-challenging alternative, as every success story it is prone to future decisions of policymakers and individual customers.
 Ernst & Young, ‘World Islamic Banking Competitveness Report 2013-2014: The transition begins‘.
 Schoon, N. ‘Islamic finance – a history‘. BLME Financial services review (August 2008), p.10.
 Alhabshi, S.O. The History of Sukuk Development in Malaysia: Legal and Governance Perspective‘. (Paper presented at the International Seminar on Sukuk and Islamic Financing Instrument 2013, organized by Yarmouk University, Jordan and IKIP International College, Malaysia on 12-13 November, 2013).
 El Qorchi, M. ‘Islamic Finance Gears Up‘. Finance and Development IMF Magazine (December 2005, Volume 42, Number 4).
www.islamicfinanceservice.com/ (data available upon subscription)
www.us.spindices.com/ (S&P Dow Jones indices)