Large current account deficits and declining conventional financing sources have prompted governments from Arab spring countries to look at opportunities offered by Islamic finance, said Standard & Poor's.
Standard & Poor's Credit Analyst Mohamed Damak said, "We have observed this development in the North African countries where we rate banks - Egypt, Tunisia, and Morocco. These sovereigns have recently taken steps to implement policies to support the development of Islamic finance: Tunisia plans to issue Sukuk to attract a new class of investors; Egypt implemented new regulatory frameworks for Sukuk issuance; and Morocco is laying the legal foundation for Islamic banks."
Islamic finance first appeared in North Africa in the 1970s and it remains embryonic, as shown by the Islamic Finance Development Indicator (IFDI), a composite weighted index created by the Islamic Corporation for the Development of the Private Sector (ICD) and Thomson Reuters. IFDI provides an aggregate assessment of the evolution of Islamic finance based on five pillars: quantitative developments, knowledge, corporate and social responsibility, governance, and awareness (see chart 1).
Only a limited number of players are active in Islamic finance (banking, insurance and funds) in North Africa. They represent between one per cent and five per cent of their respective industries. Overall, North Africa's contribution to global Islamic banking assets stood at about one per cent at mid-year 2013. This minimal development is linked to the low-key presence of Islamic finance in the public debate until recently.
"Shari'ah-compliant banking previously presented an attractiveness that was at best exotic for regulators and banks active in these markets," said Damak. "Now, the perception is changing and public awareness is increasing."
THE PRICE IS RIGHT?
Standard & Poor's believes that Islamic financecouldmakesomeadvancesin North Africa over the coming two to three years. However, its success will depend on its ability to demonstrate its economic added value in this part of the world. "In our view, this could be achieved either through creating access to a new class of customers and investors or by offering Islamic products at costs comparable with conventional counterparts, both for corporate and retail products," the report said.
Wealth in Maghreb countries is much lower than in other regions where growth in Islamic finance has accelerated. Stiff price competition in some of the North African markets indicates that customers in these regions are relatively more sensitive to the costs associated with banking products, according to the report. "In our opinion, the success of Islamic banks in North Africa would be closely related to their capacity to offer products at a cost comparable with conventional banking activities," it said.
Historically, Islamic financial products were more expensive than their conventional counterparts due to their structured nature or lower liquidity, particularly in Gulf countries. S&P said it may not be the case in North African countries, where price competition is already stiff because banks compete for a relatively narrow band of clients.
RIGHT TIME, RIGHT PLACE
The revolutions in Tunisia and Egypt and the constitutional reforms in Morocco brought conservative parties to the driving seat of the political scene. These parties are more inclined to cooperate with Gulf countries and are more interested in the development of Islamic finance compared with previous regimes that turned more toward western powers and conventional banking, said the report.
In addition, the economic slowdown in Europe together with political instability in Tunisia and Egypt caused a major slump in these countries' economic performance, increased their current account deficits, and widened their financing needs.
The limited capacity of multilateral lending institutions to satisfy all these needs pushed some of the North African countries to turn to Gulf countries for foreign direct investment and financial support; and to consider the Sukuk market as an alternative to raise foreign currency funds. To facilitate this, in late 2013, the National Constituent Assembly in Tunisia and the parliament in Egypt approved laws governing Sukuk issuances. "We understand that Tunisia aims to tap the Sukuk market for about $500 million in 2014," said S&P.
In January 2014, the Moroccan cabinet approved the legal terms organising the activities and the development of Islamic finance, after they were authorised by the Central Bank in 2007. Approval was delayed as the country dealt with the negative impacts of the economic recession in Europe and the setbacks caused by the Arab spring. The bill has yet to be endorsed by the parliament.
Regulatory changes are creating an enabling environment for the development of Islamic finance in North Africa. However, its success will depend on its ability to demonstrate its economic added value in this part of the world. In S&P's view, this could be achieved either through creating access to a new class of customers and investors or by offering Islamic products at costs comparable with conventional counterparts, both for corporate and retail products.
"Islamic finance in North Africa remains underdeveloped but regulatory changes are laying the groundwork for its growth," said Damak. "However, we believe that success will depend on their ability to offer products at a cost competitive with conventional banking activities."
Sovereign issuance of Sukuk could help meet sizable funding needs as other financing alternatives have diminished. According to S&P, corporate and financial institutions could follow sovereigns' lead and issue Sukuk when it provides access to an untapped class of investors. "We expect the process to be very gradual, however, because local banks and corporates are slowly familiarising themselves with Islamic finance and the Sukuk markets as a credible financing alternative," said S&P. "In Morocco, upon approval of the pending legislation, we think that some banks will be interested in developing Islamic windows to tap the unexploited potential of this market," the report said. "However, we do not foresee a radical change in corporate or consumer behaviour. Although a considerable portion of the retail and corporate customers may have a natural bias toward Islamic financial products, ultimately, the price difference will be a chief determinant, in our view."
The asset-backing principle embedded in Islamic finance and the significant infrastructure needs in North African countries could work hand-in-hand, said the report. Traditional financiers, such as bilateral financiers and multilateral development institutions, have been very active in infrastructure financing in North Africa; their total commitments exceeded $4.9 billion in 2012.
However, the capacity of these institutions to satisfy the full demand for infrastructure financing is limited and North African countries will need to attract additional financing sources.
"We also believe that Islamic finance can be a good fit for infrastructure and project finance, as banks lack long-term funding capability required by these projects," said Damak. "Several projects in renewable energy, transport infrastructure and communication are ongoing or expected to be launched in the future in North African countries. Using Sukuk to finance some of these projects could help diversify investor bases and tap additional pools of resources."
In our opinion, the success of Islamic banks in North Africa would be closely related to their capacity to offer products at a cost comparable with conventional banking activities