February 8, 2016
In this issue…
As equity markets tumble, a key Fed official has signaled concern that “the possibility that inflation expectations become unanchored to the downside”. With the Fed’s latest statement signaling four rate hikes in 2016, concern at the Fed about deflation lowers the probability that the Fed will go through with all four hikes, weakening the dollar. With less upward pressure on the dollar, commodity price volatility that has destabilized many emerging markets may abate.
Kuwait Finance House, one of the largest Islamic banks in the world, has said it is considering a capital-boosting sukuk to increase its Tier 1 capital. Dubai Islamic bank has also said it will need to increase capital during 2016 on the back of strong asset growth in 2015. While Islamic banks remain well capitalized, the rapid growth in assets that has continued unabated despite the oil price crash will likely lead many Islamic banks in the GCC to raise additional capital.
Conventional banks in the GCC have seen slower asset growth which limits their need to raise capital at the moment. However, if loan losses pick up, they may also see pressure on their capital ratios and a return to capital markets. The prospect for stronger asset growth at Islamic banks than conventional banks which underpins their likelihood to raise capital was one of the factors identified in the Finance Forward Islamic Finance Outlook 2016 as a supporting factor for Islamic banks in an environment with lower oil prices.
In addition to their greater resiliency to any slowdown in deposit growth, Islamic banks are less exposed to the large government projects which have been the first to see delay or cancellation proposed. Efforts to reduce subsidies for basic services, which are likely to come and will likely retail demand for financing on which many Islamic banks depend, have been slower to materialize as they are more difficult politically than cuts to mega-projects.
Greater market stability, in particular, would be a boon for commercial banks looking to raise capital and the investment banks looking to underwrite these capital-raising sukuk and bonds and help spring back after a tough year. Investment banking revenues in the GCC dropped by 16% in 2015, twice the drop in investment banking revenues globally. To estimate the likely number of banks needing to raise capital, we assume continued asset growth in line with growth in 2015 and assume a bank would likely raise capital if it would end the year with Tier 1 capital lower than 13% at the end of 2016, or if they experienced a drop in Tier 1 capital by at least 2%.
Based on this criteria, 9 of the 31 banks where data was available would be expected to raise additional Tier 1 capital (either from equity or debt). Within the 31 bank sample, one-third of the banks likely to raise new capital were Islamic banks and 3 of the 7 Islamic banks (42%) were likely to have capital raising needs in the next 12 months.
This would continue a relatively strong issuance trend by Islamic financial institutions in the GCC which have so far not been as affected by recent financial market volatility. According to Zawya, sukuk issuance by financial institutions in the GCC (excluding the Saudi-based Islamic Development Bank) reached $6.9 billion from 13 issues during 2015, compared with $2.7 billion from 4 issues in 2014. While many companies in the GCC are scrambling to deal with the effect of lower oil prices, Islamic banks have entered the slowdown in a relatively better position and, provided that they can raise the necessary capital, are in a position where they are likely to gain market share in the coming year.
The responsible finance opportunity in Asia is truly massive compared to what exists today. Two weeks ago, Finance Forward looked at the impact that large capital account inflows had in insulating many countries from the pressure by responsible investors. Today, with the inflows turning to outflows, there is a greater recognition that responsible investors hold capital badly needed by many businesses to continue their growth.
When the issue of responsible investing is discussed in common parlance, the default reference is to responsible investment from developed market investors, using traditional responsible finance techniques (environmental, social and governance (ESG) factors). However, within Asia, this focus may miss an opportunity to spur growth more rapidly not just in investments, and not with just capital from developed markets, but also from within the region.
A leader in this regard is the Employees Provident Fund in Malaysia which, last week, reaffirmed its commitment to setting up a Shariah compliant fund at the same time as it assured contributors that it integrates ESG into its investment decisions. The EPF, which is not presently included in either the Islamic fund or responsible investment universe, represents a huge catalyst for responsible investment and Islamic funds with its move towards responsible finance.
To put the relative sizes in context, the Responsible Investment market globally is $21.4 trillion, about 30% of all managed assets. Islamic finance, of which about three-quarters is banking assets, holds $1.81 trillion. About one-quarter of Islamic banking assets are based in Malaysia alone, representing $170 billion, which is larger than the entire responsible investment universe in Asia (of which 37%–about $20 billion—are Islamic) by a factor of 3!
With responsible investment assets in Asia representing just 0.2% of global responsible investment assets, and Islamic finance assets in Malaysia alone representing 1.9% of total responsible finance assets (including Islamic banking assets), there is clearly room for cooperation towards huge growth that is likely to accompany economic growth and financial market development in developing Asia.
To get an idea of the size of asset growth we are talking about, consider if the total responsible finance assets of today were split according to the global population instead of its current developed market tilt. Of the $23.1 trillion in responsible finance assets, a representative split based on the share of the global population would mean Asia’s responsible finance assets would be $12.7 trillion). If a more conservative split based on economic size (measured by GDP) were used, the share from Asia would still represent $5.2 trillion in responsible finance assets, nearly 100 times the current responsible investment assets in Asia and more than 10 times the sum of current Islamic finance assets in Malaysia (the largest market) and responsible investment assets in Asia.
The prospects for responsible finance growth across Asia is tremendous and Malaysia’s experience with both Islamic finance, and more recent developments with its national pension fund integrating ESG and expanding to incorporate an Islamic investment option, the future for responsible finance in Asia is bright.