Islamic Finance As A Tool For Economic Recovery Post Covid-19

The Beginning of Islamic Finance

Islamic Finance has gone a long way since the establishment of the first full-fledged Islamic bank in 1975, the Dubai Islamic Bank. Since then we have seen various revolutions in this industry with the United Bank of Kuwait being the first conventional bank to introduce Islamic finance products. HSBC moved it further being the first UK lender to offer house mortgages that fit within the Islamic Finance definition and subsequently the establishment of HSBC Amanah, their Islamic bank division of HSBC.

Strong Growth And Resilience

Islamic Finance has since then shown steady growth since its inception close to five decades ago. Total assets have reached a staggering value of USD 2.5 trillion in 2019. The ecosystem has grown exponentially with the emergence of a full suite of Shariah-compliant offerings such as Islamic Funds, Takaful, Sukuk, and more. Countries such as Malaysia, UAE, and Turkey have consistently led the growth with Malaysia Sukuk marketing accounting for 51% of the US$396 billion (RM1.66 trillion) of total global outstanding Sukuk in 2017.

Many factors contributed to the growth of Islamic Finance worldwide, including the sophisticated regulatory regimes as well as compliance in place, ensuring investors' confidence in Islamic Finance offering and instruments. Islamic Finance has also proven to be very resilient in the wake of the 2008 global financial crisis, surviving the crash with minimal impact. One of the main contributors to this was that Islamic banks prohibit unethical and high-risk investments at the same time promote interest-free services. It is also backed by real physical assets preventing a high level of debt that can cause the institution to crash when the debt is too high to sustain.

Due to the strong resilience nature of Islamic Finance, various tools and instruments of Islamic Finance can be utilized in aiding the economic recovery post-Covid-19 in 2021 and beyond.

Islamic Finance As A Tool For Economic Recovery Post Pandemic

2020 saw an unprecedented move by governments worldwide introducing enforced lockdowns to flatten the infection curve at the expense of the economy. Domestic consumer demands have dropped drastically mainly due to those lockdowns and movement restrictions. This has disrupted global supply chains and caused many businesses to lower production or ceased operation, restricting cash flow, ultimately contributing to a high unemployment rate globally. This has caused a scenario whereby the flow of cash is restricted both for the businesses as well as the mass.

To navigate this, a wide range of Islamic Finance instruments can be used, both in the short term recovery as well as long term which can positively impact consumer power as well as the businesses. In fact, in April of 2020, the United Nations Development Program (UNDP) highlighted several Shariah-compliant financing instruments that could be part of the integrated pandemic response plan to help countries prepare, respond, and recover from the pandemic.

a.    Zakat

Zakat can play a crucial role in the short-term recovery benefiting national as well as NGO emergency support programs. Zakat refers to the obligation that an individual, corporation, or institution has to donate a certain proportion of wealth each year to charitable causes. Typically, Zakat is disbursed in the same year it was collected. Zakat essentially supports those severely affected economically due to the pandemic, as well as those living in poverty. Zakat donors, both individuals as well as corporations often make cash transfers, which can be especially important for liquidity in emergencies and increase immediate cash flow within the economy.

b.    Sukuk

Think of Sukuk as Islamic bonds that are structured in a way to generate returns to investors and similar to an asset-backed security. But unlike bonds, a Sukuk holder is granted an ownership interest in the asset or business being financed. The financing of businesses or projects is key to any economic recovery in the medium to long term.

In 2020, the Sukuk market has proven to be very resilient despite the COVID-19 pandemic. In the first nine months of the year, issuance was a total of $130.5bn, compared with $127.3bn for the same period in 2019. The UK was the first non-Islamic country in the world to issue a sukuk when it raised ￡200 million ($256 million USD) in 2014. As of last year, over 20 banks in the UK offer Islamic services, and five of these banks are fully Sharia-compliant, including Al Rayan Bank. Assets of UK-based institutions that offer Islamic finance services totaled more than $5 billion.

The government of Malaysia launched a RM 500 million (USD 124 million) Sukuk in 2020 as part of the government's efforts to raise funds for their coronavirus economic recovery plan. The Sukuk was oversubscribed at RM666 million (USD 165 million) in less than 3 months, surpassing the original target of RM500 million (USD 124 million). These funds are used to enhance connectivity to rural schools, which will also act as hubs to connect nearby villages, COVID-19 response related projects, as well as financing and grants for micro-enterprises. Due to the nature of Sukuk, it attracts high numbers of environmental, social, and governance investors (ESG).

c.    Waqf

Waqf is a special kind of philanthropic deed in perpetuity. It involves donating a fixed asset that can produce a financial return or provide a benefit. The revenue or benefit generated then serves specific categories of beneficiaries which can be an important contributor to long-term resilience. With Waqf, financial or non-financial assets such as land or buildings are permanently dedicated to social purposes. This could help provide affordable housing solutions or access to health care and education for people that might have lost a portion of their income.

Waqf can, in many contexts, be important contributors to long-term resilience. Financial or non-financial assets such as land or buildings that are permanently dedicated to social purposes ultimately contribute to a cheaper healthcare system, more affordable housing, and mass education especially amongst developing countries.

d.    Takaful

Takaful is a system of insurance based on the concept of mutual assistance (ta’awun) and donation (tabarru). Takaful means a joint guarantee, whereby a group of participants contribute towards a pool of money and mutually agree to protect each other by compensating those participants who suffer from an insured peril.

Takaful as a concept is the very idea during a crisis recovery primarily because it is based on small participant contributions and additional donor risk capital, enabling participants to reach out to commercial healthcare providers for diagnosis and treatment of Covid-19. This is only a small proportion in comparison to overall Takaful participants given that less than 15% suffer severe infection, requiring hospitalization, and only 5% are critical infections requiring more invasive clinical ventilation. This redirecting of poorer patients to otherwise unaffordable private healthcare providers would aid the public healthcare system that is overburdened and on the brink of collapse to regain its footing.

Takaful also provides coverage against the collapse of micro, small and medium businesses due to the lockdown imposed globally to curb the pandemic. Payouts from the Takaful pool could also protect microentrepreneurs as well as businesses from selling productive assets such as land or tools and therefore support eventual economic recovery.

Islamic Fintech The Solution For Economic Resilience

We have seen how drastic global lockdowns and movement restrictions contribute towards an increase in online businesses including in the banking sector. E-wallets and cashless payments saw a drastic increase in usage compared to the previous year. Islamic Banks have started to digitize and increase fintech collaborations hence strengthening their resilience in a crisis volatile environment and open new avenues for growth.

The PENJANA Sukuk issued by the Malaysian government was able to be subscribed online via various Malaysian banking websites hence opening an avenue for new sets of investors and appeal to the younger generation as well.

Islamic Finance instruments coupled that with Islamic Fintech can be a great tool for economic recovery post-Covid-19. 

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*Faeez is an entrepreneur, board member, advisor as well as mentor. His interest and passion lie in Islamic Finance. Faeez was named 30 under 30 by Forbes magazine in 2016, 40 Under 40 by Prestige, Top 10 Young Entrepreneur Rising by Top 10, People To Watch 2016 by TTG as well as the Most Innovative Young Leaders Award 2016 by UCSI.