Unlocking the Potential of Islamic Finance: An In-Depth Look at IsDBI’s Islamic Finance Country Assessment Framework

Turkhan Ali Abdul Manap, Syed Faiq Najeeb, Yahya Aleem ur Rehman

12 Nov, 2023

Introduction

Over the past few decades, Islamic finance has gained significant recognition as a viable alternative to conventional finance. In the early 2000s, the estimated value of Islamic finance assets was roughly USD 200 billion. Despite facing various financial crises, the industry has seen remarkable growth and is now valued at USD 3.25 trillion as of 2022.

This success can be attributed to the industry’s adherence to Shari’ah principles, which promote ethical and just financing, equity, and mutual risk-sharing to support the real economy. Even during the 2008 Global Financial Crisis, the Islamic banking sector achieved an impressive annual expansion rate of 16% between 2008 and 2012, with a combined value of USD 1.4 trillion in 2013. Moreover, Islamic finance has demonstrated resilience during the COVID-19 pandemic, expanding globally by 10.7% in 2020, 11.3% in 2012, and 6.2% in 2022, ultimately surpassing USD 3.25 trillion in 2022 (Figure 1).

The imperative for an efficacious diagnostic instrument

While certain regions have made substantial strides in advancing Islamic finance, the industry’s development is not uniform globally (Figure 2). Many member countries are still in the early stages of establishing the industry. According to the Islamic Finance Stability Report (2023), 15 IFSB jurisdictions are considered Islamic banking systemically important. These 15 countries hold USD 2.07 trillion, which accounts for 91.4% of global Islamic banking assets worth USD 2.25 trillion.

Specifically, Islamic finance assets are primarily concentrated in three main regions: the Gulf Cooperation Council (GCC) region (53.6%), the Middle East (excluding GCC) and South Asia (18.6%), and Southeast Asia (23.3%). The cumulative assets in the top six countries total USD 1.883.9 billion, which accounts for 83.8% of Islamic banking assets. In 2022, Southeast Asia and GCC accounted for 74% of global Ṣukūk issuances. Despite this, there is growth potential in emerging markets across Africa, Central Asia, and South America, where Islamic finance remains underdeveloped.

The IsDBI IF-CAF

The Islamic Development Bank Institute’s Islamic Finance Country Assessment Framework (IF-CAF) is an evaluative framework encompassing essential aspects such as the legal and regulatory framework, market infrastructure, liquidity management, financial safety nets, and Shari’ah governance. Through a comprehensive assessment of these fundamental pillars, the IF-CAF can pinpoint particular deficiencies or opportunities for enhancement within the Islamic finance sectors of individual countries. This allows governments and regulators to make well-informed decisions that strengthen regulatory frameworks and better support industry growth.

The main goal of the IF-CAF is to assist member countries in effectively integrating Islamic finance principles into their national development strategies. This facility serves as a valuable resource in helping nations utilize the potential of Islamic finance for sustainable economic growth and development. This includes increasing diversity in the Islamic financial sector to achieve development objectives, utilizing modern technology to enhance financial inclusion, competitiveness, innovation, and efficiency, promoting Islamic social finance and social-safety net components to meet the Sustainable Development Goals (SDGs), helping MCs build their Islamic financial ecosystems, supporting IsDB’s member countries partnership strategy (MCPS) initiatives, and producing case studies and publications on successful strategies and lessons learned by MCs in their pursuit of developing their national ecosystems for Islamic finance. All these efforts are geared towards benefiting the broader IsDB Group development initiatives. At present, IF-CAF has been launched in Uzbekistan and Kazakhstan.

“The main goal of the IF-CAF is to assist member countries in effectively integrating Islamic finance principles into their national development strategies”

The IF-CAF’s Consultative Approach

The IF-CAF assessment adopts a collaborative approach involving consultations with diverse stakeholders in each country. These include industry players, regulators, policymakers, and Shari’ah scholars. The consultative process enables comprehensive discussions to gain insights into on-the-ground realities. Meetings focus on deconstructing the Islamic finance ecosystem to identify strengths, weaknesses, risks, and recommendations. This consultative approach is vital for an accurate diagnosis that forms the basis of tailored policy prescriptions.

Critical Components of the Islamic Finance Ecosystem

The IF-CAF team utilizes the diagnostic framework to evaluate facets across critical dimensions (Figure 3). For the legal framework component, not only is the alignment of laws and regulations with Shari’ah examined, but also specific laws and articles are identified that require modifications. For regulatory guidelines, the capacity of supervisory bodies is assessed based on available resources, trained staff, and oversight mechanisms.

When evaluating market infrastructure, aspects like adopting new technologies, participation of private sector players, and cross-border linkages are considered. Under liquidity management services, the report provides recommendations to develop additional instruments to promote stability and growth. Financial safety nets are strengthened by proposing reforms to existing structures and introducing global best practices. For Shari’ah governance, ways to increase standardization while allowing for diversity are explored. This approach aligns with guidelines on conducting comprehensive assessments of financial inclusion ecosystems, emphasizing inclusive stakeholder engagement and evaluation across multiple dimensions. This multidimensional analysis enables a robust evaluation of the Islamic finance ecosystem.

Tailored Policy Recommendations

The IF-CAF assessment synthesizes findings across all dimensions into tailored reports for each country. Based on the evidence collected, these reports emphasize the notable progress and existing strengths within each member country’s Islamic finance industry. The IF-CAF assessment generates tailored reports containing evidence-based policy recommendations to strengthen each country’s Islamic finance sector. Countries have seen enhanced economic outcomes through adopting policymaking based on evidence. With an accurate diagnosis of strengths and weaknesses, countries can develop home-produced strategies. The IF-CAF empowers stakeholders with the insights to unlock Islamic finance’s potential.

By implementing the recommendations formulated through the IF-CAF exercise, IsDB member countries can strengthen the foundations of their Islamic finance industry. This enables them to channel Islamic finance into priority development areas sustainably. As Islamic finance gains mainstream relevance, it can increasingly complement conventional finance to support socioeconomic goals. The IF-CAF allows each country to assess how best to integrate Islamic finance into its national systems based on local contexts.

Conclusion

The Islamic Finance Country Assessment Framework (IF-CAF) is a tool that evaluates the potential of Islamic finance in member countries. It conducts a comprehensive diagnostic assessment of the existing Islamic finance ecosystem and related sectors in each participating country. An important aspect of the IF-CAF is that it involves diverse local stakeholders from public and private sector institutions in each assessment, ensuring that the evaluation reflects the unique political, economic, and commercial context while benefiting from local expertise.

Considering all dimensions of the Islamic finance industry, the IF-CAF takes a holistic, evidence-based approach that helps countries strengthen the regulatory and institutional foundations to expand their Islamic financial services sector. It also supports the contribution of Islamic finance to national priorities such as SME financing, infrastructure development, and economic inclusion.

The IF-CAF’s comprehensive diagnostic framework is expected to play a crucial role in developing Islamic finance ecosystems within its member countries. By identifying challenges and highlighting untapped opportunities at an early stage, it offers guidance to overcome obstacles that may hinder industry growth. This contributes to the continued expansion of the global Islamic finance industry.