COVID-19: AN EXOGENOUS SHOCK OR A WAKE-UP CALL FOR RE-ASSESSMENT OF ISLAMIC BANKING AND FINANCE?
Islamic finance is badly affected by the ongoing COVID-19 pandemic. Thankfully, however, it is not only Islamic finance that is being adversely impacted, as the whole world is suffering, with businesses being down-sized or completely shut down. Nonetheless, it shouldn’t pass by merely as an exogenous shock to the system. Rather, the following questions must pause us for a while to think:
Are Islamic banks and financial institutions going to get hit worse than other conventional players in their respective markets?
Can Islamic banks and financial institutions come out of the crisis faster than their conventional counterparts?
In the context of the last Global Financial Crisis (GFC), many industry observers and analysts argued that IsBF coped better with the adversary than many conventional financial institutions. However, that might have been due to the smaller size of Islamic banks and financial institutions, and relatively less (or no) exposure to the toxic assets. It is also heartening to observe that Islamic banks went into the COVID-19 pandemic a lot healthier than when they were hit by the GFC. Hence, recovery should also be faster, as the forecast for economic growth for 2021, globally as well as for individual countries, is certainly healthy.
There are various techniques that may be used for stress testing (see p. 23-24). As an example, stress testing in the wake of a change in a macroeconomic variable like GDP growth may be used to illustrate the gravity of the situation.
The worst-case scenario for annual stress testing that the banks have been subjected to since the end of the GFC assumed a decline in the global GDP by 5% to 7%. With the estimated decline in GDP in EU and US of 28% to 30% (Fitch Ratings) and over 25% decline in the global GDP (Euromoney), the banking sector has already been hit with a big blow. While regional or global GDP is relevant, a more important factor would be a decline in the national GDP of the country where a particular Islamic bank operates. For example:
What would be the impact of nearly 14% (estimated for 2020) decline in GDP in Malaysia on its Islamic banking sector?
How would the largest Islamic bank in the world (outside Iran), namely Al Rajhi Bank (of Saudi Arabia) cope, given the sharp drop in oil prices and the decline in GDP growth in the wake of COVID-19?
Pakistan is expected to experience a decline of over 80% in its GDP growth rate in 2020. How is the Pakistani Islamic banking sector going to respond to this external shock?
These, and many more, questions must be answered. The risk managers within Islamic banks and similar businesses must be busy running simulations. This should not be deemed sufficient. An industry-wide assessment is essential. To start, there is a need to conduct something similar to the Supervisory Capital Assessment Program (SCAP) for the largest 20 Islamic banks to assess the stability of Islamic banking in the wake of the current crisis. Ideally, a comprehensive SCAP should be developed for the global Islamic banking industry to assess the stability and sustainability of IsBF. It is absolutely imperative to do so, given that the growth in the global Islamic AUM has been declining over the past 5-7 years.
Despite its devastating economic effects, the COVID-19 may, in fact, be a blessing in disguise for IsBF if the captains of the industry and other stakeholders take it as a wake-up call and start re-assessing its fundamental value proposition. This pandemic has unambiguously conveyed the message to each and everyone that any and everything is possible in terms of risks and opportunities. The IsBF industry, therefore, must realise that it is quite possible that the demand for IsBF or supply of Islamic financial services withers away in future, following an “event” or at the end of a “process.” One may shun this view completely, but the on-going COVID-19 crisis has made nothing impossible and everything possible in terms of incidence, quantum and proportion.
The COVID-19 may present an opportunity to IsBF to rethink and redefine itself.
A reassessment of the direction of the industry requires the exploration of the possibility of developing IsBF as a development-oriented financial intermediation model rather than a purely technical phenomenon based on Shari’a. Also, this is perhaps the timeliest warning for Islamic banks (and other service providers in the industry) to start taking technology seriously. In a situation following the outbreak of COVID-19, technology is perhaps the only winner. In the post-COVID-19 era, FinTech must play a bigger role in Islamic finance.
There is no indication of any sort that IsBF will suffer more or less than conventional banking and finance during or after the ongoing pandemic, but it is always a good idea to grab any opportunity to pause and reflect on past performances and decide the future course of action. The COVID-19 may present such an opportunity to IsBF to rethink and redefine itself. The question arises, are any stakeholders out there who are ready to seize this opportunity.
