Stress-testing Islamic Finance

Now that the results of the US Treasury’s stress test of US banks have been released, it seems apt to also turn the attention to other financial systems. Islamic Finance has been touted as an alternative model, less exposed to securitization, with ethical guidelines, and its proponents hoped better insulated from global trends.

However, Islamic banking and finance faces many of the same vulnerabilities as conventional finance (See more on the outlook for Islamic financial institutions in this recent presentation). These financial institutions, both Islamic banks and those issuing Sharia-compliant investment products, are vulnerable to changes in liquidity and growth conditions globally and in the targeted regions. The countries of the Gulf Cooperation Council (GCC) a particular source of growth in demand for Islamic financial products continue also to suffer from tight liquidity.

In this piece we look at some of the vulnerabilities but also the opportunities of Islamic finance, to discuss how one might test this financial model. We focus on the dynamics in the GCC especially in relation to GCC investors, sovereign and private, and to Islamic banks operating in the GCC and MENA region though some of the analysis is also relevant to South East Asia.