The Expansion of Islamic Finance Globally: Opportunities in Europe and Spain

Socioeconomic notes of Casa Árabe

142024

The Expansion of Islamic Finance Globally: Opportunities in Europe and Spain

Report published by the Observatory of Islamic Finance in Spain SCIEF-Casa Árabe

The Observatory of Islamic Finance in Spain SCIEF - Casa Árabe, serves as a premier hub for analysis and consultation regarding the current state of Islamic finance in Spain. Established by Casa Árabe and the Saudi-Spanish Center for Islamic Economics and Finance (SCIEF) at IE University, it publishes this socio-economic update about the latest developments and trends within the global Islamic finance sectors and markets, spanning various regions and countries, including North Africa, Europe, and Spain. It also highlights those markets where Islamic finance has reached significant structural influence and identifies opportunities for Spanish enterprises.

In recent years, Islamic finance has undergone remarkable growth in both volume and geographical terms, showing its resilience and efficacy in providing tailored financial solutions to meet the demands of contemporary economic realities across diverse sectors and markets. Within the European landscape, Islamic finance presents avenues for development, intersecting with one of the most rapidly expanding sectors: ESG criteria (environmental, social, and governance). Moreover, as Islamic finance gains systemic prominence in numerous countries, companies operating within these regions increasingly require expertise in Islamic financial products to navigate effectively. The economic diversification initiatives in the countries of the Gulf Cooperation Council (GCC) and the burgeoning growth observed in Southeast Asia are paving the way for business opportunities that necessitate companies to align their projects with Islamic finance principles or leverage them to finance their ventures.

Islamic finance in the world

In recent years, Islamic finance has experienced remarkable growth in both volume and geographic expansion. The total pool of Islamic financial assets reached an estimated total value of USD 4.5 trillion in 2022, which is expected to increase to USD 6.7 trillion by 2027 (ICD 2023), which gives evidence of

Chart 1. Total Assets in Islamic Finance (Billions of USD)

Source: ICD - LSEG Islamic Finance Development Report 2023

their resilience and robustness today, since they have achieved substantial structural weight in many countries.

1. Islamic Finance Sector Analysis Across the Globe

Across sectors, Islamic banking retains its prominence, constituting 72% of total assets. The segment witnessed a 13% growth in 2022, partly attributed to the rise in conventional banking interest rates (GIFR 2023). Presently, Islamic banking operates in 77 countries, with Australia being the latest addition, where its inaugural Islamic bank, a digital neobank, commenced operations in July 2022.

The Islamic capital markets segment, encompassing sukuk, Islamic funds, and Islamic stocks, has sustained continuous growth since 2015 but experienced a recent slowdown. While sukuk growth was previously in double digits, it amounted to 7% in 2022 (ICD 2023).

The lower growth of sovereign sukuk, in particular, is result of a reduction in the financial needs in GCC countries due to high energy prices. Nonetheless, Saudi Arabia remained the largest global issuer of sovereign sukuk, trailed by Malaysia and Indonesia. Despite mounting interest rates and liquidity tensions, corporate issuances grew, with Malaysia leading the pack, followed by Turkey.

Islamic funds, which have decelerated its expansion in recent years, recorded negative growth in 2022. This segment faced several challenges such as escalating inflation, rising interest rates, and persistent supply chain issues. Nevertheless, the market has exhibited resilience and is forecasted to reach USD 416 billion by 2026 (ICD 2022).

The takaful sector, also known as Islamic insurance, accounts for only 2% of the total global assets in Islamic finance, making it the smallest segment in the industry. However, its performance in 2022 was notable, with a remarkable growth of 16%, even amidst unfavorable conditions for this type of product. This upward trajectory is expected to persist in the coming years, fueled by the anticipated proliferation of Islamic Fintech, which aims to enhance the creation and delivery of takaful products. Additionally, regulatory frameworks in certain countries and the trend towards mergers and acquisitions within the sector are expected to further support its growth.

The segment of Other Islamic Financial Institutions (OIFI) expanded by 53% over the last decade, reaching 793 institutions by 2022, including 124 Fintech companies. Its growth has primarily stemmed from digitization and the emergence of crowdfunding and Fintech entities. The adaptable nature of this sector may facilitate its growth prospects in Europe, where certain traditional financial institutions have started providing Islamic products through OIFI. Examples include Ijarah and Mudarabah services tailored for SME financing.

2. The Growth of Islamic Finance

Across Regions

While Islamic finance has experienced growth, its current development primarily reflects a response to various local developments rather than a global implementation. In mature markets such as GCC countries and Southeast Asia, Islamic finance has established a systemic significance that continues to grow. This expansion is not spontaneous but rather the outcome of comprehensive strategic plans, supported by a range of public policies.

The GCC countries, in particular, stand out for hosting the largest volume of assets in Islamic finance, accounting for 53.6% of the global total. Across all financial segments, growth has been evident in recent years, notably with a remarkable 10.8%

Chart 3. Percentage of Islamic Finance by Product Type

Source: ICD - LSEG Islamic Finance Development Report 2023

Chart 2. Global Sukuk in circulation. (Billions of USD)

Source: ICD - LSEG Islamic Finance Development Report 2023

Sukuk

Islamics Funds

OIFIs

Takaful

Islamic banks

The potential of Islamic Fintech

In 2022, the Islamic Fintech sector comprised 375 identified companies, generating an estimated volume of $79 billion. Projections indicate that by 2026, this figure will soar to $179 billion, marking an annual growth

rate of 17.9% (ICD 2022). Leading the list of countries with a higher volume of transactions are Saudi Arabia, the United Arab Emirates (UAE), Malaysia, Indonesia, and the United Kingdom. In terms of numbers of companies, Saudi Arabia leads the ranking again, followed by Indonesia, the United Kingdom, Malaysia, and Kazakhstan. Together, these five countries account for 70% of Islamic Fintech companies, underscoring the notable concentration within this sub-segment.

Particularly noteworthy is the remarkable growth observed in Saudi Arabia. The country has embarked on a strategic development plan with the goal of establishing itself as a center for Islamic Fintech, aiming to attract 230 companies by 2025.

ESG and Islamic Finance: Distinct yet Converging

Islamic finance and sustainable finance intersect significantly, both sharing a core emphasis on harm prevention. The guiding principles of Islamic finance closely parallel those of ethical finance, commonly referred to as ESG (Environmental, Social & Governance). This alignment paves the way for the integration of products such as Islamic funds or sukuk into the portfolios of ESG-minded investors, thus fostering the expansion of Islamic banking institutions within one of the world’s fastestgrowing sectors: ESG.

There exists a tangible opportunity for operators to devise effective strategies for project development that harmonize the fundamental tenets of both Islamic and sustainable finance. Notably, the Islamic Development Bank made a commitment in 2019 to allocate at least 35% of its operations to climate finance by 2025, signaling a significant advance in this direction. Additionally, some Islamic funds,

using complementary investment criteria, aim to attract non-Muslim investors by offering opportunities that adhere to ESG principles.

Several Islamic finance initiatives incorporating ESG principles are already underway, particularly within the energy sector. An outstanding example are the DEWA solar projects, financed by the Abu Dhabi Islamic Bank in Dubai, expected to supply energy to 270 000 households and mitigate carbon emissions by a total of 1.18 million tons annually. Such endeavors align with the strategic goals of Gulf Cooperation Council (GCC) countries to diminish dependence on oil, with Dubai targeting to reach a 75% clean energy by 2050 and Saudi Arabia aiming to supply half the nation with renewable sources by 2030.

In the current context, within the framework of the objectives outlined in COP27, Islamic finance can have a significant potential to foster projects in the energy sector that facilitate the reduction of CO2 emissions through the needed transition from fossil fuels to green energies.

Chart 4. Number of Islamic Fintech by Country (2021)

Source: ICD - Islamic Finance Development Report 2022

increase in Islamic banking during 2022 (IFSI 2023), despite the global economic slowdown.

This surge in growth was closely tied to the region’s economic recovery, driven by increases in oil prices and the development of large-scale projects. As ambitious economic diversification initiatives progress to the construction phase, it is expected that the positive impacts of mergers and acquisitions within the Islamic financial services sector will become more pronounced.

Southeast Asia is consolidating the progress of Islamic finance, representing 23.5% of total assets. Across the region, all sectors of the financial and investment industry experienced growth in 2022, with the exception of Islamic funds. The resurgence of activities in sectors like tourism and industry has bolstered their economies, and the Islamic financial sector is anticipated to play a substantial role in the region’s economic enhancement. This expectation is reinforced by the fact that the three primary jurisdictions have implemented specific strategies aimed at promoting the effective progression of Islamic finance.

The Middle East and South Asia region (excluding the GCC) represents 18.9% of the total Islamic financial assets. In 2022, despite facing economic

Source: IFSI Stability Report 2023

difficulties, political instability, and natural disasters, the region witnessed a notable increase of 13.8% compared to 2021 (IFSI 2023). Pakistan’s advancement is particularly noteworthy, as the country is undergoing conversions from conventional banks to fully-fledged Islamic banks, resulting in significant and rapid growth in the Islamic banking sector.

In Africa, the penetration of Islamic financial products stands at a mere 1.7%, despite the adoption of national initiatives in certain countries. For instance, Morocco introduced regulatory measures in 2017 to ease the establishment of Islamic banks. However, despite a notable 21.7% surge in “participatory” financial assets in Morocco in 2022, these assets presently constitute only 2% of the overall financial landscape. Meanwhile,

Relaunching of Islamic Finance in Algeria

In recent years, Algeria has witnessed notable transformations, advancing Islamic financial products through regulatory frameworks, governmental policies, and outreach initiatives. These efforts have spurred demand for Islamic financial products, particularly within the housing finance sector. Presently, six Algerian public banks and four foreign private banks offer services via Islamic windows. Moreover, two fully operational

in Egypt, where modern Islamic finance originated in 1963, Islamic banking comprised 4% of total banking assets in 2023.

In Central and Sub-Saharan Africa, Islamic banking, which had grown by 19.2% in 2021, decreased by 14.8% in 2022, primarily due to the significant depreciation of the currency in Sudan. It is likely that Islamic financial products will experience a resurgence once the economic situation improves.

Europe, CIS countries, and Turkey: In 2022, this group of countries represented only 2.7% of the total global assets. Considering that the recorded percentage in 2021 was 4.5%, the projections of significant growth in Islamic finance made a few years ago are far from being realized. In continental Europe and the United Kingdom, there

Islamic banks, Al Baraka Bank and Al Salam Bank, are active in the country. The proportion of Islamic deposits relative to the total has risen from 1.5% in 2020 to 4% in 2023 (IFN 2024). The effective progress of Islamic finance may rely significantly on the fact that 95% of Algeria’s banking volume is managed by state-owned banks, facilitating alignment between governmental objectives and banking sector actions. With the expansion of Islamic banking, experts also foresee developements in the takaful sector.

Chart 5. Percentage of Islamic Finance by Region

Islamic Microfinance: Fostering Financial Inclusion and Economic Growth

In the global financial arena, Islamic microfinance emerges as a pivotal instrument for fostering financial inclusion and mitigating poverty. As of 2023, the Islamic microfinance sector managed assets valued at approximately $2 billion. While this amount may appear modest, its significance is profound, particularly given its crucial role in extending financing to micro and small enterprises key drivers of economic growth and job creation in numerous countries, notably those with substantial informal economies (SMEs constitute between 80-90% of the private sector and 60-70% of employment in Arab nations, according to data from the World Bank and IMF).

These small businesses frequently encounter significant difficulties in accessing credit and financial services within the conventional

is a trend towards stagnation or even regression. This is evident from the fact that the 2.7% includes both Turkey and the CIS countries, where Islamic finance is experiencing successful development and taking an increasingly prominent position in the financial landscape.

3. Islamic Finance in European Countries: Current Status and Opportunities

In 2015, Germany inaugurated BT Bank, marking its entrance into the realm of full-fledged Islamic banking. Nonetheless, the bank’s performance fell short of its expectations what made other Islamic banks that were considering entering the German market to disregard that opinion. BT Bank managed to reach the break-even point of equilibrium in 2020 and continues its operations. Alongside BT Bank, Al-Baraka has been providing Islamic digital banking services since 2018, and in 2022, Islamic Fintech INAIA joined them, offering financing services

banking sector, with over 60% of SMEs not having access to credit in the Middle East and North Africa.

Currently, there exist approximately 3 500 providers of Islamic microfinance worldwide, functioning as microfinance banks, cooperatives, or Fintech entities. Nonetheless, a significant portion of their assets are controlled by few major players, such as Akhuwat in Pakistan or Amanah Ikhtiar in Malaysia, who wield considerable influence over the global market.

The sector’s growth prospects are intrinsically tied to digitalization, which has rendered financial services more accessible to previously underserved populations. By integrating technology, Islamic microfinance can extend its reach to more individuals and communities, thereby fostering financial inclusion.

through crowdfunding, takaful, or Islamic funds, among others. Therefore, while traditional Islamic banking has faced difficulties in its development, as it has not attained a significant customer base for retail activity, it is expected that the volume of Islamic financial assets will increase in the coming years through digital banking and Fintech.

Luxembourg remains a significant hub for Islamic funds; its adapted regulation and reduced taxation make it an attractive country for funds. However, its global weight is proportionally decreasing due to the growth that funds have experienced in other places.

Ireland ranks as the third most developed European country for Islamic funds, following Luxembourg and the United Kingdom. This achievement is attributed to its favorable regulation and attractive tax system, which have attracted considerable interest. While there has been stagnation in recent years, experts foresee

a resurgence in growth once the global economic situation improves. Moreover, the Irish government has introduced measures aimed at easing the transition of Fintech companies from the United Kingdom to Ireland, a move that may also appeal to Islamic Fintech firms.

The United Kingdom remains a significant player in Islamic finance within Europe, although its performance in terms of volume and growth rates has fallen short of previous expectations, particularly in the retail banking sector. In 2022, Sharia-compliant products constituted a mere 0.1% of the UK’s total financial assets, prompting some experts to question whether its reputation as a hub for Islamic finance in the non-Muslim world was more hype than substance.

Despite initial ambitions to expand substantially in retail banking, the five fully-fledged Islamic banks operating in the country have faced disappointing outcomes, leading to staff reductions and a shift in focus towards private banking. Al Rayan is the only

one among these banks that has maintained a retail banking focus, although it ceased its physical branch operations in 2023, opting instead to operate exclusively online.

Reflecting a global trend, Islamic banking in the UK is transitioning towards digital platforms, as a launching of the Islamic neobank Nomo in 2023 has put into evidence. The rise of such banking institutions could potentially revitalize the stagnant Islamic banking sector by attracting a new customer base and offering innovative services.

Significant developments include the issuance of a sovereign sukuk by British authorities in March 2021 and the emergence of various options for takaful and other products, including pension plans, through Islamic Fintech companies. The UK ranks among the top five globally in Islamic Fintech, both in terms of quantity and volume, and it distinguishes itself with its robust academic and training programs in Islamic finance, holding the fourth position worldwide as a hub for Islamic funds (ICD 2023).

Despite the stagnation observed in “traditional” Islamic banking, the United Kingdom maintains its status as a key player in Islamic finance in Europe, with promising growth prospects ahead.

4. The delayed takeoff of Islamic finance in Spain

4.1. Availability of Islamic Financial Products in Spain

Islamic financial products in Spain are currently underdeveloped, resulting in an supply considered insignificant in the IFCI (Islamic Finance Country Index), where it ranks last.

None of the major conventional banks currently offer Islamic banking services, and there is also no provision from the digital banking entities operating today. However, outside the banking sector, there are Islamic financing options available through Coophalal. This organization provides housing financing to families and Profit and Loss Sharing (PLS) solutions for microenterprise projects, highlighting in this regard taxi licenses. Coophalal commenced operations in 2015 and claims to be experiencing a growing demand for its services. Additionally, it offers takaful insurance aimed at covering funeral expenses and repatriation.

Furthermore, the company FwU also offers takaful services in Spain. This German company markets insurance products whose funds are entirely invested in the MSCI (World Islamic Net Return USD Index).

The potential of this subsector in Spain is significant due to the deeply rooted mutualistic tradition, which is compatible with Sharia principles. This suggests that numerous Spanish mutuals could offer Islamic products if they ensured that the funds are invested in non-haram activities (RODRÍGUEZ MORENO 2022).

4.2. The Potential of Islamic Finance for Spanish Companies in Overseas Projects

The knowledge and management of Islamic financial products are increasingly essential for companies aiming to expand into regions where Islamic finance is strengthening its position. Economic diversification in the GCC and growth in Southeast Asia are creating business opportunities, many of which are in the ESG sector. Spanish companies are well-positioned to enter these markets. However, in some cases, their initiatives will need to align with Islamic financial products—or even utilize or finance through them. The availability of these products from Spanish banks, coupled with the expertise of professionals such as lawyers or financial advisors, would facilitate the implementation of such plans and enhance the opportunities for getting involved in large-scale projects in these markets.

4.3.Knowledge, Training, and Dissemination

The SCIEF (Saudi-Spanish Center for Islamic Economics and Finance) was established in Madrid in 2009 by the IE Business School and King Abdulaziz University with the aim of becoming a hub for research, education, and promotion of Islamic economics and finance. Its activities are centered around academic development, research, and engagement with the business community. The center regularly hosts training

Chart 6. Countries with the Highest Volume of Islamic Funds (2022, USD Billion)

Source: ICD - LSEG Islamic Finance Development Report 2023

programs, seminars, webinars, and other initiatives to nurture and enhance understanding in the field of Islamic finance. Additionally, it collaborates with experts for the publication of specialized literature and participates in socially impactful projects, such as organizing the Islamic Changemakers Challenge Awards in partnership with the Islamic Development Bank.

Casa Árabe, a Spanish public institution founded in 2006 and part of the Network of Houses of the Ministry of Foreign Affairs, European Union, and Cooperation, is dedicated to fostering knowledge, understanding, and relations between Spain and Arab countries across various domains, including culture,

economics, and politics. Among its activities, Casa Árabe organizes seminars, meetings, and training sessions focused on comprehending Islamic finance.

In 2017, Casa Árabe and the SCIEF joined forces to establish the Observatory of Islamic Finance in Spain, an analytical platform aimed at maintaining up-to-date knowledge on this subject. The Observatory brings together leading experts, consulting firms, law firms, and financial institutions involved in or interested in Islamic finance in Spain. It maintains regular activities, including annual member meetings and the organization of conferences and symposiums.

Conclusion and Perspectives

Other informational gatherings and events occur regularly, such as the Islamic Finance Forum, an annual event, with the most recent edition held in November 2023 as part of the Mediterranean Week of Economic Leaders (MedaWeek Barcelona).

Despite a certain rise in Spanish literature on Islamic finance since the mid-1990s (see note published by the Observatory in 2017), publications have seen a decline in recent years. Nonetheless, the IE Business School incorporates Islamic finance training into its master’s and general finance courses, while the International University of Andalusia (UNIA) offers a module on Islamic finance as part of its master’s degree in international relations.

Islamic finance continues to expand, and its systemic importance extends to an increasing number of countries, which generates a significant increase in the opportunities that their evolution can bring to European economies.

In a global context where environmental, social, and governance (ESG) concerns are increasingly important, Islamic finance may emerge as a more suitable alternative than conventional finance for channeling ethical financial investments that promote sustainability.

The sector of the industry that is lagging behing in Europe is commercial Islamic banking, which has grown less than expected and is experiencing a regressive phase. However, the emergence of Islamic digital neobanks in recent years, offering products and services tailored to the new digital generations, can be a catalyst for change in this trend.

Islamic Fintech companies are making a strong impact in numerous countries, including Europe, offering various takaful services and tailored financing solutions for small businesses and families where traditional banking falls short. While strict banking regulations and the subjection to central banks hinder the establishment and development of Islamic banks in non-OIC countries, operating outside this restricted framework currently promises rapid expansion opportunities for Islamic Fintech in Europe.

Furthermore, a greater understanding of Islamic finance by companies and financial actors in Spain could unlock opportunities for Spanish companies seeking to operate in foreign markets where these financial instruments are relevant or where significant projects are financed through them.

The potential development of Islamic finance in Spain will depend significantly on supportive policy measures, regulatory adaptations, a favorable tax environment, and effective dissemination and educational efforts. Even among the Muslim population, these products remain relatively unknown today.

The Observatory of Islamic Finance in Spain: SCIEF-Casa Árabe

The Observatory of in Spain, a collaboration between SCIEF-Casa Árabe, serves as an analysis and consultation group focused on understanding the current context of Islamic finance. It brings together key experts, consulting firms, law practices, and banking institutions involved or specialized in this

References

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Socioeconomic Notes of Casa Árabe - Year XVII Nº 14/2024 - Madrid, 24th of April 2024 Legal Deposit: M-11912-2024

Text prepared by Natalia Jiménez Arroyo and edited by SCIEF and Casa Árabe