Islamic Banks Stay Strong as Regional Tensions Rise

Tim Elliott (0:01)

It's the Morning Drive here at Mira Business FM. Regional tensions are putting financial systems across the region under pressure, but Islamic banks are showing resilience, strong capital and liquidity buffers are helping the sector to absorb shocks. So what is it that's keeping Islamic banks stable? And can that resilience hold if tensions do persist? We're joined all the way from Kuala Lumpur, actually, by Islamic finance and economics expert, Dr. Adnan Aziz. Dr. Adnan, it's good to see you.

Dr. Adnan Aziz (0:38)

Likewise, Tim, good to see you again.

Tim Elliott (0:40)

Good to have you back on. Just very briefly, I know you're in Kuala Lumpur. I don't know the... You're there for a conference, am I right? I'm just trying to catch up, really.

Dr. Adnan Aziz (0:50)

Well, there is a workshop on an Islamic development bank project, and I'm actually here to lead that workshop.

Tim Elliott (1:00)

Gotcha. Well, thank you for taking time to join us. It's good to have you back with us. It's been a while, and what a time it's been since February the 28th.

Uncertainty has been the norm. Let me start with this very broadly. What's behind the current resilience? That's really the word of the year that we see in Islamic banks across the GCC. And how much of that is genuinely due to the Islamic banking model rather than just simply a strong balance sheet?

Dr. Adnan Aziz (1:36)

Well, actually, you're absolutely right. The times have been very unprecedented, as we all know.

And I think to your question, what is behind the current resilience of Islamic banks?

And is it really because they're Islamic? I think it's a good question to ask. I think we need to separate Tim two things here.

Islamic banks are certainly looking resilient today, primarily because they came into this period with very strong balance sheets. That's important recognition for us to be, for us to acknowledge something, that the reason primarily they're being resilient is because they actually started with good balance sheets. For example, if you take the numbers across GCC, Islamic banks, the non-performing financing or NPLs conventionally, as we call, was only around 1.75 percent, compared with 2.23 percent of the conventional counterpart. Now, similarly, the core equity, Tier 1 capital, is stronger in Islamic banks. And this is actually a very substantial cushion. There is a very substantial cushion, which is what is driving what you call the resilience in a way. Now, what I would also say is that Islamic banks, they also benefit from relatively stable customer deposits. And particularly in the Gulf, a customer base that includes a large number of salaried nationals, government employees, or the government related businesses, they're all contributing to it. What is also, however, important, Tim, to me, does Islamic banking itself help? Yes, but we should not, for lack of a better word, we should not romanticize it, I would say. Islamic finance does require transactions to have a connection with economic activity. We have, it also discourages excessive speculation. It puts some discipline around the leverage. So all of that is true.

But, say, a Murabhar customer can still default. A property price can still fall. Depositors can still withdraw the money. So I would say that Islamic banks are resilient today, not simply because they're Islamic, but also because many of them have combined Islamic financial discipline with very sound banking. And that is, that distinction is important. So to me, I would say, I would emphasize to sum it up, that being Islamic does not make a badly managed bank safe, if that answers your question.

Tim Elliott (4:48)

It does. No, I appreciate that. I'm wondering, then, how important are the sector's capital, liquidity and asset quality buffers? And what could start testing those buffers if regional tensions become prolonged or flare up in some way?

Dr. Adnan Aziz (5:12)

I think this is absolutely right. And actually, these buffers you're talking about, the capital and the liquidity buffers, they are absolutely central.

So, or if I can describe them slightly differently, liquidity is like the oxygen, and capital is the shock absorber. Now, the liquidity allows a bank to survive the immediate period of uncertainty, the kind of period we have been living. But if there are deposit withdrawals, if there is volatile market, expensive funding, so all of those kinds of things, so the liquidity would help there.

But the capital becomes a critical element at a later stage. Then the economic shocks, they start producing actual losses. That is when these things help. So to me, I would say that Islamic banks, they have or they currently at least have both the liquidity and the capital. And you know, and across GCC banking system, both the core capital, the tier one capital, and the liquid assets, they are at a very comfortable levels. But the real issue, Tim, would be the duration.