Islamic banking is a branch of banking that is exclusively compliant with the Shariah (Islamic) law. The main underlying concepts and principles that encompass Islamic banking are profit-sharing between industry players and mutual risk, all the while ensuring justice and fairness for participants, transactions are based on an underlying asset or business operation and prohibited activities (interest, gambling, speculative trading) are avoided at all costs.

Islamic finance caters to every segment and niche of the society regardless of race, beliefs and gender. It has grown and helped develop and shape the real economy as well.


In a bid to propel development of the Islamic economy, the Islamic Banking and Finance sector in UAE’s banking industry has grown considerably and become an important facet, with the number of Islamic banks in the nation rising to seven along with several conventional banks offering Shariah-compliant services.

According to a study by Bloomberg, UAE residents are leaning more towards Islamic financial loans and products than their conventional counterparts as awareness and popularity of Shariah-compliant products are increasing.

During 2015, the Islamic Finance industry witnessed a substantial expansion, wherein growth in the first and second quarters was mainly contributed by the insurance, banking and finance sectors, as well as from a number of conventional SMEs and small and specialised government organisations that took interest in the products and services. The UAE government introduced regulatory policies to organise the sector and implement international standards to make Dubai as one of the Islamic capital markets such as London and Malaysia.


Performance of Islamic Finance in the Industry (2015 - 2017)

UAE Islamic banks’ performance in 2016 was hit by higher funding costs and financing impairment charges with stronger financing growth than conventional banks, according to Fitch.

Although the average Islamic bank’s impaired financing ratio increased further to 5% in 2016 which was aided by rapid financing growth (above conventional banks), this ratio is skewed by the two of UAE’s largest Islamic banks that account for almost two-thirds of Islamic banking assets, and whose ratios have dropped to around 4%. The other Islamic banks have young, fast-growing franchises, and their impaired financing ratios are between 5% and 9%.

Due to the deterioration in the SME segment, impairments increased from 1.1% to 1.4% of financing in 2016. Islamic financing grew at a gradual rate of 10% to 19% in 2015 due to innovative Shariah-compliant structures and wider adoption.

In 2016, higher funding costs put pressure on most Islamic banks’ net financing margins and operating profitability metrics, despite many banks succeeding in repricing their financing books. The main reasons for the increase are the high reliance on profit-generating time deposits and lower liquidity in the system due to lower oil prices. The Islamic banks’ average cost/income ratio was almost stable due to tight cost control.

In the first quarter of 2017, Islamic banks’ gross credit rose by 8.4% to AED 343 billion, including domestic credit of AED 325 billion that increased by 7.4% which will result in UAE’s halal economy to expand faster than non-halal sectors.

Out of 23 registered commercial banks, seven Islamic banks represent nearly a fifth of UAE’s banking assets, which grew more than three times than that of conventional banks’ assets during the first quarter of 2017. Financing growth in Islamic banks surpassed the conventional banks’ loans increase in the same period in nearly all subcategories, barring the financing to government and GREs.

Higher assets and gross credit growth rates pave the way for Islamic banks to fund the Halal industries and help accelerate the growth of Halal or Islamic economic activities. Generally, Islamic banks engage in ethical finance and asset-based lending eliminating speculation-based high-risk financial activities and protect the sector from economic crises and also aid Islamic banks in passing the stress tests by a wider margin.

UAE’s Islamic banking assets stand at an amount of around AED520 billion which is about 7% of the global total and 20% of AED 2.6 trillion of the state banks’ total assets.

Higher financing impairments also affected profitability, using 38% of pre-impairment operating profit compared to 33% in 2015.

Islamic banks in the UAE have been experiencing tightening of liquidity from mid-2015 which continued into 2016. The average financing/deposits ratio surged to almost 95%, and is now much closer to that of the conventional banks. Islamic banks tend to have higher levels of deposit funding than conventional banks, as their retail focus gives them a larger influx of retail customer deposits, although this has decreased in 2016 with further Sukuk issuance.

The UAE Central Bank’s centralised Sharia board was further formalised in 2017. Following the declaration of non-Shariah compliance of its Sukuk by Dana Gas, the mandate of a centralised Sharia board and the extent of its association in Sukuk standardisation are more important than ever. However, the board’s mandate and influence are still unclear.

UAE Infrastructure and Funding

The Islamic Banking and Finance sector has been playing a major role in financing infrastructure projects, residential properties and corporate expansion. Shariah-compliant financial instruments could become an important funding source for UAE’s infrastructure needs and will likely continue as the economy maintains its steady growth as a result of high oil prices and an influx of petrodollars. At a time when conventional banks are providing fewer and shorter loans, companies and the UAE government are scouting for alternative financing options, some of them being Islamic financial instruments.

Key Recommendations

Shariah-compliant products have evolved to cater to both, the pious and those seeking value propositions due to the relatively lower risk and volatility, and better performance in the long run. As a result, the industry’s market share gains have risen and many of the largest Islamic banks are in the GCC countries such as the UAE. One perk Islamic banks in the GCC has is the strong liquidity coverage ratios (LCR) due to their widespread base of core retail customer deposits, increased Shariah-awareness and low reliance on market-sensitive wholesale funding.

Contrarily, its South-East Asian counterparts demonstrate a constraint by small branch networks on retail funding leading to lower LCRs when compared to their conventional peers and GCC competitors. If the current momentum in Islamic Banking and Finance is to be sustained, factors such as innovation, the development and expansion of a talent pool and the use of technology will need to be stepped up.

UAE taking a proactive role in resolving key issues facing the development of the Islamic Banking and Finance sector will help contribute to Dubai’s vision to become the ‘Capital of Islamic Economy’. It was recommended to build a robust institutional investor base for Islamic Finance, enhance Sharia governance, the templatisation of Islamic product offerings and the convergence of Islamic finance with the ethical and socially responsible investment industry. It was also suggested to delegate specific task forces for reviewing some of these issues in further depth, arranging summits and roundtables with the socially responsible investment industry to enhance awareness and possibilities of cooperation in the future.

It would prove beneficial to develop standards equivalent to triple bottom line reporting for Islamic financial institutions, and assign independent and objective research to institutional investors about the potential positive or negative impact of Islamic Banking and Finance on the economic development and financial stability of their economies.