Globally, assets under management in compliance with the principles of Islamic finance are worth an estimated $700bn. But while sharia banking has taken off across the GCC, its development in the wider Middle East has been unspectacular. Across the whole of North Africa and the Levant, the total sum of funds managed along Islamic banking lines amounts to little more than $30bn.

“This part of the world hasn’t seen the same growth in Islamic finance,” says Ghassan Chammas, professor of Islamic banking at the American University of Beirut. “The main reason is there’s not as much money around as in the GCC. In the GCC, we’ve seen the launch of heavy instruments such as sukuk [Islamic bonds] to finance big projects such as refineries, telecoms, cooling systems, highways and petrochemicals [schemes], which can each be worth $6bn-$9bn.

If the situation stabilises for a couple of years [in Syria] then Islamic banking should pick up

Rajesh Prasad, KPMG

“But outside the GCC, large infrastructure projects are not tapping into Islamic finance. Many countries are already heavily indebted and running high fiscal deficits. You compare a country such as Lebanon with a GCC country that is processing, selling or shipping a couple of million barrels of oil a day and you can see why things are different.”

Barriers to growth

Even in those countries that do have oil, there are other barriers, such as political instability in the case of Libya or a relatively closed economy in the case of Algeria. “You have to bear the risk of these [non-GCC] countries,” says Chammas. “None of them has an investment-grade rating, which means your sukuk or other instrument is extremely heated. There’s no one who would want to buy it even if you could offer double or triple the return.”

If North African governments and central banks create an enabling environment, we could see a boom

Ghassan Chammas, American University of Beirut

Islamic financing is by no means absent from the wider region, however. In Iran, banking has to be sharia-compliant by law. But the Islamic Republic uses a different model to that employed by GCC countries. There are no sukuk, and cross-border trades, already hampered by international sanctions, are more difficult. “It’s like using the metric system rather than the imperial one,” says Chammas. “You have the equivalent instrument in each system, but a screw and a bolt in system one would not work in system two.”

In markets such as Syria and Iraq, the development of Islamic banking has been disrupted by conflict. The Syrian government allowed for the establishment of Islamic banks in May 2005, when it issued legislative Decree 35. A year later, the cabinet approved licences for Cham Bank and Syria International Islamic Bank (SIIB) to launch services in the country. Bahrain’s Al-Baraka Banking Group began operating in Syria in 2009.

Cham Bank has branches in eight towns across the country, while Al-Baraka and SIIB have branches in Damascus, Aleppo, Hama and Homs. But the conflict that has riven Syria since 2011 means many of these towns are no longer functioning as commercial centres, and even the capital has been affected. “Damascus is a safe island for business,” says Chammas. “But because of the embargo, they’re having to work in euros rather than dollars.”

If the political situation were to improve, there is room for Syria to become a significant player. “If the situation stabilises for a couple of years then Islamic banking should pick up,” says Rajesh Prasad, director of consulting at Netherlands-based KPMG.

Iraq potential

In Iraq, the central bank lists eight Islamic banks in the country, but it too has suffered from political instability over the past decade and a further deterioration in the security situation in recent months. “A lot of regional banks are looking at setting up in Iraq, especially to finance construction work, particularly in the oil and gas sector,” says Prasad. “But the security situation makes it difficult for lenders to open up in certain areas of Iraq. There is huge potential, but one key factor for banks to consider is whether they can attract the right kind of talent.”

Lebanon has not been untouched by regional instability, but the disruption has been slight in comparison. Already a centre for Islamic learning and innovation, Beirut formally introduced Islamic finance in February 2004, with the adoption of Law 575. A year later, Lebanese Islamic Bank was established and Al-Baraka Bank Lebanon was granted an Islamic banking licence. Blom Development Bank was established in 2006, beginning operations the following year.

The sector remains relatively undeveloped compared with conventional banking in Lebanon, but this could change in the coming years. “There are about $140bn-$150bn in deposits, of which only $1bn is in Islamic banking,” says Chammas. “But the Islamic banking sector has been operating for about seven years, while the conventional banking sector has been operating for about 70 years. Give them another seven or eight years and let’s see. Globally, Islamic financing is about 10-15 per cent of the total, so maybe they’ll have reached $15bn.”

Lebanon’s neighbour Jordan is among the better prospects for Islamic finance outside the GCC. Al-Baraka established Jordan Islamic Bank (JIB) in 1978 to carry out sharia-compliant banking and it now has 80 branches across the country. Islamic International Arab Bank (IIAB) began operating in the country in 1998 and Saudi Arabia’s Al-Rajhi Bank in 2011. In 2007, Dubai Islamic Bank and Jordan Dubai Capital began the acquisition of shares in Industrial Development Bank and converted it into an Islamic bank – Jordan Dubai Islamic Bank (JDIB). By the end of 2012, JIB, JDIB and IIAB had combined assets of $6.6bn.

Jordan promise

“Jordan is one of the more promising areas for Islamic banking,” says Chammas. “It doesn’t have the same GDP as Lebanon, but Lebanon has several religions and sects, and a fair amount of secular political views, which means much of the population is not attracted to Islamic banking products.”

At the end of 2012, Jordan further developed its sharia finance market when it passed a law allowing the government to raise funds through sukuk. Additional regulations were passed in April this year to facilitate an issue. Amman is now studying a proposal to issue its first Islamic bond, although it may opt against it in favour of continuing its focus on donor-based concessionary finance. Al-Rajhi Cement issued the country’s only corporate sukuk, worth JD85m ($120m), in 2011.

Egypt, the most populous country in the Middle East, has a long history of sharia-compliant banking, but still lacks a fully fledged regulatory structure for Islamic finance. Faisal Islamic Bank (FIB) began operating in the country in 1979 and Abu Dhabi Islamic Bank (ADIB) Egypt in 1980. Al-Baraka is also present in the market. In addition, 11 conventional banks have Islamic branches there.

Sharia-compliant banking assets in Egypt are expected to exceed $18bn by the end of this year, with annual growth of more than 10 per cent, according to FIB governor Abdel Hamid Abu Mousa. Growth in Islamic banking assets in 2013 was 11 per cent, according to the Egyptian Islamic Finance Association.

But Islamic finance still accounts for just 7 per cent of total banking assets in Egypt, and the most recent regime change has introduced a government less committed to the accelerated development of sharia banking than its forerunner, led by the Muslim Brotherhood-backed Mohamed Mursi.

Much like Egypt, Algeria has a long history of Islamic banking, but lacks legislation to encourage the growth of the sector. Al-Baraka incorporated an Algerian subsidiary in 1991, while Bahrain’s Al-Salam Bank and Gulf Bank of Kuwait each have an Algerian arm offering Islamic banking services. The UAE’s Salama Islamic Arab Insurance Company is also present. But the market share of Islamic banks is just 1.5 per cent, and the private banking sector as a whole less than 15 per cent.

The sector could grow in the coming years, however. ADIB has had an interest in Algeria for several years and has applied for a licence, according to a statement last year by its CEO, Tirad Mahmoud. Kuwait Finance House also explored the possibility of opening an Islamic banking operation in the country in 2008, although no further progress has been reported. There are also reports that Algeria is exploring the possibility of issuing its first sukuk.

In the rest of North Africa, Islamic banking is also relatively undeveloped. In Libya, where economic growth continues to be hampered by political instability, “most of the 16 registered Islamic banks are looking at Islamic finance”, says Prasad, while others are “looking at entering the market”.

Tunisia expansion

Tunisia is still picking itself up from the aftermath of the economic downturn in Europe – its major trading partner – and the fall of the Ben Ali regime in 2011. But Prasad predicts that there will be “very strong growth in Islamic finance in Tunisia in the next five or six years”.

Morocco, one of the few countries in the region to escape serious political instability in the past three years, is “being promoted as a regional centre for Islamic banking”, says Prasad. “A lot of investment is going into Morocco from the GCC and Islamic instruments are being proposed to finance some projects. There’s also a spur from the government’s side. New legislation for the registration of Islamic banks was passed earlier this year.”

North Africa as a whole offers great potential for the sharia-compliant banking sector in the coming years. “The market is picking up after the [regional unrest], as countries start to look for alternative means of financing growth and infrastructure development,” says Prasad. “I believe sukuk is one of the tools they can use.”

“The barriers to Islamic finance in North Africa are largely regulatory,” says Chammas. “But if North African governments and central banks create an enabling environment, we could see a boom, especially in Algeria, Morocco and Egypt.”