Analysis of Challenges and Opportunities in Islamic Banking

By Salman Ahmed Shaikh

Abstract

Islamic banking has achieved exceptional growth in the last two decades and has been able to sustain it even during the recession and afterwards. In this paper, we analyze the economic merits of Islamic banking principles that have made it so successful and widely acceptable. We provide mathematical exposition of the Islamic banking architecture and discuss its salient economic merits. Then, we discuss the potential challenges that it has to overcome. We discuss that lack of flexible financing options, incomplete product mix, scale diseconomies, contractual frictions and constraints in liquidity management are potential future challenges for this industry. We also highlight growth opportunities by noting that Islamic banks in many jurisdictions are yet to enter into infrastructure financing for development spending, energy financing, investment banking and sovereign financing. 10 of the 25 most growing economies have Muslim majority population and it is a lucrative market for transnational banks especially after the credit crisis and contagion in Europe. We also note that Islamic banks are yet to fully capitalize on their ideals and principles. By establishing their niche in microfinance and agriculture finance, they can validate their egalitarian status and mandate. We also show that most Muslim majority countries have savings deficit which is important for growth and development. Hence, Islamic banking has the potential to promote savings culture and contribute in capital formation in these economies.