The need to rationalize capacity in the Islamic finance industry is likely to be one side effect of a more deliberate economic setting worldwide. In particular, we expect to see further dislocations in the sukuk business, as issuance falters. That outlook contrasts with the industry-centric view that the asset class will grow continuously. We focus on macroeconomic issues, not structural ones such as deal standardization.

Cyclical context is instructive. One reason that sukuk issuance peaked in 2012 was a growing concern about the end of the liquidity cycle that was induced by the high oil-price. Going forward, sukuk may be crowded out of the marketplace by conventional debt offerings. Sovereign issuers need to raise capital in robust conventional markets in order to meet outsized fiscal demands. Sukuk—however aspirational—does not yet provide access to a deep vein of global capital. Contrast the role of sukuk in meeting the affinity needs of Shariah-compliant investors. The recent $9 billion sovereign offering by Qatar illustrates this point.

Still another problem is that profit returns on sukuk are generated by the cash flow on underlying assets. At the aggregate level, that cash flow will be weak, raising concerns about creditworthiness. Expect a cyclical mismatch between potential supply and actual demand. Islamic-banking specialists also need to distinguish between the demand generated by those investors who are grooming existing allocations and those who are willing to move fresh capital into the asset class. Stock variables are not flow variables.

Our experience suggests that the Shariah-compliant finance industry does a poor job of understanding the impact of global trends on its livelihood. Despite our desire to think otherwise, banking is a notoriously cyclical business because of its intermediation qualities. Rapid-growth years are now giving way to more sober activity levels. In this operating environment, Islamic bankers will be less frustrated if they think in terms of refining and consolidating their hard-won expertise, rather than amplifying it.

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