Lower liquidity in Gulf Cooperation Council (GCC) banking systems is not the main driver of muted sukuk issuance in recent years, said S&P Global Ratings in a report published Tuesday entitled "Is Sukuk Issuance Suffering From The Liquidity Drop In Gulf Countries?. "Some market participants believe that the liquidity drop in Gulf countries, where the majority of sukuk investors are based, explains the lower issuances volumes,» said S&P Global Ratings' Dr. Mohamed Damak, Global Head of Islamic Finance. "We see liquidity in GCC as adequate in a global comparison, though, and believe that the less supportive economic environment is translating into fewer growth opportunities, which could actually encourage banks to reallocate liquidity in the bond and sukuk market, ultimately leading to an uptick in issuance volumes." The decision to issue sukuk or bonds ultimately lies with the issuer and depends on many factors. These include the cost of issuance, the capacity of the market to absorb the transaction, the issuer's target investor base, how ready the issuer's regulatory and legal environment is for sukuk issuance, and the complexity of structuring sukuk. "We think that the latter factor is one of the main reasons behind muted sukuk issuance in 2016 and believe it will continue to weigh on volumes in 2017,» said Dr. Damak. "In our view, the key to broadening the sukuk issuer base and volumes lies in market education on sukuk in Western countries and higher standardization of legal documentation and Shariah interpretation, or at least the establishment of large issuance programs, as some market participants have suggested." "We have confirmed our finding by looking at a representative sample of 16 Islamic banks in the GCC with total assets of $438.5 billion at June 30, 2016." The Islamic finance industry remains dominated by banking, which accounted for over 80% of the industry's $2.1 trillion assets at year-end 2016. This statement is somewhat confirmed by the distribution of the sukuk market's investor base. "Over the past two years, we have observed a reduction in liquidity in GCC banking systems. We use system-level data rather than Islamic banking data because not all the central banks in the region publish granular data on Islamic banks." Growth in GCC banks' customer deposits slowed to 2.4% in the first nine months of 2016, compared to 5.4% in 2015. "We expect this trend will continue in 2017 and 2018. This is because governments and their related entities – whose deposits depend on oil prices – contributed between 12% and 35% of the total deposits of GCC banks at Sept. 30, 2016, and we project that oil prices will stabilize at around $50 per barrel in 2017-2018. Despite this drop, we think that GCC banks still have some cards to play. We view their funding profile as strong by international standards, as it is mostly dominated by core customer deposits with an average loan to deposit ratio of 91% at Sept. 30, 2016," the report said. Moreover, GCC banks tend to keep sizable amounts of cash and money market instruments on their balance sheets (around 18% of total assets at Sept. 30, 2016). It is worth noting that this ratio has dropped from around 22% at year-end 2014, yet compares favorably with global peers'. In their current challenging operating environment marked by lower opportunities for growth, we think that some GCC banks might divert a portion of this liquidity toward assets that generate higher income. In this context, bonds and sukuk are attractive compared with interbank deposits or deposits with the central banks.
