(Reuters) - Islamic banks have continued to expand their balance sheets and capital buffers, but the era of double-digit growth rates could be coming to an end while asset quality concerns creep up, an industry oversight body said on Tuesday.
Islamic finance, which has its core markets in the Middle East and Southeast Asia, follows religious principles that forbid interest and shun outright speculation, and as such is seen as an alternative to interest-based banking.
That proposition is underpinned by claims that Islamic finance can weather, if not avoid, the kind of financial turmoil that has embroiled conventional banking in recent years.
Islamic banks have indeed expanded but uncertainties in the global economy and political disquiet have taken their toll, the Islamic Financial Services Board (IFSB) said in its fifth financial stability report.
Although it was weathered those challenges, the industry has moved away from double-digit growth rates enjoyed in previous years, the IFSB’s Acting Secretary-General Zahid ur Rehman Khokher said.
“This slowdown underscores the importance, more than ever, of strengthening the resilience of the Islamic financial system and addressing internal weaknesses and vulnerabilities.”
An IFSB survey of 170 Islamic banks and 83 “Islamic windows” in conventional banks across 17 countries found their combined assets grew by 10.9 percent to reach $1.4 trillion at the end of September 2016.
Islamic banks extended $939 billion in financing during that same period, up from $826 billion a year earlier, while their capital adequacy ratios remained above regulatory requirements.
Despite this, the asset quality of Islamic banks is deteriorating: Their net non-performing financing to capital ratio increased sharply to 25.6 percent at the end of September, up from 16.1 percent a year earlier.
In addition, the short-term liquidity of Islamic banks continues to be an area of concern, the IFSB said.
The IFSB also released findings of a study of stress-testing of Islamic banks conducted earlier this year.
The study found important links between four macroeconomic variables - namely interest rates, unemployment, real estate prices and oil prices - and the non-performing financing ratios, deposits, financing and assets of Islamic banks.
There are some bright spots, with the wider Islamic finance industry growing to $1.9 trillion in assets, with strong gains in sectors including Islamic insurance or takaful.
Takaful remains a small segment of the industry but contributions have grown by 12 percent, compared to 4 percent for conventional insurers, the IFSB said.
Scale remains a challenge for takaful firms, although the IFSB said it expected consolidation efforts to continue in the sector.
Reporting by Bernardo Vizcaino; Editing by Eric Meijer