THE ROLE OF ISLAMIC FINANCE TO STRENGTHEN INTERNATIONAL TRADE
Trade is a key ally in the fight against poverty, especially if additional measures are taken to improve education levels, strengthen governance and deepen the financial sector.
World trade growth has been sluggish since the global financial crisis of 2008-2009. Average annual trade growth slowed from more than 7% during the period before the global financial crisis to less than 3% during 2012-2015. Much of this disappointing trade performance can be explained by sluggish global GDP growth.
But the decline of world trade since the financial crisis is also related to the reduced availability of trade finance. The financial crisis hit hard a number of major financial players and impaired the ability of banks to lend money. Although the initial credit crunch eased after the major central banks rolled out unprecedented policy measures to boost global liquidity(including quantitative easing and negative policy rates), the new, tightened regulatory regime for the banks will continue to limit availability of financing in the foreseeable future. The new regulatory measures, that have caused the banks to tighten eligibility criteria,include higher capital requirements under the Basel III accord that are scheduled to come into force by 2019. Other such measures are the new and tighter regulations to combat financial crime such as money laundering and corruption.
The ITFC also contributed to the aid-fortrade initiative – one of the global initiatives aimed at strengthening the capacity of developing countries to participate in and benefit from international trade.
The prospects for global trade have deteriorated even further over the past three years as a result of an unexpected decline in oil prices, appreciation of the US dollar, a growth slowdown in China, and the start of monetary policy normalization in the United States. All these shocks have increased uncertainty about global economic prospects and increased reluctance to commit financial resources. Global trade expanded only2.8% in 2015 and its growth is expected to remain below the long-term average of 5.1% in the next two years.
Over the past two decades, trade liberalization has been associated with higher growth, investment, job creation and human development. A remarkable progress by developing countries in all these areas has come hand in hand with increase in their share in global trade from28% to 42%. It would be therefore fair to say that trade is a key ally in the fight against poverty, especially if additional measures are taken to improve education levels, strengthen governance and deepen the financial sector.
Trade finance to boost global trade By providing working capital and reducing the payment risk, trade finance plays a vital role in supporting cross-border trade transactions. The letter of credit is one of the oldest and most common trade finance instruments used by the banks to reduce payment risk.According to WTO (2015), nearly 80%of world trade relies on trade finance and credit insurance. Although there is no official data on the total size of global trade finance, existing studies estimate that some US$6.5–8 trillion of trade finance was provided in 2011. The Asia-Pacific region accounted for more than50% of the total, while Europe accounted for nearly 25%.
With the ongoing economic slowdown and increasing uncertainty at the global level, access to international trade finance has deteriorated considerably and financial institutions are finding it hard to meet existing demand. Small and medium-sized enterprises have become especially constrained.
According to the recent WTO report,the estimated size of the trade finance gap ranges between US$ 110 and 120billion in Africa and over US$ 1 trillion in Asia. By filling the trade finance gap,millions of people and thousands of businesses across the world could unleash their economic potential.
Against this backdrop, it is incumbent upon the multilateral development banks (MDBs) to keep the supply chains financed. With increased pressure on the global financial markets, demand for MDB support is likely to increase further. This is why the MDBs need to look beyond their traditional methods of mobilizing resources, and explore alternative financing mechanisms such as Islamic finance in order to support trade and achieve higher economic growth results.
Islamic Finance: High potential
Considered as one of the fastest growing segments of the global financial industry,Islamic finance industry has recorded an impressive growth rate of around15% during the past two decades. The current size of the Islamic finance market is estimated at $1.8 trillion, and expected to reach $3.4 trillion by the end of 2018.About 73% of the Islamic finance asset sare held by Islamic banks.
Most of the Islamic finance assets are located within the 57 member countries of the Islamic Development Bank (IsDB). Among them, Malaysia, Qatar, Saudi Arabia, Iran, Kuwait, Pakistan, UAE, Bahrain, Indonesia, and Jordan account for the major share of the Islamic finance market, but the industry’s geographical presence has now grown to include newp layers in Europe, Africa, East Asia and the Americas.
With preferences among the Muslim populations shifting towards more Shariah-compliant banking, Islamic finance has grown and developed to include a number of new trade finance products, listed in Table 1.
With a combined GDP of US$ 6.7 trillion and a population of 1.7 billion, the Is DB member countries have the potential to become an engine of global trade. Many of the 57 Is DB member countries are among the world’s largest exporters of strategic commodities, such as oil, natural gas, wheat, rice, and cotton. They are also among the world’s largest importers of food and agricultural products, various consumer goods as well as machinery and equipment.
Moreover, evidence shows that Islamic finance could be more resilient to external shocks than conventional finance. This is because of the emphasis on risk sharing,which reduces leverage and leads to better risk management. Islamic finances also based on ethical principles that Trade is a key ally in the fight against poverty, especially if additional measures are taken to improve education levels,strengthen governance and deepen the financial sector.The ITFC also contributed to the aid-nonadministrative – one of the global initiatives aimed at strengthening the capacity of developing countries to participate in and benefit from international trade.prohibit speculation and exploitation.With these values, Islamic finance has the potential to strengthen financial and social stability, and foster comprehensive and inclusive human development.
Is DB’s role in promoting trade finance
The importance of trade finance as a key driver of economic growth. Trade finance has always been one of the main areas of the IsDB Group’s operations, and despite a dramatic contraction in global trade flows in recent years, the IsDB Group has remained very active in this area. The cumulative trade financing approvals of the IsDB Group stood at US$ 61.4 billion,with infra-OIC trade financing accounting for more than 70% of the total.
The IsDB was the first international development institution to adopt a program to finance trade and to promote trade between its member countries.In this context, the Bank established the International Islamic Trade Finance Corporation (ITFC) and the Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC)to promote the economic development of member countries through the expansion of international trade.
The activities of the ITFC include financing of intro-regional trade,in accordance with the Islamic principles, and development of the export capacity of the member countries through its Trade Promotion and Cooperation Program. Since its inception, the ITFC has extended nearly US$ 30.5 billion in trade financing,of which it allocated nearly 47% to the least developed member countries. It has also organized and supported more than 200 operations in the areas of development and trade facilitation. The ITFC also contributed to the aid-for-trade initiative–one of the global initiatives aimed at strengthening the capacity of developing countries to participate inland benefit from international trade.
International trade has a key role to play in promoting economic growth and,ultimately, helping to alleviate poverty in developing countries.
In this respect, additional efforts are needed to develop and improve the export capacity of developing countries by fostering investment in their infrastructure, transport networks and education, and by facilitating productive foreign direct investment into the export oriented sectors of the economy.
To the extent that many developing countries continue to face challenges that prevent them from accessing conventional trade finance, there is also a need to explore all new, alternative trade finance options.
The contribution of Islamic finance will be critical in this context. With its growing role at the global level, it provides new and innovative ways for the financial institutions to diversify their sources of funding. Furthermore, given the wide range of Islamic financial products that the banks can now offer to importers and exporters, Islamic finance can help ensure that global trade continues to expand and fosters economic growth,especially among small and medium sized enterprises.
The IsDB Group will continue its efforts to provide innovative Shariah compliant financial solutions to ensure that millions of people across the world are able to benefit from growth opportunities offered by international trade. The Group will also continue to make sure that international trade brings about growth that is inclusive and does not leave any section of the society behind by facilitating targeted, solidarity based interventions aimed at the most vulnerable segments of the society.