A potential “no-deal Brexit,” a case in which the UK leaves the European Union without any arrangements or accords about their future co-operation, could have a negative impact on the Islamic finance industry in the UK, a new study issued by S&P Global Ratings found.
In the paper “Countdown to Brexit: Implications of a No-Deal Brexit for Islamic Finance” released on February 18, the agency said that such a scenario would lead to a deterioration of Islamic banks’ asset quality, particularly in the real estate sector.
“Given these banks’ primary focus on the UK domestic banking business, we see their exposure to Brexit risks as similar, if not more significant, to that of rated UK domestic banks,” said S&P Global Ratings’ global head of Islamic finance, Mohamed Damak.
There are currently five fully-fledged Islamic banks in the UK, two of which have Qatari shareholders, namely Al Rayan Bank and QIB UK. Apart from that, 15 other banks offer Islamic financial services through Islamic windows. Total assets stand at about $20bn as per figures of the UK Trade & Investment department, of which the five fully Shariah-compliant banks hold about a quarter.
The Islamic banks have a significant exposure to real estate at about 67%, while the rest comprises of sukuk investments and deposits, mainly based on murabaha, an Islamic financing structure that involves mark-up payments.
Given the high exposure to real estate financing, S&P Global Ratings said a potentially damaging effect of a no-deal Brexit on real estate prices in the UK will likely have a knock-on effect on UK Islamic banks’ asset quality.
“However, we believe these banks’ relatively strong capitalisation provides a buffer against a slide in asset quality,” the report said, adding that “given the small size of UK Islamic finance compared to the UK domestic banking sector, we do not expect stresses arising in UK Islamic finance will lead to systemic risks for the UK, or that a no-deal Brexit will make a difference to the global Islamic finance industry.”
The same applies to the UK sukuk sector, since only a few sukuk investors are from the UK or the EU, therefore there is limited reason to change legal structures for such investments at a broader range.
“On a positive note, a no-deal Brexit could revive Islamic finance investors’ appetite for UK [real estate] assets, typically popular investments for investors in the Gulf, assuming a significant drop in their prices,” Damak said.
Experts are widely pessimistic about how Brexit will affect real estate prices in the UK. The Bank of England in a worst-case scenario recently warned that capital values on commercial property could fall by 27% over five years under a “disruptive” Brexit and by 48% under a “disorderly” departure.
Total average returns are expected to drop from 6.2% in 2018 to 3% this year, while capital values will likely fall across all sectors, market analysts predict.
Prices for residential housing are already at their lowest level since 2012, data provided by the Royal Institution of Chartered Surveyors showed. In the southeast of the UK alone, house prices fell by more than 30% over the past three years, and some experts say owners, as well as buyers, should prepare for an additional post-Brexit meltdown.
The date for Brexit has been set for March 29, 2019, pending a possible delay of up to 21 months as it turned out on Monday.
The risk of a no-deal Brexit continues to be high, because it remains the default legal option in the absence of any agreed alternative, and many wouldn’t bet on whether there would be one reached in the short term.
A terraced row of residential housing sits in the Muswell Hill district, in view of the Canary Wharf financial, business and shopping district of London (file). Islamic banks in the UK have a significant exposure to real estate at about 67%.
