Investors are showing increased interest in Islamic derivatives according to a report from credit rating agency Fitch.
However, there are challenges to be solved if the instruments are going to realise their full potential, stated the report.
The derivatives, financial instruments that comply with Islamic law, have been adopted by a growing number of institutions, according to Fitch.
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It states that three-quarters of Fitch-rated institutions used Islamic derivatives in the first half of 2024 – a statistic that highlights the strength of Islamic banks as well as the creditworthiness of the financial instruments.
But the report also highlights the limitations currently facing the nascent sector. This includes the complexity of the sharia restrictions imposed on these instruments which can lead to different interpretations and a lack of standardisation.
There is also an underdeveloped infrastructure for trading these instruments, especially for OTC transactions.
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However, there are some regulatory developments that could help address these challenges. The UAE central bank has encouraged Islamic banks to adopt hedging techniques that include sharia-compliant instruments. And the Saudi Central Bank is considering close-out netting legislation in an effort to boost market efficiency.
“The rise of Islamic derivatives reflects the growing importance of risk management for Islamic banks in a maturing financial landscape,” concludes the report.
“As the market overcomes challenges related to standardization and infrastructure, these instruments have the potential to become a cornerstone of Islamic banking’s continued development.”