Islamic finance’s next test: Connecting fragmented markets

As trade corridors shift, Islamic finance is helping strengthen regional connectivity and resilience. Key insights from this year’s IBFI Forum.

This article outlines the key discussions at this year’s Global Islamic Financial Institutions Forum, from the case for establishing new corridors and moving beyond domestic markets, to the funding paradox facing Islamic banks.

Businesses are increasingly seeking more resilient routes for finance and payments as geopolitical tensions accelerate shifts in global trade patterns and create new trade corridors.

Against this backdrop, the growing relevance of the GCC–ASEAN corridor has brought Islamic finance to a crossroads.

Islamic bankers, regulators and industry experts gathered at Standard Chartered’s annual Global Islamic Financial Institutions Forum in Kuala Lumpur, Malaysia, to discuss Islamic finance’s next chapter and its role as a connector.

Islamic banking penetration has reached 50–70 per cent in key GCC and ASEAN markets. The question facing the sector is whether Islamic finance’s next phase will be shaped by deeper domestic integration or by a broader ambition: creating new forms of value, widening access to liquidity, connecting institutions and markets and building a more resilient financial system.

Bilal Parvaiz, CEO, Standard Chartered Saadiq Malaysia, framed the discussion: “Is it always going to be a numerical exercise? Is this what our stakeholders and the shareholders are expecting – that the financial system just becomes fully Islamic?

Or are we looking at the next era of Islamic banking, which brings in a real economic value for society and spurs economic growth?

Sharifatul Hanizah Said Ali, Executive Director, Islamic Capital Market Securities Commission Malaysia, spoke about the country’s role as a connector for Islamic capital markets in the region.

The Capital Market Masterplan 2026–2030 (CMP), launched in the first quarter of 2026, targets market growth of around 6–8 per cent a year over the next five years, with the market projected to reach RM6.3 trillion by 2030. The plan aims to maintain Islamic finance’s share of the market at 65 per cent.

“For Malaysia, the task is to raise capital that will attract international capability that lasts,” Ali said.

Countries that attract capital without building capacity win one cycle and lose the next.

Sharifatul Hanizah Said Ali

Executive Director, Islamic Capital Market Securities Commission Malaysia

The CMP looks at what the country needs in the next 20 years, and the steps it will take to get there, positioning Malaysia as a gateway to regional opportunity. In drawing up the plan, it became clear that collaboration was the way forward, Ali outlined.

Historically, cross-border agreements with other countries were made for enforcement and supervision purposes. Now, the country has been making concerted efforts to revisit regions and markets around the world, establishing relationships and market-building MOUs instead.

This includes a recent MOU with Hong Kong, alongside outreach to the GCC, Turkey and Central Asia, to open up dual listings, cross-listings and new investor access points.

The CMP is underpinned by Maqasid-linked guidance, which helps push Islamic capital products beyond the mechanics of traditional sukuk and equity markets, and towards measurable impact. Ali believes this shift from principles to proof can demonstrate Islamic finance’s real economic contribution to the country.

The funding paradox facing Islamic banks

Malaysia’s Islamic banks now hold almost half of the country’s total banking assets, but that misrepresents the underlying industry, the panellists argued.

Growth has almost entirely been driven by household lending, with the majority of those banking assets consisting of retail and auto financing. By contrast, the SME and corporate financing market share is comparatively small.

“Growth [in Islamic Banking] is primarily driven by the household segment. And we are reaching a point where we are not going to see much incremental growth,” Rafe Haneef, Group CEO, MBSB Berhad, said.

“The household debt in Malaysia is quite high and Islamic banks need to move. But what is constraining the move is principally the composition of deposits. Households are taking financing from Islamic banks but putting their money in conventional banks.”

While almost two-thirds of Islamic financing is extended to the household sector, households provide only a minority of their deposits. The gap is being filled by fixed deposits and institutional funding, compressing margins across the industry.

Even though Islamic financing in Malaysia has a significant share of the capital markets, it is still often driven by conventional banks with Islamic banking expertise; the role of standalone Islamic banks risks being diminished, Haneef believes.

Islamic finance as a tool for inclusion

Malaysia’s Islamic finance journey has moved through distinct phases, according to Nurul Izza Idris, Director, Islamic Finance Department, Bank Negara Malaysia. The first decade was about inclusion, the second mainstreaming, and the third about diversifying and innovation, he said.

“And then when we think about the fourth one, it becomes a crossroads. Are we going to focus purely on advancing impact and internationalisation? Or on Islamic finance deepening its productive capacity and actually delivering different economic functions, as we see the global economic and financial landscape being reshaped, as well as Malaysia’s own economic transformation.”

On the inclusion front, the results in Malaysia have been tangible. The industry has lowered its cost-to-serve and extended outreach to underserved parts of Malaysia and the wider region.

This has been seen in targeted, although small-scale, products. Agricultural financing has been structured to provide farmers with more security around crop and weather risk. Micro-entrepreneurs have been brought into the financial system through graduation programmes that have enabled them to build a credit track record.

Meanwhile, regulatory initiatives like value-based intermediation (VBI) have pushed banks to design products around social and environmental outcomes as much as commercial ones.

The challenge for Islamic banks is to scale this offering without losing the customisation that made it popular in the first place.

Liquidity as an enabler

Mohamad Safri Shahul Hamid, chief executive of the International Islamic Liquidity Management Corporation (IILM), reinforced the view that liquidity is a precondition for wider market development, while arguing that demand for liquidity management instruments is outstripping supply as the Islamic finance market expands.

Recent market stress has underlined the challenge. While geopolitical conflict and tariff shocks prompted sovereigns and corporates to defer sukuk issuance, IILM had to continue issuing.

“The market was closing, but IILM did not have the liberty to postpone issuances… we had to do it because the market is asking for it,” he said.

For several months after conflict broke out in the Middle East, IILM was the only sukuk issuer in the global market. To keep pace, support price discovery and increase market confidence in Islamic liquidity products, IILM has expanded its dealer network in Malaysia, including Standard Chartered as its sole global primary dealer.

The case for cross-border scale

But despite the successes being celebrated in growing Islamic finance, it is still “too small, and too domestic”, Pierre Paoli, Global Head, Strategic Advisory Solutions, Standard Chartered, argued.

The bigger risk is that much of Islamic finance’s growth has been concentrated in domestic markets, with capital effectively recycled locally rather than deployed across borders.

Overcoming this requires banks to invest deliberately in Islamic finance rather than treating it as a secondary offering. The current environment has created complexity but also opened opportunities for partnerships, and for banks on the ground to connect with regulators, institutions, suppliers and buyers.

Banks should also take a more active role in originating new Shariah-compliant assets by educating issuers who wouldn’t normally consider a sukuk. A clear case in point is the growing number of Western-backed data centres using Islamic finance structures.

The next frontier, Paoli believes, lies in corridors not traditionally associated with Islamic finance at all – China, Africa and the West.

Watch the full panel discussion here: