Islamic finance is an option for the struggling shipping industry

Islamic finance, due to its asset-based nature, has been repeatedly mentioned to be a viable funding option for capital-intensive industries in the transportation sector, namely aviation and shipping. While the aviation sector, at least in Muslim countries, is already widely open to Islamic funding, the shipping sector keeps struggling with access to finance as banks have become reluctant to lend to a highly capital-intensive industry which has been weathering rough seas for decades, even more so after the global financial crisis in 2008. The industry is directly exposed to changes in global trade politics which are, particularly in recent times, fairly unpredictable.
On the other hand, the shipping industry remains a global economic engine with an estimated annual economic impact exceeding $430bn and providing for some 13.5mn jobs. Roughly around 52,000 merchant ships and 11,000 bulk vessels are each year carrying $4tn worth of goods across the oceans, and there are little alternatives to large ships doing that. Among the few options for rationalisation are to make vessels bigger so that they can carry more load, which – in turn – makes them even more expensive.
As of 2017, the world’s top 40 banks were lending more $350bn – predominantly in conventional debt – to the shipping industry, while the momentum for the industry remained not too optimistic. This is increasing credit risk and prompting more and more banks to leave shipping finance entirely and divest their shipping loan portfolios.
But the international shipping finance market still remains a substantial one. As other forms of finance remain scarce for shipping companies and port operators, Islamic finance could come to the rescue given the global growth of sukuk as a form of asset-backed finance in long-term structures. These are fitting well in the shipping industry starting with straightforward financing vehicles such as murahaba or ijara, and also other contracts including istisna for the pre-delivery financing of ships under construction, as well as equity partnerships such as musharakah.
The key advantage of Islamic finance for the shipping industry are higher liquidity, encouraged by asset-backed transactions that provide banks with better risk management options than non-asset backed conventional finance transactions, and risk-sharing between parties which leverages the loan exposure for them.
When it comes to risks, the securitisation of borrowing is important and encouraged in Islamic finance, and therefore all types of guarantees can be built into Shariah- compliant financing contracts. Islamic finance can also be provided as sole source of funding, for example for a single vessel, or as multi-sourced financing, for example for a larger fleet or to provide working capital for shipping companies.
However, there are challenges too. One is the lack of standardisation of Islamic finance in different jurisdictions. Due to the high-capital nature of shipping finance, most contracts involve a larger number of financiers and banks from different countries, and not all have the same regulations on Shariah compliance of Islamic financing contracts. It is also not certain that financing contracts get enforced in the same way in different jurisdictions, which is – nonetheless – a fundamental requirement for global trade and makes it necessary that certain types of Islamic ship financing get backed by state export credit guarantees. Thus, the higher number of financiers and jurisdictions involved in Shariah-compliant shipping financing makes it rather complex to create a contract that takes all those eventualities into account. This is exacerbated by the fact that Islamic shipping finance is still in its infancies and both the maritime industry and Islamic banks and financial institutions on the other end are just beginning to understand the needs, opportunities and challenges the sector brings with it, placing them still at the lower end of the learning curve.