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Islamic finance entered 2026 with strong momentum, but war, disrupted trade and weaker Gulf growth now threaten its expansion. HANEEF MAHAMED discusses the S&P Global Ratings’ warning that resilience will be severely tested this year.
The global Islamic finance industry is heading into a far more difficult period after expanding strongly in 2025. In its latest industry outlook, S&P Global Ratings predicts that growth will slow to between 5% and 10% in 2026, down from 10.2% last year, as war in the Middle East disrupts trade, transport, energy supplies and economic activity across the sector’s most important markets.
The warning carries considerable public interest because Islamic finance is no longer a small, specialised corner of the financial system. The industry is worth more than $5 trillion and includes Islamic banks, sukuk, takaful and investment funds operating across the Gulf, Southeast Asia and a growing number of emerging markets. Yet its concentration in oil-exporting Gulf economies also makes it vulnerable when regional conflict threatens energy routes, government finances and investor confidence.
S&P’s central message is not that Islamic finance has lost its long-term potential. Rather, the industry is entering what the ratings agency describes as “rough waters”, in which its resilience will depend heavily on the duration of the conflict, the restoration of trade routes and the capacity of governments and financial institutions to adapt.
War reaches the heart of the industry
The immediate danger lies in the Gulf, which remains the engine room of global Islamic finance.
The conflict has weakened economic prospects in several core markets and created uncertainty around the Strait of Hormuz, one of the world’s most important oil and shipping routes. Disruptions to oil exports, imports, transport and supply chains could slow economic growth, postpone major projects and reduce demand for financing from Islamic banks.
Islamic banks are closely tied to the economies in which they operate. When governments reduce spending, businesses delay investment and property activity slows, banks have fewer opportunities to extend new financing. The report therefore expects weaker Gulf growth to translate into slower expansion for Islamic lenders, particularly those exposed to infrastructure, real estate and trade.
The impact is not uniform. Saudi Arabia benefits from an east-west oil pipeline that bypasses the Strait of Hormuz, while Oman’s location has allowed it to continue exporting oil and gas more easily. However, even these advantages do not fully insulate the region from military escalation, inflation, supply disruption or changes in government spending priorities.
Higher oil prices may appear beneficial to exporting countries, but S&P warns that they may not compensate for a sharp fall in production and exports. Governments could consequently draw on reserves or raise more debt to cover weaker public finances.
Sukuk remain resilient but vulnerable
One of the report’s most striking findings is that the sukuk market remained surprisingly strong during the opening months of 2026.
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Global sukuk issuance increased by 20% year on year during the first four months, supported by activity in Saudi Arabia, Malaysia, Türkiye and Indonesia. Issuance in Gulf Cooperation Council countries rose by 13.1%, largely because of Saudi Arabia’s local-currency borrowing.
This resilience matters because sukuk provide governments and companies with Shariah-compliant funding for public spending, infrastructure and refinancing. They are also among the most visible instruments connecting Islamic finance to global capital markets.
However, the strong early figures should not be mistaken for certainty. Gulf countries accounted for 45% of global sukuk issuance in 2025, meaning that prolonged regional instability could quickly weaken the market.
Local-currency sukuk may become increasingly important as governments seek funding from domestic investors. Foreign-currency issuance, by contrast, could come under pressure if market volatility raises borrowing costs or reduces international investor appetite.
S&P also suggests that some governments may favour conventional bonds because sukuk structures can be more complex and time-consuming to arrange. Countries with established sukuk programmes are better placed to continue issuing them, but less experienced borrowers may choose the simpler conventional route during periods of urgency.
Strong growth before the storm
The slowdown follows a notably strong year for the industry. Islamic finance grew by 10.2% in 2025, driven mainly by expanding banking assets and increased sukuk issuance. Islamic banking contributed about 74% of the industry’s growth, compared with 54% in 2024. Gulf countries generated roughly two-thirds of banking asset growth, led by Saudi Arabia and the United Arab Emirates.
Saudi Vision 2030 projects and strong economic performance in the UAE helped generate financing demand. This illustrates both the strength and the vulnerability of the industry: concentrated growth can produce impressive results in good conditions, but it also leaves the sector highly exposed when those same markets face war or economic disruption.
S&P believes growth could improve again in 2027, but only if oil, trade and transport flows normalise. Its outlook therefore depends less on demand for Islamic financial products than on developments beyond the control of banks and investors.
A test of resilience and diversification
The report raises an important strategic question for the industry. Can Islamic finance become less dependent on a small number of oil-producing countries?
Its long-term opportunities remain significant. Takaful, Islamic investment funds, sustainable sukuk and digital financial services can broaden the industry’s reach. Growth in Malaysia, Indonesia and Türkiye during the opening months of 2026 also shows that activity outside the Gulf can provide some balance.
Yet genuine diversification will require more than increasing the number of countries offering Islamic finance. The industry needs deeper domestic capital markets, a broader range of products, stronger legal frameworks and greater participation by businesses and ordinary consumers.
For Muslim investors, the report is a reminder that Shariah compliance does not eliminate conventional financial risks. Islamic banks and sukuk remain exposed to war, recession, inflation, political instability and falling investor confidence.
The industry entered the present crisis from a position of strength. Its next phase will reveal whether that strength rests on durable foundations or remains too dependent on favourable conditions in the Gulf.
S&P’s forecast is ultimately a warning rather than a verdict. Islamic finance is still expanding, sukuk remain in demand and the industry’s ethical and structural appeal endures. But the war has exposed its geographic concentration and its dependence on stable energy, trade and investment flows.
The Islamic finance boom is not over. It is, however, facing its most serious test in years.
