Gulf Islamic banks remain resilient as stable deposits and capital buffers offset slower growth and regional disruption
Islamic banking continues to expand across the Gulf Cooperation Council, although growth prospects vary considerably as regional conflict, funding constraints, real estate exposure and market maturity shape the outlook in each country.
A series of country assessments by S&P Global Ratings showed that Saudi Arabia remains the region’s dominant Islamic banking market, with Sharia-compliant assets representing about 76 percent of the country’s total banking assets.
Islamic banks account for approximately 51 percent of Kuwait’s banking sector, 27 percent in Qatar, 19 percent in Oman and 18 percent in the UAE. In Bahrain, Islamic banks represent close to 30 percent of the entire banking industry, including wholesale institutions, and approximately 70 percent of retail banking assets.
Saudi Arabia and the UAE offer some of the strongest expansion prospects, supported by national development strategies, large investment programmes and regulatory reforms. Qatar faces more limited growth, while consolidation is reshaping Bahrain, Kuwait and potentially Oman.
Saudi market dominates
Saudi Arabia’s Islamic banking industry is among the world’s largest and has expanded beyond its traditional retail focus into corporate lending, project finance and financing for small and midsize enterprises.
The sector’s development is closely connected to Vision 2030, broader capital-market reforms and the financing requirements of economic diversification and major infrastructure projects.
Islamic finance dominates the Saudi financial system. In addition to the four major Islamic banks—Al Rajhi Bank, Alinma Bank, Bank Albilad and AlJazira Bank—conventional lenders typically offer Sharia-compliant products.
At the end of 2025, Islamic financing represented 83 percent of Saudi National Bank’s loan book and 62 percent of Riyad Bank’s lending portfolio.
The four leading Islamic banks more than doubled their combined assets over the five years through 2025, increasing them by 2.1 times. That exceeded the 1.8-times expansion recorded by the six largest conventional banks.
Mortgages drive expansion
Residential mortgages have been a major growth engine since 2018 because housing finance in Saudi Arabia is generally structured in accordance with Sharia principles.
Islamic banks have simultaneously expanded into corporate financing linked to non-oil industries, government initiatives and major infrastructure projects.
SME financing has gained momentum with support from the Kafalah credit-guarantee programme. SMEs now account for more than 11 percent of total credit in Saudi Arabia.
Retail customers represented approximately 53 percent of Islamic banks’ loan books at the end of 2025, while corporate borrowers accounted for 38 percent. The retail concentration primarily reflects Al Rajhi Bank’s large consumer franchise, while Alinma and some other institutions maintain a stronger corporate focus.
Customer deposits represented approximately 87 percent of Islamic banks’ funding at March 31, 2026, compared with 82 percent for conventional banks. Wholesale funding accounted for about 14 percent, below the 21 percent recorded by conventional competitors.
Saudi funding tightens
Islamic banks reduced their reliance on wholesale funding after the Middle East conflict began, while domestic deposit growth accelerated, particularly among public-sector entities. Interbank funding also became more expensive.
Liquid assets represented 15.2 percent of Islamic banks’ total assets at March 31, compared with 17.7 percent for conventional banks. The difference reflects the limited availability of Sharia-compliant liquidity instruments and lending growth that has outpaced the accumulation of liquid assets.
Islamic banks nevertheless held more cash and central-bank balances, equivalent to almost 5 percent of assets, compared with 3.7 percent for conventional institutions.
Profitability was broadly comparable, with both segments recording returns on average assets of approximately 1.8 percent at March 31. Islamic banks’ net intermediation margin reached about 2.8 percent at the end of 2025 but had narrowed because of greater reliance on more expensive term deposits and wholesale funding.
Operating efficiency generally remained weaker than at conventional banks, with Al Rajhi representing the major exception because of its scale.
Credit quality holds
The average nonperforming financing ratio for Saudi Islamic banks and the nonperforming loan ratio for conventional institutions both stood at approximately 0.95 percent at the end of 2025.
Islamic banks’ direct exposure to real estate and construction was below 10 percent of lending, compared with a banking-industry average of 16 percent. Indirect exposure through residential mortgages remained substantial, but salary assignments and stable employment among Saudi borrowers reduced the associated risks.
Al Rajhi held $280.1 billion in assets at March 31, 2026, representing 21.3 percent of total Saudi banking assets and 28.1 percent of Islamic assets. Alinma had $86.4 billion, Bank Albilad $48 billion and AlJazira $46.1 billion.
S&P expects continued expansion as Islamic banks finance Vision 2030 and benefit from sukuk issuance, investment banking, Islamic fintech, sustainable finance and structured products.
However, banks must balance growth with capital requirements, tighter funding and limited Islamic liquidity. Mortgage concentration and housing affordability also leave the sector sensitive to interest rates and real estate supply and demand.
UAE business resilient
Islamic banks in the UAE held AED989 billion in assets at April 30, 2026, equivalent to approximately 18 percent of the country’s banking system.
Their market share has remained broadly stable over the past five years. The sector includes nine stand-alone Islamic banks, 15 Islamic windows operated by conventional institutions and nine Islamic finance companies.
Islamic banks’ financing books have expanded faster than conventional loan portfolios. Their share of total banking-system financing consequently increased to 23.4 percent in April 2026 from 21.4 percent at the end of 2021.
Their share of systemwide deposits edged up to 21.5 percent from 21.2 percent during the same period.
Asset quality remained broadly comparable. Stage 3 financing at the four largest Islamic banks represented 2.7 percent of their portfolios at March 31, only slightly above the 2.5 percent reported by the six largest conventional banks.
Direct financing concentration
Islamic banks maintain a considerably higher concentration in direct financing, which represented approximately 64 percent of their assets at April 30. Financing accounted for only 45 percent of conventional banks’ assets.
The difference reflects the limited range of Sharia-compliant liquidity-management instruments and the smaller size and liquidity of the sukuk market.
Using more of their balance sheets for direct financing enables Islamic banks to generate higher profitability than conventional competitors. However, it also makes their earnings more sensitive to changes in the operating environment.
Their exposure to real estate remained broadly comparable with conventional peers.
Customer deposits provided approximately 83 percent of Islamic banks’ total liabilities at April 30, compared with 67 percent at conventional banks. This structure improves funding stability and reduces refinancing risks during volatile periods, including the regional conflict.
Capital adequacy remained comfortably above minimum regulatory requirements, although Islamic banks’ ratios were lower than those of conventional institutions.
Strategy targets AED2.56 trillion
The Central Bank of the UAE has not formally implemented the Accounting and Auditing Organization for Islamic Financial Institutions’ alpha-factor framework. S&P considers that approach prudent because the agency does not expect Islamic banks to transfer losses to depositors during a financial shock.
The Middle East conflict is expected to slow UAE Islamic banking activity in 2026, but medium-term growth prospects remain positive.
The National Strategy for Islamic Finance, announced in May 2025, aims to more than double Islamic banking assets to AED2.56 trillion (697.1 billion) by 2031.
Its main objectives include harmonizing regulatory frameworks between the central bank and the Higher Sharia Authority, strengthening governance consistency and accelerating digital-first Islamic finance. The UAE’s retail sukuk initiative demonstrates how technology can open new growth channels.
Dubai Islamic Bank held AED419.916 billion in assets at March 31, representing 8.4 percent of systemwide assets. Abu Dhabi Islamic Bank held AED287.065 billion, Emirates Islamic AED149.442 billion and Sharjah Islamic Bank AED90.867 billion.
Qatar growth limited
Islamic banks in Qatar represented approximately 27 percent of commercial banking assets at the end of the first quarter of 2026, an increase of about 10 percent from the end of 2021.
S&P expects their market share to remain between 25 percent and 27 percent over the next two to three years because of limited growth opportunities.
Qatar National Bank dominates the broader banking sector and holds more than 60 percent of total system assets, limiting the scope for other institutions to gain substantial market share.
Islamic financing growth is expected to moderate in 2026 as the regional conflict affects Qatar’s economy. The slowdown in liquefied natural gas production and weaker financing demand from real estate, hospitality, trade and commercial services are expected to restrict expansion.
Real estate accounts for between 20 percent and 25 percent of Islamic banks’ financing, averaging 23 percent at the end of the first quarter. The sector faces lower prices and rents because of excess capacity.
Stable deposit funding
Qatar’s Islamic banks remain strongly capitalized and exceed both Qatar Central Bank requirements and Basel III standards.
Deposits provided about 80 percent of their total funding at the end of 2025. This was comparable with Qatar National Bank but considerably higher than the 55 percent to 60 percent recorded by midsize conventional institutions.
Nonresident deposits represented less than 10 percent of Islamic banks’ customer deposits, compared with approximately 19 percent to 20 percent across the banking system. Their focus on public-sector deposits and lower reliance on external funding have improved stability during the geopolitical disruption.
Concentration in cyclical sectors remains a significant risk. Stage 2 financing represented approximately 13 percent of Islamic portfolios during the first quarter of 2026.
Asset quality was nevertheless slightly stronger than at conventional peers, with modestly lower nonperforming financing ratios and higher provisioning. Qatar Islamic Bank was the main contributor to this advantage, while midsize Islamic lenders exhibited weaker credit quality.
Qatar profitability moderates
S&P expects the average nonperforming financing ratio at Qatar’s four leading Islamic banks to rise to between 3.8 percent and 4 percent in 2026 from 3.5 percent at the end of 2025.
Precautionary provisions accumulated during previous years, together with recoveries and write-offs, should help stabilize asset-quality indicators.
Islamic banks have lower cost-to-income ratios than conventional competitors because of strong margins and operating efficiency. Profitability will likely weaken moderately in 2026 as financing growth slows and the economy potentially contracts.
Impairment losses and tax expenses are expected to increase. Higher tax costs reflect global rules requiring large multinational companies to pay a minimum level of tax in every jurisdiction where they operate.
Qatar amended its Islamic Banking Business Prudential Rules in 2024 to improve alignment with Islamic Financial Services Board standards and parts of Basel III.
Sharia rules decentralized
Qatar operates a decentralized Sharia-governance framework. Individual institutions can follow their own supervisory boards rather than being required to observe every standard issued by a central Sharia board.
The system provides flexibility but could produce different interpretations of Sharia requirements between banks.
Qatar Central Bank’s partnership with the International Islamic Liquidity Management Corporation improved access to high-quality Sharia-compliant liquid assets. Its treasury sukuk programme, introduced in 2022, also diversified funding and strengthened short-term liquidity management.
Recent Islamic banking expansion largely resulted from two mergers. Barwa Bank and International Bank of Qatar combined in 2019 to create Dukhan Bank, while Al Rayan Bank merged with Al Khalij Commercial Bank in 2021.
S&P considers additional mergers between Islamic and conventional institutions unlikely over the next two years.
Qatar Islamic Bank held $61.5 billion in assets in the first quarter, followed by AlRayan Bank with $48.1 billion, Dukhan Bank with $34.7 billion and Qatar International Islamic Bank with $17 billion.
Kuwait holds half
Kuwait’s four fully fledged Islamic banks held KWD53 billion, or approximately $172 billion, in combined assets at May 31, 2026.
Kuwait Finance House, Boubyan Bank, Kuwait International Bank and Warba Bank represented 51 percent of banking-system assets, making Kuwait one of the few markets where Islamic and conventional institutions compete on broadly equal terms.
Islamic banks have expanded faster over the past six years. Their share of total banking assets increased to 51 percent from 46 percent in 2020, while their share of domestic credit climbed to 53 percent from 48 percent.
Asset quality remained comparable with conventional banks because both segments face the same conditions, including oil-price movements, government spending, geopolitical developments and real estate trends. They are also subject to similar prudential, provisioning, underwriting and credit-classification requirements.
Real estate and construction represented approximately 28 percent of Islamic financing at the end of 2025, compared with 21 percent for conventional banks.
Kuwait profitability leads
Some Islamic real estate transactions are disconnected from the underlying property sector’s performance because the property serves primarily as an asset required to ensure Sharia compliance.
Islamic banks generally generate higher profitability than conventional peers, supported by stronger financing margins, controlled costs and balance-sheet growth.
They allocate a larger proportion of earning assets to customer financing. Conventional banks hold more investment securities, interbank placements and corporate loans, which typically generate lower returns.
The profitability gap widened after 2024, primarily because of Kuwait Finance House. Its Turkish business supported net financing margins, while its acquisition of Ahli United Bank Kuwait created cost efficiencies.
The historically limited availability of domestic Islamic liquidity-management instruments, government sukuk and central-bank sukuk also influenced Islamic banks’ balance-sheet composition.
Resident deposits represented approximately 67 percent of their liabilities at May 31, compared with 62 percent at conventional banks. Foreign liabilities accounted for 14 percent, compared with 26 percent at conventional institutions.
Competition intensifies ahead
Kuwait applies broadly consistent capital, liquidity, governance and risk-management regulations across Islamic and conventional banks. Islamic institutions are additionally subject to legislation covering Sharia compliance and internal Sharia supervisory boards.
The country does not provide preferential regulatory capital treatment for transactions funded through profit-sharing investment accounts. S&P considers this prudent because sharing losses with depositors could trigger liquidity pressure.
Islamic banking growth is expected to slow in 2026 before recovering in 2027. Competition will remain intense following Kuwait Finance House’s acquisition of Ahli United Bank Kuwait.
Smaller lenders are expected to concentrate on technology, customer experience and specialized financing to protect their positions. Geographic and sector concentration remain significant, but strong capitalization, stable funding and sound asset quality support resilience.
Kuwait Finance House held KWD43.555 billion in assets at March 31, equivalent to 33 percent of the assets of Kuwait’s nine largest banks. Boubyan held KWD10.358 billion, Warba KWD6.13 billion and Kuwait International Bank KWD4.571 billion.
Oman growth continues
Islamic banking in Oman represented approximately 19 percent of banking-system assets at the end of 2025, an increase of roughly 200 basis points over two years.
The sector comprises Bank Nizwa, Alizz Islamic Bank and five Islamic windows operated by conventional banks.
Islamic assets reached $25 billion at the end of 2025. The sector’s shares of deposits and credit were slightly higher at 22 percent because Islamic institutions maintain smaller securities portfolios.
Corporate financing represented 63 percent of gross financing at the two stand-alone Islamic banks, while retail customers accounted for 37 percent, down from 42 percent in 2020.
Corporate financing grew at a compound annual rate of 12 percent between 2020 and 2025, compared with 8 percent for retail financing. Growth in non-oil industries and conventional banks’ established retail franchises supported this shift.
Oman credit risks rise
Islamic banks’ nonperforming financing ratio increased from 2.3 percent in 2020 to 3.6 percent at the end of 2025 and 4.2 percent in March 2026.
The ratio is moving toward the 4.6 percent recorded by conventional banks during the first quarter as Islamic portfolios mature. Stage 2 financing is also higher than at conventional competitors and includes a substantial share of restructured exposures.
S&P expects Islamic banks’ asset quality to approach the industry average over the medium term. Real estate and construction account for approximately 12 percent of their portfolios, a proportion that has remained stable despite corporate growth in trading and manufacturing.
Islamic banks recorded a return on average assets of 0.9 percent and return on average equity of 7.4 percent in 2025. Conventional banks produced 1.2 percent and 8.3 percent, respectively.
Islamic institutions’ cost-to-income ratio was approximately 50 percent, compared with 44 percent for conventional banks, reflecting weaker economies of scale.
Merger could improve scale
Bank Nizwa’s proposed acquisition of Alizz Islamic Bank could create a national Islamic banking leader with better operating efficiency and profitability.
The combined institution would nevertheless remain relatively small, with a market share below 7 percent.
Islamic banks’ average Tier 1 capital ratio stood at 15.1 percent in 2025, approximately 210 basis points below conventional banks but comfortably above regulatory requirements.
Customer deposits provided 98 percent of Islamic banks’ funding, compared with 91 percent at conventional institutions. This is among the highest deposit-funding shares in the region.
The 2025 Banking Law broadened the financial activities that the Central Bank of Oman may license under Sharia principles, including services offered by finance and leasing companies.
The central bank’s introduction of Islamic liquidity-management instruments at the end of 2025 should improve access to liquidity and reduce Islamic banks’ competitive disadvantage.
Government measures support
Oman’s Islamic derivatives market remains at an early stage, while the limited domestic sukuk market restricts investment options.
Asset-quality deterioration represents the main risk as financing portfolios mature. The regional conflict could also weaken real estate, construction and hospitality.
S&P expects the impact to be less severe than elsewhere because Oman’s geographical position allows oil and other exports to continue without using the Strait of Hormuz.
Competition from Islamic windows operated by larger conventional banks will place pressure on stand-alone institutions. However, capital buffers, stable funding and 100 percent nonperforming-financing coverage support resilience.
Bank Nizwa held $5.3 billion in assets at March 31, equivalent to 3.9 percent of Oman’s banking system and 21 percent of Islamic assets. Alizz held $3.9 billion, representing 2.9 percent of system assets and 15.5 percent of the Islamic segment.
Bahrain consolidation advances
Bahrain’s Islamic banking sector comprises six retail banks, three wholesale institutions and Islamic operations within several conventional retail banks.
Islamic retail banks held $70.3 billion in assets at March 31, 2026, representing approximately 70 percent of total retail banking assets.
Islamic assets grew by an average of between 9 percent and 10 percent annually over the past five years, exceeding the 5 percent to 6 percent growth recorded by conventional retail banks.
Consolidation has transformed the market. Kuwait Finance House acquired Ahli United Bank in 2024, converted it to Islamic banking and rebranded it as KFH Bahrain, the country’s largest retail lender.
Al Salam Bank acquired Ithmaar Bank’s retail assets in 2022 and the carved-out assets of KFH’s previous Bahraini subsidiary in 2024.
KFH Bahrain and Al Salam now control approximately 80 percent of Bahrain’s Islamic retail market.
Efficiency improves returns
Both Islamic and conventional retail banks generated strong earnings in 2025, although conventional institutions have historically produced more stable and stronger results.
Islamic banks’ average return on assets was 0.9 percent over the past five years before improving to 1.2 percent in 2025. Their more diversified income and improving cost efficiency contributed to the increase.
S&P expects returns at Islamic and conventional banks to converge as consolidation increases the scale of Islamic institutions.
The two segments maintain similar asset structures. Lending generally represents between 45 percent and 50 percent of assets, while investment securities account for between 25 percent and 30 percent.
Islamic banks rely substantially on customer deposits, including Wakala and Mudaraba profit-sharing investment accounts. Exposures funded by these accounts receive favourable regulatory treatment because their risk weights are reduced to reflect their theoretical capacity to absorb losses.
This treatment contributes to higher reported capital adequacy ratios for Islamic banks.
Asset quality pressured
S&P does not make the same adjustment in its capital analysis because of uncertainty over whether Islamic banks could transfer losses to customers without creating severe liquidity pressure.
Islamic and conventional retail banks generally maintain balanced exposure to consumers, corporations and SMEs. KFH Bahrain is an exception, with corporate and SME customers representing approximately 80 percent of net financing.
Most of those exposures are outside Bahrain, which accounts for only about 10 percent of KFH Bahrain’s financing portfolio.
Mortgages represented approximately 28 percent of Islamic retail financing during the first quarter, while construction and commercial real estate contributed another 13 percent.
These sectors have been major sources of nonperforming financing and remain sensitive to weaker economic activity.
Islamic banks have historically recorded higher nonperforming financing and credit costs than conventional competitors. Their nonperforming financing is expected to increase in 2026, although central-bank measures should keep deterioration manageable.
Central bank responds
Fiscal tightening and the regional conflict are expected to slow Islamic and conventional banking growth during 2026.
The Central Bank of Bahrain introduced a support package that included three-month loan-payment deferrals for individuals and companies and six months of unlimited liquidity through a repurchase facility when required.
The central bank also reduced reserve requirements to 3.5 percent from 5 percent and eased other funding and liquidity rules.
External funding remained stable during the conflict but continues to represent a vulnerability for Bahrain’s retail banks.
The country’s Islamic finance ecosystem remains supported by regulation and specialist institutions. The central bank introduced Islamic liquidity windows in late 2024 to mirror facilities available to conventional banks.
Bahrain is also home to the Accounting and Auditing Organization for Islamic Financial Institutions and other bodies that contribute to the development of international Islamic finance standards.
KFH Bahrain held $28.376 billion in assets in the first quarter, followed by Al Salam with $22.545 billion, Ithmaar with $7.418 billion, Bahrain Islamic Bank with $4.663 billion, Khaleeji Bank with $4.555 billion and Al Baraka Islamic Bank with $2.765 billion.
Regional growth slows
The six assessments form part of S&P Global Ratings’ broader Islamic Finance 2026–2027 report, which warned that geopolitical disruption and weaker economic conditions would slow industry expansion in 2026.
Global Islamic finance assets grew 10.2 percent in 2025. Islamic banking accounted for approximately 74 percent of the industry’s growth, compared with 54 percent in 2024, while Gulf markets generated about two-thirds of the increase in banking assets.
Saudi Arabia and the UAE were the main contributors, supported by credit growth, government development programmes and large financing requirements.
The outlook depends heavily on the duration of regional instability, energy exports, oil prices, government spending and the ability of banks to maintain funding and liquidity. S&P expects Islamic finance growth to recover gradually in 2027 if geopolitical tensions ease and global trade and energy flows normalize.
Standards shape development
The Islamic Financial Services Board develops prudential standards covering capital adequacy, risk management, liquidity and supervision for institutions offering Islamic financial services.
Its work is particularly relevant as Gulf regulators seek to align Sharia-compliant banking with Basel requirements while accounting for contractual structures that differ from conventional finance.
The Accounting and Auditing Organization for Islamic Financial Institutions develops accounting, auditing, governance, ethics and Sharia standards used by Islamic financial institutions internationally.
Differences in national adoption remain important. Qatar allows decentralized Sharia supervision, the UAE maintains a central Higher Sharia Authority and Kuwait requires internal Sharia boards under dedicated legislation.
The treatment of profit-sharing investment accounts also varies. Bahrain provides favourable regulatory treatment, while Kuwait does not and the UAE has not formally adopted the AAOIFI alpha factor.
These differences influence reported capital ratios, risk-weighted assets and the comparability of institutions across the GCC.
Technology broadens access
Digitalization is becoming a central competitive factor as smaller Islamic banks seek to protect their market shares against larger institutions.
Saudi Arabia’s fintech expansion, the UAE’s digital-first national strategy, Kuwait’s emphasis on customer experience and Oman’s regulatory reforms all create opportunities to broaden access to Sharia-compliant products.
Retail sukuk platforms can bring capital-market products to individual investors, while digital onboarding and mobile banking can reduce customer-acquisition and servicing costs.
Structured sukuk, sustainable finance and Sharia-compliant liquidity instruments could also diversify funding and revenue beyond traditional consumer and corporate financing.
However, the sector’s continued expansion depends on addressing persistent constraints, including limited sukuk-market liquidity, the early development of Islamic derivatives and a narrower range of instruments available for managing short-term liquidity.
Across the six markets, stable deposits and strong capital provide substantial protection. The main test will be preserving those strengths while financing national development plans and managing the credit consequences of slower growth and regional disruption.
