The Gulf’s Islamic banks are expected to continue outperforming their conventional peers despite a tougher operating environment marked by geopolitical tensions, slower economic growth and higher funding costs, according to a new report by Moody’s Ratings – GCC Islamic banks set to outperform conventional peers despite tougher conditions.
Moody’s said the structural strengths that have powered the rise of Islamic finance across the Gulf will remain largely intact, allowing Islamic lenders to post stronger credit metrics, higher profitability and faster financing growth than conventional banks.
“We expect Islamic banks to continue expanding faster, supported by solid demand for Shariah-compliant finance, while higher exposure to the public sector across both their retail and corporate books underpin superior loan quality,” said Abdulla Al Hammadi, Assistant Vice-President at Moody’s Ratings. He added that Islamic banks are likely to outperform on earnings because of “their structurally higher margins and lower credit cost.”
The outlook comes as Gulf banks contend with the fallout from regional tensions and disruptions to trade and supply chains. Moody’s expects non-oil economic growth across the GCC to slow in 2026, affecting confidence-sensitive sectors such as tourism, real estate, construction and logistics. However, the ratings agency believes the region’s banking sector remains well positioned due to strong capital buffers, liquidity and stable funding profiles.
For the UAE, Islamic banking is expected to remain one of the fastest-growing segments of the financial sector. Moody’s noted that the UAE continues to support the expansion of Islamic banking and the sukuk market, while demand for Shariah-compliant products among consumers and businesses remains a key growth driver. Islamic banks already hold a leading position in the UAE banking system alongside Saudi Arabia.
“Increasing demand for Shariah-compliant products across retail and corporate segments will continue to support long-term growth, with Islamic banks maintaining significant market shares across GCC banking systems, and leading positions in Saudi Arabia and UAE,” Al Hammadi said.
Loan quality is expected to remain a major advantage. Islamic banks entered 2026 with an aggregate non-performing financing ratio of 1.75 per cent, compared with 2.23 per cent for conventional banks, reflecting their larger exposure to government-related lending and public-sector employees. Financing backed by salary assignments and collateral is expected to shield lenders from the impact of weaker economic conditions.
At the same time, banks across the region continue to maintain strong loss-absorption capacity through conservative provisioning and healthy capital buffers. Moody’s said Islamic banks retain ample capacity to absorb any deterioration in asset quality while continuing to fund future growth. Several lenders have also strengthened capital through Additional Tier 1 sukuk issuances this year, highlighting continued investor appetite for Gulf banking assets despite regional volatility.
Profitability is another area where Islamic lenders are expected to maintain an edge. While provisioning costs are likely to remain elevated across the sector because of geopolitical uncertainty, Islamic banks benefit from stronger profit margins, lower credit costs and improved operational efficiency.
According to Moody’s, Islamic banks historically maintained a margin advantage over conventional peers and should continue to benefit from resilient fixed-rate retail financing originated during the recent period of higher interest rates. Lower loan-loss provisions are also expected to support stronger bottom-line profitability.
Funding and liquidity remain key strengths. Islamic banks generally enjoy a larger share of retail deposits than conventional banks, providing a more stable source of funding during periods of economic uncertainty. They have also maintained access to capital markets through regular sukuk issuance.
In the UAE, this trend was demonstrated by Emirates Islamic’s $500 million sustainability-linked sukuk issued in June 2026, which Moody’s cited as evidence of continued investor confidence in Islamic banking.
Although challenges remain, particularly around the limited availability of Shariah-compliant liquidity-management instruments, Moody’s believes government efforts to deepen sukuk markets and expand investment opportunities will gradually ease those constraints.
The overall result, the agency said, is that Islamic banks are likely to remain among the most resilient and profitable financial institutions in the Gulf, continuing to gain market share even as economic conditions become more challenging.
Source: Khaleej Times