The Islamic finance sector is increasingly witnessing diversification, sophistication and innovation, thanks to new entrants, the launch of new products and abundant liquidity in the market, a new report has revealed.

"We have seen a mushrooming of new Islamic financial institutions (IFIs), and there are several reasons for this," said Anouar Hassoune, a Moody's Vice-President Senior Credit Officer in Global Banking report.

"The consolidation is not on the agenda of Islamic financiers at this stage: Microenomomic theory says that a growing and profitable market provides enough space for a sizeable number of newcomers," said Hassoune. The report also emphasises the expectation that the expansion of the Islamic financial industry will lead to further diversification. Benefits are expected to be extracted from increasing sophistication and further innovation, but also from growing operating and geographic diversification.

While new Shari'ah-compliant business lines are gaining ground, especially in investment banking, IFIs are exploring new horizons across a wide range of territories starting from their Asian and Middle Eastern platforms. Africa, the Americas, and Europe (especially the UK, but also countries in continental Europe like France) have been identified as very attractive potential markets. Hassoune said Paris is competing hard with London to become European hub for Islamic finance.

Commenting on sukuk market, Moody's said sukuk structures are evolving rapidly and the market is increasingly moving away from the "lease and lease back" Sukuk structures of the first generation and towards "structured" Sukuk. Underlying assets eligible for sukuk schemes have witnessed increasing diversification. The number of issuers has also grown, both within the Muslim world and beyond its natural borders.

The rating agency said the more liquid the sukuk market becomes, the deeper, more disintermediated, and efficient Islamic capital markets will be.