Friday 19 July 2024

Islamic banking: The three keys to new growth

DUBAI, September 23, 2014

The global Islamic finance industry is estimated to be worth $1.3 trillion and is growing at a rate of between 15 per cent and 20 per cent per year. However, growth comes at a cost. Many Islamic banks haven’t had the time to develop a true culture of risk, strong operational workflows, standard internal policies or consistent regulatory compliance.

This has made it more challenging to turn the market’s growth into business profits. Today, the majority of Islamic banking entities are significantly smaller than conventional banking organizations in both the number of customers and the size of the balance sheet.

However, they are growing faster than conventional banks. Today, Islamic banking operations are recognizing that they need to focus on three areas if they wish to capitalize on the potential for growth: regulation, risk and retail banking.


Regulatory support and clarity are critical to the growth of Islamic banking. It is the reason why Islamic banking has flourished in countries such as Bahrain and Malaysia but struggled to gain momentum in Turkey and Egypt.

The lack of regulatory support also explains why India has no Islamic banking despite a significant Muslim population. Two forces are now incentivizing central banks to support Islamic banking. The first is popular politics: customers, who are generally citizens of the country, want Islamic banking. The second is the momentum and network effect: as more countries and more banks turn to Islamic finance, it will be easier and cheaper for new entrants to join the market.

Overall, however, the prospects for Islamic banking are bright. But this trend also means that there is little standardization or unification of laws. No two countries have the same interpretation of the Shari’ah law.

In fact, in most countries, no two banks follow the same interpretations. It largely depends upon the scholars who are on each bank’s Shari’ah board. Needless to say, this is a big challenge for the industry.

A survey conducted by SunGard Financial Systems, a provider of mission-critical software and IT services, of senior executives in six cities and five countries within the Gulf Cooperation Council States found  that about a third of respondents (32 percent) believed that  the lack of standardization for Shari’ah compliance was a top business challenge for them.

Without standardized documents, the operational overhead for each Islamic transaction – whether it is with a customer or between banks – becomes a complex and time-consuming process that requires significant manual intervention.


Risk management was voted as the top business challenge, with 41 percent of respondents calling it a critical business challenge. This spanned operational, regulatory and market risk. Many banks are in the process of setting up an enterprise risk management framework.

However, lack of expertise, limitations on instruments allowed for hedging, and poor data due to disparate systems have hindered progress so far. Banks also need to determine how to define and segment their clients and how to create segment-specific risk models.

Retail banking

The foundation for the growth of Islamic banking is retail banking. However, the initial growth was based on customers who wished to bank solely on religious grounds. In order to expand market share, banks must convince conventional banking users to switch. This means compete with conventional banks on customer service, product offering and price.

In fact, 32 percent of respondents indicated that competing with conventional banks was a top business challenge. The same percentage of respondents also called out customer service as a top challenge. Islamic banks still have to play catch-up with conventional banks in terms of customer centricity. They need to establish 360-degree views of their customers.

They also need to enhance the customer experience through multi-channel access, a well-organized branch and ATM network, online and mobile banking, and the utilization of data analytics and business intelligence to support sales and management. In addition to all these complexities, Islamic banks need to manage legal and reputational risks.

Given that Islamic banking is still relatively new, the strength of the legal documents has not been stress tested in the court of law. Additionally, if a bank’s product turns out to be non-Shari’ah compliant, a bank is not only at risk to financial loss but also to reputational damage, which can be fatal for any organization.

The survey also further identified important business challenges facing Islamic banks (participants selected their top three issues):

1.     Risk management (41 per cent)

2.     Customer service (32 per cent)

3.     Competing with other regional players (32 per cent)

4.     Lack of standardization (32 per cent)

5.     New product development (27 per cent)

6.     Legal and reputational risk (14 per cent)

Wissam Khoury, managing director, Middle East and Africa, SunGard Financial Systems, said: “Islamic banking is one of the fastest growing areas in financial services globally. This is evident here in the GCC, with the World Islamic Economic Forum taking place in Dubai next month as well as the growth of and recent acquisition activity by regional Islamic finance providers.”

“Elsewhere, governments in the UK, Hong Kong and South Africa have all issued their first sukuk this year. The opportunities for growth are huge.

“SunGard believes that to capitalise on this, Islamic banks need to establish first class enterprise risk management frameworks. In addition, enhancing their customer experience through multi-channel access and an improved branch with mobile and online banking will allow Islamic banks offer compelling products and services to help attract retail customers.

“And finally, the industry needs to keep building relationships with and educating regulators. Many central banks have now passed regulations in support of Islamic banking, so it is vital that this opportunity is not lost,” Khoury added. – TradeArabia News Service

Tags: regulation | Retail banking | Islamic Banking | Shari’ah | SunGard |

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