Islamic Banking: The Challenge Ahead

Jamil Hassan, Principal Consultant, Islamic Banking, Oracle Financial Services

The adoption of Islamic banking is a simple case of supply and demand. It continues to see growth in countries that have large Muslim populations, such as Malaysia, Indonesia and Turkey. It is also expected that many North African countries will move relatively quickly to Islamic banking, once authorities and laws required to facilitate the introduction and growth are in place.

However, we are starting to observe a strategic reprioritisation of interest around the adoption of Islamic banking elsewhere in the world. From what had become a relatively fast adoption rate, we’ve seen banks and institutions in global financial centres re-assess their priorities in response to market conditions. They have been considering complexities, addressing compliance requirements and establishing that there is a need for relevant technologies to be in place before new Islamic banking products can be implemented.

As a result of these considerations, Islamic banking is being strategically deprioritised, particularly in the Western markets, where there are still growth opportunities within conventional banking products. It has also been deprioritised by financial centres where it was anticipated to see significant growth, such as London, Singapore and Hong Kong, as institutions instead focus their energies on tackling the current economic problems and complying with new regulations.

Conventional banks in other regions are likely to implement Islamic banking only if it becomes a threat to their banking franchises and their market share, or if it provides them with an easier path to expand their overall market share. For example, in Malaysia, Islamic banks are allowed to open more branches more easily than non-Sharia compliant financial institutions, which can encourage conventional banks – including international banks – to establish Islamic banking subsidiaries and open more new branches.

There is a plethora of benefits for those institutions that offer Islamic banking products, particularly in highly competitive markets where there is a significant Muslim population. Firstly it offers key market differentiation, providing better choice for their customers and a service that is more aligned with their personal requirements, which will in turn improve the customer experience significantly and thus increase loyalty. In addition, the adoption of Islamic banking can offer growth opportunities beyond the domestic market, opening up the potential to operate in new regions and meet any growth objectives banks may have.

Why is it then with so many apparent benefits that the spread of Islamic Banking seems to be suffering what the global banking and finance industry deems to be a significant setback in adoption?

Part of the challenge these institutions face, is that it is not as simple as on-boarding a conventional banking customer or account. Islamic Banking must comply with the prohibition of interest in all financial transactions, as mandated by Sharia law. Therefore, Islamic bankers use alternative structures to deliver products with similar benefits to their conventional counterparts. The acceptable structures revolve around trading (buy and sell), rental or equity. This adds additional complexity and requires separate functionality that is not currently supported or fully supported by their existing infrastructure.

The issue of the adoption challenge can be exacerbated by local interpretations of Islamic Banking regulations leading to separate compliance and regulatory requirements in local markets. In general, compliance with Sharia law in banking is guided by the standards issued by Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). However, in some markets discrepancies occur when Sharia law and AAOIFI regulations are interpreted and varied to fit cultural beliefs. Global and regional financial institutions therefore need systems that can support Islamic banking products whilst remaining compliant at a global, regional and local market level.

Such solutions do exist, and they are at the core of financial institutions across the Middle East, so the issue here is that these Sharia-compliant products are often perceived by non-specialist banks as more complex and risky than their conventional counterparts, requiring lengthy planning and integration projects.

However, IT vendors are able to provide ‘out of the box’ banking solutions, which minimise the length and complexity of these integration projects, provided they are managed closely and take advantage of the experience available in the wider global market place. The technology is there to bring Islamic Banking to any market that desires it, but the will, resources and the business case have to match that demand and capability.

These are just some of the challenges that Islamic banking faces if uptake is going to increase where demand is bubbling under the surface, but they are far from insurmountable. Most of them can be overcome with sufficient effort and resources, as well as enhanced cooperation from governing bodies and relevant political entities. Politically, many of the regions that would be natural adopters of Islamic banking have had a tumultuous few years, but as the situation begins to settle, there is an opportunity for banking institutions to take the next step towards Sharia-compliant products and services for their customers, in-branch, on mobile and on-line.