Islamic banking products are becoming popular worldwide and the market is expanding. Joy Macknight looks at the differences in the technology underpinning this growing sector.
Islamic banking finance industry assets have reached close to $300 billion in 2005 and the market has an estimated annual growth rate of more than 10 per cent, according to recent figures gathered by the Council for Islamic Banks.
In June, Muslim bankers and regulators announced their intention to set up a global Islamic bank by next year that could rival Western lenders and to chart a 10-year blueprint to encourage growth in the Islamic financial sector as proposed by the General Council for Islamic Banks and Financial Institutions in order to serve the 1.3 billion Muslims internationally.
With over 270 Islamic financial institutions in more than 40 countries, the market is mainly concentrated in Muslim countries of the Middle East, North Africa and South East Asia, but many international financial institutions have recently realised that there is potential to increase their market share if they provide Islamic products. The migration of Muslims has created large communities across the globe that are keen to bank in accordance to the Muslim Shariah law.
Ziad Aba Al-Khail, group head of the support group at Saudi Arabia-based Bank Aljazira, comments: “The interest in Islamic banking is not limited to the Middle East region. Most of the international banks are trying to discover new business opportunities in the local and international markets. They are trying to introduce Islamic compliant products to increase their market share and customer base. Some Islamic banks have been established in foreign countries, like Islamic Bank of Britain; this bank has branches in London and is planning to open branches in all European Union countries.” The UK is a good base to start from for it has an estimated 2 million strong Muslim community out of more than 12 million Muslims in Western Europe; other countries like Spain, France and Germany are also being explored.
International banking giants, such as HSBC, BNP Paribas, Citigroup, and Credit Suisse First Boston, are all developing Shariah compliant products. Some have created a separate Islamic subsidiary — such as HSBC Amanah or UBS’s Noriba Bank — that function as an independent institution with a separate balance sheet and completely sanitised funds free of non-Islamic income; a board of Shariah scholars oversees its operation. Other conventional banks, including Lloyds TSB and ABN Amro, have created ‘Islamic windows’ that maintain a separate balance sheet and Islamic Banking and Finance books within a conventional operation. These institutions, as well as the standalone Islamic banks, offer a wide range of financial products from current and savings accounts to home finance to sukuks (Islamic bonds) — all which are compliant with Shariah law.
Shariah law is the code of conduct for Islamic followers that governs both religious and secular aspects of everyday life. In the financial sector, certain business practices are in conflict with the rules of Islam. Four main rules can be used as simplified guidelines: interest (riba) is forbidden because that would be to earn money from money; activities involving speculation (ghirar) are also forbidden; an Islamic tax (zakat) is implemented; and avoidance of investing in activities that are considered to be haram, or forbidden, such as gambling, pornography and alcohol.
Paul Dodd, regional marketing director at Misys, explains some of the more complex issues surroundingharam. “If I was a full Islamic bank, I would not be allowed to lend or invest or otherwise get involved with companies that have anything to do with armaments, alcohol, gambling or anything like that. But that is not all: on the investment side, stocks and shares that are on the Islamic index are for companies that do not have significant incomes or expenditures in interest. So even if I am Mothercare and I am not doing anything that one would consider to be non-Islamic — if I have a lot of surplus cash that was in major deposits gaining a lot of interest, they would exclude that as well.”
Another complexity in Islamic banking is that profit and loss must be calculated through an agreed and “fair” process, and both parties shoulder the risk. This is based on the Islamic legal concepts of shirkah(partnership) and mudaraba (profit sharing) and is overseen by the Shariah board. Joseph Koh, vice president of marketing at Infopro, a Malaysian banking software company, says: “You have to switch off your conventional mind. Field, functions and features are similar but the contract, which is physical, is tied into the system. When you first see it, you might say that Islamic banking is just like conventional banking but a reversal. But when you go deeper into it, it becomes more interesting.”
Effectively the main difference is the principle behind two things: how the bank makes its money from its customers and how the internal processes of the bank work.
Although the technology is fundamentally similar to conventional banking, the internal workflow is different. For example, if a customer wanted to buy a car, in the conventional system they would apply for a loan, the bank would give them the money and then they would pay it back with interest. The bank is not interested in what is done with the money. In Islamic banking, the customer would go to the bank and say they want to buy the car, and then the bank would go ahead and buy the car and then sell it to them with an agreed profit margin. That is where the internal processes become important: when the customer buys the car, it has to be registered in the assets of the bank, it goes on the general ledger and then the bank sells them the car. This internal process must be integrated into the core banking system.
Douglas Jaffe, associate director at Financial Insights Asia Pacific, says there are some banks that believe they can build it themselves out of their conventional system, while vendors, such as Misys and I-flex, are marketing completely separate Islamic core banking systems. “Banks entering late into the Islamic banking market might be more keen to purchase an existing Islamic banking package as opposed to building or developing one from scratch or customising their existing conventional systems. This desire for jumpstarting their business might be a mark in favour of the specialists,” he says.
Koh argues that banks cannot just use a conventional system and remove words like interest. “The screens that you use in Islamic banking need to have the proper workflows so that the customer will have to issue the purchase order to the bank and the bank will in turn go and purchase the identified product or property or the identified goods. Normally, in all Islamic financing, goods will be involved. A very key element to remember in Islamic banking is that you cannot finance any of your customers where there are no goods involved.”
Adwait Nene, associate director of pre-sales at I-flex, agrees that there are fundamental differences: “In many markets the regulators have prescribed that the Islamic operations be clearly separated from the conventional one. Plus they are under separate licences that are required to be procured before a bank can launch Islamic operations. What is clear is that the period of the cosmetic changes in products to deal with the customers is over. Customers would really see through such cosmetic presentation level changes that certain banks might be making. The added value comes from transactions that are very carefully structured to comply with the Shariah principles.”
Kuwait-based International Turnkey Systems looks at the technology in a more modular way. “There are some unique components that we built just for the Islamic finance arena which primarily focus on the area of profit calculations which is the main difference between conventional banks — this is the equivalent of interest distribution but in the Islamic way,” says Haitham Abdou, manager of banking marketing and product development, ITS. “We have also developed a lot of modules or systems where we incorporated the management of the goods and assets for financial institutions. Most Islamic financing is based on the trading of goods or the financing of projects, so the asset management part is very critical to the whole chain of Islamic finance.”
He points out that the other main area where Islamic banking has an edge or has the ability to offer different products from the conventional banks is the business-to-business or business-to-customer model when the Islamic banks start to have an affiliation with non-banking organisations, like a car dealership. “When a customer goes to buy a car, he goes to the dealer, he chooses the car and then he needs finance. Then the customer probably has to go back to the bank and say I want the car, this much, I need some finance and there’s paper work and so on. To eliminate this cycle, what a lot of Islamic banks are looking to do to expand the delivery channel is to have a station based on the internet at the car dealer, so the car dealer can do the financing online with the customer without having to go to the bank.”
Technology is going to be the major differentiator to what services the bank can offer to the customers. “Now that the world has opened up with globalisation, everyone should be able to have access to all his or her banking needs anywhere, anytime. Everything should be able to be internet-based or mobile-based,” says Abdou. “Strong systems, like our CRM system, allow us to create marketing campaigns to target each customer’s specific needs. There should be less of the mass campaigning and then sheer hope that the customer is hooked. The business-to-business model I mentioned with affiliation is a great opportunity for banks to expand their customer base without having to spend on acquiring customers — another organisation is going to get you that customer. These are the main factors why I think that this way of banking is going to continue to grow, not only in the Middle East, but worldwide.”