Although the principles underlying Islamic banking are as old as the religion itself, modern banks did not start offering Sharia-compliant products until the mid-1970s. They did so for a number of reasons: in the GCC, for example, many Muslims who were coming into significant wealth were weary of interest and conscious of being religiously compliant with their banking activities.
Since then, however, Islamic finance products have evolved to appeal to the pious and those looking for value propositions. Today, investors around the world purchase sukuk, Islam’s answer to bonds, Islamic investment funds and takaful, the Islamic version of insurance. Sharia-compliant investments tend to record lower risk and are less volatile and better-performing in the long run.
As a result, the industry has captured impressive market share gains. Many of the largest Islamic banks are in the GCC and in the UAE, to use just one example, Islamic financing assets make up about 30 per cent of the local financial system.
It is no wonder that banks, cities and countries across Asia and beyond are vying to be hubs of Islamic finance.
One advantage Islamic banks in the GCC have over their counterparts elsewhere in Asia is the strong liquidity coverage ratios (LCRs) they enjoy due to their large base of core retail customer deposits and low reliance on market-sensitive wholesale funding. In South-East Asia, the retail funding of Islamic banks is constrained by small branch networks, which results in weaker LCRs when compared with their conventional peers and GCC counterparts. Also, in GCC countries, retail customers tend to be more Sharia-aware, resulting in a large base of low-cost retail savings deposits at Islamic banks and hence a lower reliance on short-term wholesale funding. In October, the Dubai Centre for Islamic Banking and Finance found that outside Malaysia, the GCC region had the world’s most efficient Islamic banking capabilities.
There are also some pressing challenges that the industry will begin to face. For example, despite its growth, outside GCC countries low levels of public awareness and understanding of Islamic financial products and services persist. Also, although standard-setting bodies have developed specific standards, regulatory and supervisory frameworks in many jurisdictions still do not address the unique risks of the industry. In some jurisdictions the practice of Islamic banking has resulted in complex financial products and corporate structures, indicating a need for increased regulatory clarity and harmonisation, better cooperation between Islamic and conventional financial standard-setters and further improvement of supervisory tools. Finally, the internationalisation of the industry will need to progress rapidly to maintain continued growth, with the concentration of the industry in just a few markets being a potential threat to its stability.
As the industry matures, several high potential segments remain largely unaddressed – perhaps none more so than digital and mobile payment systems. Across the world, banks are engaged in setting up mobile banking and payment systems that use technology to efficiently channel funds and the opportunity is there for Islamic banks to provide Sharia-compliant internet-based banking platforms. Unfortunately, according to a report by EY in September last year, Islamic banks still struggle with lower customer penetration in mobile banking when compared with conventional banks. The same report suggests that over the next five years, profits at corporate banks that remain digital laggards could drop significantly compared with their digitally fast-moving competitors. Technology-enabled, simple end-to-end experiences that use highly amenable features such as Blockchain technology should therefore be seen as a priority by banks within the industry.
Over the next year, we are going to see a rapid consolidation of much of this technology. The value that it will have on our lives is hard to quantify, but it is obvious that as awareness of the industry grows, and as digital platforms become more industry-specific, innovation within the Islamic banking space will accelerate as a result.
Aladdin Al Deesi is the chief executive of Mashreq Al Islami.
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