Islamic retail banking is at the frontline of the industry’s growth and acts as the vanguard for development in terms of public opinion and global usage. Yet all too often the media focuses on the investment and commercial side of the industry and ignores the innovations occurring on the retail side. This week therefore, we take a closer look at the factors driving (and limiting) consumer banking.
Retail banking is not commonly a focus area within the context of Islamic finance but it is vital to the industry’s capacity to grow. The sector also acts as a valuable bellwether for the industry as a whole: where retail banking prospers, we can expect the commercial and wholesale side to follow. This is especially true in countries new to Islamic finance, such as developing African nations, where there is a strong grassroots demand for Shariah compliant retail products that offer the chance to develop at a consumer level from the ground up.
Social responsibility
Dr Adnan Ahmed Yousif, CEO of Al Baraka Banking Group, in a recent speech at the International Islamic Retail Banking Conference in October 2011, noted that the vital importance of the retail Islamic banking industry lies in its overall strategic objectives, which are built around three key pillars:
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Ultimate end result must serve at least one or more social responsibilities: such as income increase, job creation, savings etc.
The end result of the Islamic retail system is to build a “fully integrated socially responsible financial system” which over the past five years, as the conventional system has been rocked by financial and economic crises, has benefited from a growing social profile as a safer and more ethical method of banking. President Obama famously commented on the 2008 financial crisis that: “The crisis was born of a failure of responsibility –from Wall Street all the way to Washington…”
The key advantage of Islamic retail banking is the maintenance of a strong sense of social responsibility. This perceived advantage has led to considerably increased interest in the sector from the international financial community, looking for a safe haven.
But is the Islamic retail banking system really a safer bet? Regrettably the answer is not that simple. The Islamic system despite its religious base must operate within the international community, and as such it will always be affected by the same risks and economic consequences.
However, Yousif points out that: “Islamic finance draws upon values of Islamic economics and social ethics… the values of Islamic finance. Thus I can claim with full confidence that the system is highly qualified to provide workable solutions to the current issues or challenges.”
Customer is king
This focus on the social aspect is what drives the growth of the Islamic retail business, with grassroots demand from consumers pushing its development. Across the core strongholds of Islamic finance, retail banking has seen strong and consistent growth over the last five years. And banks are thus increasingly adopting a consumer-centric strategy to achieve scale and tap the massive potential of the market. Recent research suggests that the 1.6 billion global Muslim population is expected to grow by 35% over the next 20 years, offering a fertile market for retail banking services.
“One of the challenges we face is creating enough awareness amongst Muslim and non-Muslim customers, potential customers and bank staff,” said Amman Muhammad, the managing director of South African Absa Islamic Bank, in a recent interview. “There`s still a fair level of scepticism towards Islamic banking and we find there`s still a high level of not fully understanding the products.”
Muhammad says the bank`s approach is: “To educate … via a customer focus group where we invite people from a certain area to congregate, and invite international Shariah scholars and members of our Shariah board to interact with them and answer questions.”
Educating customers about Islamic finance, understanding their needs and delivering products and solutions that are creative, yet adhere strictly to Shariah principles and are cost-effective, is part of a concerted strategy that retail banks are now undertaking upon in order to develop the sector more fully and enlarge their share of the Islamic retail business.
“Players across the conventional sphere are moving away from product selling to solutions based on customer needs, and Islamic banks are doing this too,” said Wasim Saifi, the global head of Islamic banking for the consumer banking division of Standard Chartered Bank. “We take the same approach as on the conventional banking side. We encourage staff to engage customers in need-based conversation rather than engage in product pushing — that`s the need of the day.”
Malaysian dominance
Malaysia leads the world in Islamic banking, with an estimated US$86 billion in banking assets. With one of the most sophisticated and well-developed retail Islamic banking systems, the country acts as a flagship for the global industry. Eight local banks were ranked in the top 50 of the Top 500 Islamic Financial Institutions 2011 Report: including Bank Rakyat (12th), Maybank Islamic (18th), CIMB Islamic Bank (22nd), Bank Islam Malaysia (24th), Public Islamic Bank (38th), AMMB Holdings (43rd), AmIslamic Bank (44th) and Bank Muamalat Malaysia (48th).
In 2012, domestic Islamic banking assets are expected to increase to 25% of the total. Dr Zeti Akhtar Aziz, the governor of the central bank, Bank Negara Malaysia, recently announced that the market share of Islamic banking assets of the total banking industry had grown from only 6.9% in 2000 to 22% in 2011. She also noted that the contribution of Islamic finance to the Malaysian economy had also been growing significantly, accounting for 2.1% of GDP in 2009, compared to only 0.3% in 2000.
Liberalization
Recent liberalization measures have not only been successful in reducing the impact of the financial crisis and pushing the Malaysia’s banking industry forward, but have been specifically targeted at growing the Islamic retail industry across borders and encouraging the development of foreign investment and participation.
Recent measures have included two new Islamic banking licenses offered to foreign banks, five new commercial licenses for international banks and two new Family Takaful licenses offered to qualified players. In addition, domestic Islamic banks can now enter international partnerships with a foreign equity limit of 70% and a requirement of US$1 billion in paid-up capital. Locally established foreign banks are allowed to open four new branches (based on a prescribed distribution ratio) while foreign insurance and Takaful operators can open branches nationwide without restriction and have greater flexibility to employ expatriate talent. In addition, offshore banking institutions licensed by the Labuan Offshore Financial Services Authority can now open offices onshore.
Zeti recently commented that greater liberalization of the Islamic financial system has resulted in a greater foreign presence and participation in Malaysia’s Islamic financial system. This has been accompanied by an increasing trend in foreign participation in the domestic Islamic banking and Takaful industry. “Moving forward, Islamic financial institutions in Malaysia will also expand beyond national boundaries to increase economic and financial linkages with other parts of the world,” she added.
Global growth
But while Islamic retail banking is seeing strong performances in established markets, growth is not equal across the board. In Indonesia and Pakistan for example — two of the world`s most populous Muslim nations — Islamic retail banking growth is still in the single digits.
However, KFH Research notes that as the appetite for Shariah compliant products and services increases, regions such as Southeast Asia, Pakistan, India and Africa, with their sizeable Muslim populations and projections for strong future economic growth, will continue to offer the best opportunities for Islamic retail banks. There are expectations that Indonesia`s Islamic banking share could climb to 10% over the next few years, while Pakistan`s could rise to 12% from a current 7.8% in 2011 (up from 4.9% in 2008). In the December 2011 Islamic Banking Bulletin from the State Bank of Pakistan Yaseen Anwar, the governor of the central bank, noted several initiatives being undertaken in the country to promote Islamic retail banking.
“Despite significant improvement during last 10 years, still a very large segment of our population does not have adequate understanding of Islamic finance and its distinction over conventional finance. The central bank thus has assumed a dual role for Islamic banking i.e. as both the regulator and the promoter and facilitator. Under the facilitation that we have been partnering with the industry to improve Islamic banking awareness and understanding of the masses and to build the industry’s HR capacity. To create awareness we have launched an awareness campaign, whereby targeted workshops, public seminars and conferences are being organized. Further, a media campaign is being launched for mass awareness using electronic and print media. To help the industry to build its HR capacity, our training subsidiary NIBAF (National Institute of Banking & Finance) is offering regular and customized Islamic banking courses to national and international participants.”
In the MENA region, Islamic banking has also seen steady growth and has spread to several new countries. While the GCC is an established market for Islamic retail banking already several new developments, such as the introduction of Islamic banking to Oman and the impact of the Arab Spring on countries such as Tunisia and Egypt which are now pushing the development of domestic Islamic banking, have led to a growth spurt in the region.
However, further increase in appetite is contingent upon ongoing public education to raise and enhance awareness of Islamic finance — how it works, its structures and its benefits.
Limiting factors
Key concerns holding back the development of Islamic retail banking, particularly in newer markets, have also included limited liquidity management instruments and lack of lender of last resort facilities. Anwar notes that: “So far we have had limited success in developing an effective and ongoing liquidity management mechanism for Islamic retail banking institutions due to infrequent issuance of sovereign Sukuk. However, as a result of extensive efforts made both at industry and the central bank level we are at an advanced level of development of a comprehensive liquidity management solution that would include; i) development of Islamic interbank money market, ii) development of Islamic Interbank Offered Rate (IIBOR) for use as a benchmark for pricing of Islamic finance products, iii) transformation of a sizeable portion of conventional sovereign debt in the books of central bank into Shariah compliant debt, iv) allowing IBIs to place surplus liquidity with the central bank to be remunerated based the central bank’s earnings on Shariah complaint assets and investment portfolio; and v) lender of last resort facility for IBIs.”
Increased competition
Steps such as these offer strong support to the development of Islamic retail banking in new countries, and offer the prospect of real competition to the dominance of established Islamic retail banks. Flagship territories such as Malaysia should not get complacent, warn industry experts, as competition is fast developing. According to Malaysia-based Multimedia University’s Conceptual Framework for the Adoption of Retail Banking Services in Malaysia, Islamic banks in the country despite their strong growth and governmental support are constrained by a lack of innovation and risk stagnation. To keep up with globalization and to serve the growing wealth of the rapidly increasing global Muslim population, the industry needs to invest in research and development to create new and innovative Shariah compliant products and services that go beyond simply matching those offered by conventional banks.
Regulatory requirements
“Islamic retail banks must either achieve economies of scale to compete, or find a strong niche to focus on,” according to Badlisyah Abdul Ghani, CEO of CIMB Islamic. “They should also insist on a level playing field from regulators that Islamic windows operated by conventional banks should be treated as stand-alone Islamic retail bank(s).”While few would disagree that the sector`s growth potential is enormous, there is an urgent need for a regulatory, supervisory and Shariah frameworks to be put in place across all markets in order for the sector to realize its fullest potential. Stronger standards for corporate governance, transparency, disclosure, accountability, market discipline, risk management and customer protection are crucial to increase market confidence and penetration. “Without effective legislation, regulation and a legal framework, Islamic retail banking will never take off, which is what has happened in many countries,” said Badlisyah. “Even when regulations are made to be facilitative to Islamic banking, other relevant laws such as tax and land laws need to be amended or enhanced to accommodate a level playing field between Islamic and conventional retail banking.”
Moving forward
In order to keep up with the conventional sector, says KFH Research, Islamic retail banks must be able to compete by enhancing their capability and capacity in terms of investment portfolio management, pricing, staffing, corporate governance; offering innovative products; and ensuring risk management systems are up to par.
Yousif identifies a number of key challenges which he believes are vital in developing the retail banking industry, including:
• Improvement of customer services and marketing research capabilities at both the institutional level and the industry level (research firms).
• Institutions need to play an effective role to promote the system globally and raise awareness that it is not just for Muslims.
• Institutions need to work as think tanks to find solutions for the operational challenges facing Islamic banks (including internal credit processes, Shariah risk management, innovation management, consumer awareness programs, etc.)
• Professional training and certification programs.
A crossroads
The recent International Islamic Retail Banking Conference in October 2011 concluded that: “Islamic retail banking has great potential, especially in the Middle East.” However, “Islamic finance is currently at the crossroads, and needs to decide whether to continue with imitating conventional banks or to begin to improve and create products better than conventional, and beneficial for everyone regardless of their faith.” — LM