Islamic banking assets at commercial banks grew to $1.3 trillion (Dh4.77 trillion) globally last year. They are expected to reach $1.8 trillion this year and surpass the $2-trillion milestone by next year — an average annual growth of 17 per cent, according to Ernst & Young’s World Islamic Banking Competitiveness Report 2013.
The top four markets — Saudi Arabia, Malaysia, Qatar and Turkey — account for 84 per cent of industry assets.
According to the report, “The Islamic banking growth story continues to be positive, growing 50 per cent faster than the overall banking sector.”
There is a positive sentiment within the sector, as Islamic banking is seen as an antidote to the ailing global banking sector. In fact, it is noteworthy how Islamic nations have largely remained immune to the global recession, while most of the major Western economies have suffered to a large extent.
However, Islamic banking is not without challenges. The sector continues to grapple with multiple issues related to sub-scale operation, asset quality, negative operating income from core activities and a weak risk culture.
Scaling back
HSBC’s decision in October to close its Islamic retail banking operations in six countries, leaving a presence only in Malaysia, Saudi Arabia and Indonesia, highlights the sector’s contradictions. While HSBC doesn’t disclose figures for its Islamic business, experts say the closed branches in the UAE, Bahrain, Bangladesh, Singapore, Mauritius and the UK were performing poorly.
Barclay’s, Deutsche Bank and Standard Chartered have also recently scaled back their Islamic banking activities.
There are several challenges that make Islamic banking difficult, at least for Western banks with Islamic banking windows.
One of the biggest issues is the cost-profit ratio, which doesn’t come close to conventional banking products, a senior banker at a big multinational bank told GN Focus on the sidelines of the recently held Global Islamic Finance Forum in Kuala Lumpur. He said banks need to charge higher fees for many Islamic products because of complex product structuring and legal overheads.
“Global banks are worried about declining profit margins from their Islamic finance business,” said the banker, who wished to remain anonymous.
“They have been struggling for years with the cost-profit ratio, and there are also not that many customers that would help grow the business sustainably.”
Although Islamic banks have generally outperformed conventional banks in terms of growth, this doesn’t mean they have been more profitable.
“Islamic banks need to adopt more sophisticated, customer-centric sales approaches,” says Cyril Garbois, Partner, A.T. Kearney Middle East, a management consultancy firm. “They also need to think about product innovation and how they can compete with conventional banks in terms of pricing and modern forms of customer interaction, such as online banking or other alternative channels.”
Another big issue is liquidity management. Although they were not that affected by the global financial crisis, many banks in the Gulf were facing declines in profit and problems with bad debt due to local crises. Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilised either to cover liquidity shortages or to manage excess liquidity.
Operational difficulties
This problem is aggravated since many Islamic banks work under operational procedures different from those of the central banks; the resulting non-compatibility prevents central banks from controlling or giving support to Islamic banks should a liquidity gap occur.
Furthermore, the need for professional bankers or managers for Islamic banks cannot be overemphasised. Some banks are currently run by direct involvement of the owners, or by managers who have not had much exposure to Islamic banking activities and who are not conversant with conventional banking methods. Consequently, many Islamic banks are not able to face challenges and stiff competition. There is a need to institute professionalism in banking practice to enhance management capacity.
Smart moves
George Haimari, Dubai-based Partner of consulting firm Booz & Co, says Islamic banks need to take several steps to grow with the industry. “There has to be a market intelligence process that captures customers’ needs, a robust methodology for rapid development and deployment of products, a mechanism to engage the Sharia board early on to seek approval for the proposed product or service, as well as automated monitoring and compliance tools together with a management information system,” he says.
Overall, the market for Islamic banking still shows rich potential. However, as competition increases, the winning players will be those that are able to deploy differentiated capabilities and address the existing challenges unique to Islamic banks.
An issue that needs to be addressed urgently is the lack of standardisation in Sharia-compliant banking. Most Islamic financial institutions offer the same basic products but each has its own group of Islamic scholars, resulting in different features and rules.
Lack of standard financial contracts and products can be a cause of ambiguity and a source of dispute and cost.
