Islamic banks’ ability to withstand the global downturn has fuelled an expansion of Islamic finance around the world. But most institutions are taking a measured approach to growth. Writer Joseph DiVanna.
This month, The Banker begins a new regular section on Islamic finance, one of the fastest growing areas in international finance and one that has been less affected by the global crisis. The Banker’s Top 500 Islamic Financial Institutions ranking, first published in November 2007, has already broken new ground in research on the sector. We are now making our coverage even more comprehensive by focusing on every aspect of the business in this new section. To get us started, industry expert and The Banker contributor Joseph DiVanna explores the growth opportunities ahead and looks closely at cross-border services.
Similar to the repercussions of a major earthquake, with each passing week conventional banking institutions are experiencing the aftershocks of a global financial system in crisis. Islamic banks, however, are being seen as institutions insulated from the current challenges that have eclipsed global markets.
One could argue that Islamic banks are not immune from the same threats that affect their conventional counterparts, and that in a global-economic environment, Islamic banks, too, are affected by what happens to their financial peers. This is true in the case of real estate projects, where Islamic banks have participated with other banks, and there has been a 60% drop in the issuance of sukuk. But in other sectors the outlook is better.
Since the publication of The Banker’s second Top 500 Islamic Financial Institutions ranking in November 2008, 11 new Islamic banks have been formed, such as the United Arab Emirates’ first Islamic commercial bank, Ajman Bank. And 23 banks have extended their operations into new countries such as Botswana, Iraq, Kenya, Malaysia, Pakistan, South Africa, Sudan, Syria. Qatar National Bank opened a full service branch in Singapore and Arab Bank has opened a new branch in Qatar that specialises in Islamic banking services.
Although many Islamic banks are taking a cautious approach to growth by slowing down the pace of expansion – as they evaluate the ramifications of the global downturn on their conventional counterparts – for the most part, they are demonstrating resilience and optimism.
Recipe for success
Why are sharia-compliant institutions faring better than their conventional counterparts? Islamic banks have a higher dependency on customer deposits for their liquidity, which in turn makes them less susceptible to changes in credit markets. According to Abdel Hamid Shoman, chief executive officer of Arab Bank: “Islamic finance will focus more on ‘ethical’ investing; for instance, speculative financing and trading is out of bounds, hence Islamic banks were generally not impacted by collateralised debt obligation or asset-backed securities.”
Perhaps one answer lies in understanding the market discipline used by sharia-compliant institutions as they employ the fundamental tenet of Islamic finance: that of shared risk, shared reward.
When risk and reward are shared equally – or, more precisely, spread between parties – there is a tendency to take a conservative position toward protecting one’s own investment. In most cases, Islamic institutions act to create a relationship between the customer and the institution based on a joint venture-like arrangement. This philosophy fosters an inherent sense of loyalty on the part of both the bank and the customer. Loyalty in banking is typically described as a commodity that can be bought or sold using a wide variety of customer incentives.
Many Islamic financial institutions have realised that loyalty in a Muslim context has two key components: value for money and trust. Both components have a relative value reflected in customer attitudes found in local banking markets. Customers can be conservative in their interpretation of sharia-principles. For example, using an interest-based credit card might be acceptable to Muslims living in Western societies, provided they pay off the balance each month.
However, elsewhere in the world, this practice is considered unacceptable because a contract has been signed with the bank that says the customer will pay the interest if they are unable to pay the balance. Islamic banks have taken into consideration the diversity of the populations they serve, to construct a new generations of products which are now being introduced across the globe.
A two-way street
During the past five years, Islamic banks have learned that customer loyalty must be earned, not bought. Loyalty is a product of a process of building trust between what an institution says it can do for a customer versus what the institutions actually deliver to the customer. Trust is a fundamental tenet of Islamic finance often reflected in the brand identity of sharia-compliant banks such as HSBC Amanah (Arabic meaning ‘deposits in trust’).
In the context of sharia-compliant banking services, trust is valued by customers in three ways:
- the quality of the transaction (knowing that a transaction adheres to what is acceptable under Muslim ideals);
- the fidelity of the transaction (guaranteeing the safekeeping/security of a transaction); and
- that a transaction is executed at a competitive cost. Islamic banks recognise that Muslim customers compare the cost of banking against conventional banks cognisant of any premium placed on services simply to practice their beliefs.
Moreover, in the light of the global banking crisis, customers are evaluating a bank’s position in the community.
Consequently, Islamic banks have to take changing customer attitudes into account to combine brand building with product innovation. Since 2003, Islamic banks have introduced more banking products and services tailored specifically for women, such as Emirates Islamic Bank’s Al Reem banking services; small and medium-sized enterprise (SME) financing; and bank cards such as Sharjah Islamic Bank’s Visa credit, debit and prepaid cards.
Previously, Islamic banks focused their attention on the upper half of the economic earners within a nation. Now there is a movement toward engaging the lower half of the economy with products designed for the broader consumer base. These include Abu Dhabi Islamic Bank’s ‘123’ mobile banking partnership with mobile phone operator Etisalat, and new service offerings designed to engage the unbanked Muslim populations, such as Noor Islamic Bank’s agreement with Emirates Post Holding Group to provide banking services for the UAE’s low-income population.
Demand and optimism
Islamic banks throughout the Gulf are slowly, deliberately and strategically expanding their operations to engage local customers with higher quality services tailored to changing Muslim lifestyles. An example is Noor Islamic Bank’s opening of the Middle East’s first 24/7 branch as well as the proliferation of new branches in 2008 and the announcement of additional branches in 2009 by Qatar National Bank’s Al Islami, Abu Dhabi Islamic Bank, Noor Islamic Bank, Kuwait Finance House (Malaysia) and Ajman Bank.
The rise in demand for sharia-compliant banking is not contained within the Middle East. Absa Islamic Banking (a subsidiary of Barclays) and First National Bank’s Islamic Finance are engaging Muslim populations in South Africa, and Kenya’s Gulf African Bank is providing sharia-compliant products for women, having opened five new branches in eight months. In Mauritius, where 19% of the population is Muslim, Islamic finance is being considered in a new light. Known as a haven for conventional investment funds to administer and domicile, Mauritius is contemplating itself as a centre for Islamic funds. Milan Meetarbhan, chief executive of Mauritius’ Financial Services Commission, says: “We welcome all initiatives that enable us to diversify and add to the range of existing other products.”
Singapore is also vying to become the Islamic international finance centre of the Far East, adding to the competitive rivalry between Dubai, Doha, Manama, Kuwait City, Riyadh and London.
Social financial cohesion
As Islamic finance spreads across the globe, it emphasises the need for banking institutions to provide social financial cohesion. As the financial crisis continues to unfold during 2009, Western societies will learn a valuable lesson regarding the role that banks play in a national economy. Islamic financial institutions are rapidly assessing their role as financial intermediaries in their respective societies as they expand to engage additional economic segments of society.
Like their conventional counterparts, Islamic financial institutions also face challenges – such as how to improve the quality of corporate governance and the need for greater liquidity in sharia-compliant money markets. Sovereign sukuk and other instruments are necessary to provide a broader base from which Islamic banks can expand their services.
Islamic financial institutions are heralding their success on the degree in which their business models are asset-based rather than debt-based. During the past few years, the combination of factors such as a progressive industry growth, rising asset value and high levels of excess liquidity have created conditions that have not stress-tested Islamic financial institutions’ business models.
At a recent Islamic finance conference, the governor of the Central Bank of Bahrain, His Excellency Rasheed Mohammed Al Maraj, said: “We need to remember that a business model which looks robust in conditions of rising asset values and abundant liquidity may not be so when the economic environment changes.”
Islamic financial institutions are therefore revising their business models, seeking more diverse income streams and honing their ability to manage risk.
On the horizon
Experimentation, innovation, branch openings, lifestyle products and services tailored to specific market segments are financial codewords for growth. Although some Islamic banks are slowing down the pace of their expansion projects, the fact remains that they are still growing in a constricting global marketplace, proving there is truth in the Arab proverb “every delay has its blessings”.
Even mature financial markets such as London have witnessed the formation of new Islamic financial institutions such as Europe Arab Bank, Gatehouse Financial, Bank of London and the Middle East, European Islamic Investment Bank and European Finance House. Each of these brings a higher degree of specialisation and greater depth to the conventional markets as alternative forms of financing for Muslims and non-Muslims alike.
This year offers a host of opportunities for Islamic financial institutions to grow along three distinctly different dimensions by expanding their operations to new geographies, creating a new generation of sharia-compliant products that reflect the changing Muslim lifestyles, and engaging people at the bottom of the economic pyramid.
Joseph DiVanna is managing director of consultant Maris Strategies, and a frequent contributor to The Banker.
