Amid calls for greater reporting transparency and more engagement with the lower end of the economic pyramid, Islamic finance is experiencing a revival. But for sharia-compliant institutions to take advantage of the trends emerging in the marketplace, several key events need to take place.

As the global economy continues to evolve in the second decade of the 21st century, world events are providing an opportunity to evaluate the underlying value proposition of the Islamic finance industry and the trends that are reshaping what banks are offering customers. During the past five years, Islamic finance has undergone a rebirth. Now, the industry is experiencing a redefinition of what banks are offering customers in various markets.

Regulators and other government and independent agencies are calling for greater reporting transparency, higher quality regulatory practices, and greater engagement with the lower half of the economic pyramid. Islamic finance is slowly maturing at different rates in various countries and even within countries; its adoption by customer segments is mixed. Hence, Islamic finance is an industry on the move. Even though there are more providers of sharia-compliant services than ever before, it appears that the underlying value proposition is not keeping pace with the industry’s transformation.

Finding value

A value proposition is the perception a customer has of the benefit or utility they will get from purchasing a bank's products or services. Financial institutions attempt to provide customers with a clear statement of the benefits, such as savings rate, return on investment or lower cost of services.

It could be argued that the lack of a clear value proposition has limited the use of Islamic finance by Muslims and non-Muslims alike. In the early years of Islamic finance the value proposition was simple – no interest (riba) and no activities with items that were prohibited (haram). Customers of Islamic finance realised that to practice their faith they would incur a higher cost of services and fees, which the industry labelled 'the faith penalty'.

Even with higher operating costs, the industry grew due to three key factors: the conventional banking markets were plunged into unprecedented volatility; the US Patriot Act discouraged global investors, pushing them away from Wall Street; and the vast majority of Muslims worldwide had little or no access to banking products that were in line with their beliefs. The growth agenda for most banks was to market their simple value proposition to unserved customers and reap the results. This strategy worked for numerous existing banks and start-up banks because customers were eager to comply with their religious convictions.

The growth agenda for most banks was to market their simple value proposition to unserved customers and reap the results. This strategy worked for numerous existing banks and start-up banks because customers were eager to comply with their religious convictions

With popularity comes competition, and conventional banks quickly set up sharia-compliant operations that became known as Islamic windows. During this time, investors in the Middle East and north Africa region and Malaysia re-evaluated the disclosure condition in the US Patriot Act, deciding to redirect their investments into domestic markets. The surge of liquidity (primarily from Gulf Co-operation Council countries) acted as a catalyst for Islamic finance and the industry has maintained an 18% compound annual growth rate in spite of the global financial crisis.

Tougher competition

As the industry’s capacity increased, a new era of competition emerged where banks began offering similar products with new names wrapped in new brand identities. On average, Muslims in many countries understand the general concept of sharia-compliant financial services but few understand how it works and how products are constructed. Most Muslims are not familiar with what types of sharia-compliant banking products can or should be used with their lifestyle, investment appetite or financing needs. Thus, the expansion of the market has been at the same time good and bad for customers, in that at present they have more choices, but know less about what to choose.

The sudden expansion of the market with many new institutions and conventional banks getting into the competition created confusion in the minds of customers, who started to question whether their money was really kept separate from money not invested according to sharia principles from conventional funds. While the industry has arguably not been affected by this perception, it still poses a threat to an Islamic finance value proposition.

A second aspect of the customer confusion emerged as institutions began offering their product and service across international borders. Customers then realised that perhaps compliance to sharia principles is not universally applied, since individual scholars interpret Islamic concepts in their own particular ways. Thus began a movement for clearly defined Islamic banking standard practices and the harmonisation of sharia interpretations. Market confusion was replaced with a regulatory response, for example, in February 2011, as the Qatar Central Bank (QCB) declared that conventional banks must cease their Islamic windows before 2012. The reason for QCB’s actions was to delineate clearly the activities in the sector to enable a systematic framework of liquidity management and improve efficiency of open market operations. Providing clarity in the marketplace for customers is the net result.

In Qatar, customers will understand clearly which banks are practising sharia-compliance. If the industry is to preempt other central banks from taking this step, all banks offering Islamic finance must develop clear value propositions so customers know exactly what sharia compliance means in the context of their banking and investments.

Value proposition definition

So what is a value proposition? Put simply, a value proposition differentiates a bank’s products and services from competitors’ offerings by highlighting things it can do better for a customer. These include, for example, higher quality of service, more convenient hours, technological availability or higher profit rates in the context of Islamic banks. A bank's value proposition must create interest in its product or services in a way that prospective customers want to learn more and ask questions. Most importantly, a bank’s value proposition should align its operations more closely with customer needs by focusing on the customers’ point of view. Finally, a value proposition has to communicate a demonstrated result or clear benefit that will catch the attention of customers.

Customers of Islamic finance are increasingly becoming more sophisticated, and demanding a greater array of customised products

The new value proposition for Islamic finance today moves far beyond simple compliance to sharia principles, and boldly steps into a new dimension of competition on a global scale. The first aspect of the value proposition is a clear description of sharia compliance. A large part of this topic is why a product is compliant, and how does it demonstrate that fact. But it also goes beyond that. When banks declare a product riba (interest) free, ghara (uncertainty) free, maysir (winner takes all) free and free from the financing of unethical activities, customers want to know how they can ensure the status of their product offerings.

As customers read more about the financial crisis in conventional markets, they want to be assured that sharia-compliant financial instruments are based on trading in assets rather than debts. In addition to this, customers want to understand who is on the sharia board, and whether the bank’s sharia scholars share the same values. To develop this aspect of their value propositions, banks need to communicate proactively with customers on how products are structured and why. Investments and financing mechanism must be made clear as to what, how and why they are designed, developed and implemented, and hence sold to customers. Educating customers creates the understanding needed to realise the value of the product to the customer.

Customers of Islamic finance are increasingly becoming more sophisticated, and demanding a greater array of customised products. For the most part, all Islamic finance products look alike to customers, or seem to be slight variations of basic products that are available in all banking systems. To customers looking for services, from bank to bank, products look almost identical apart from the varied ways they are named in each banking context. Customers have come to realise that most Islamic banking products simply try to mimic conventional banking products and services. And often, customers are right; such packaging is what many banks have done since the hype for Islamic banking began over the past few years.

Maturing market mismatches

The problem is that now there is a mismatch between market maturities. Not all markets have matured at the same rate throughout the world. In maturing markets, Muslim customers are looking to choose smarter products that facilitate their individual lifestyles, while observing their moral and ethical convictions. In developing markets, customers are still content with simply gaining access to sharia-compliant services. Banks – especially large ones with Islamic finance products or windows – should not be content with product offerings that cater for both types of customers.

A further aspect of the value proposition offered by a bank is convenience, points of access, technologies for interaction and perhaps, most of all, access to Islamic finance at any time, anywhere. Islamic finance customers understand they are already paying a premium for their banking, which is reflected in the fees and rates offered by sharia-compliant institutions, so naturally they are now expecting premium services.

The value proposition breakdown

As value proposition is defined, it should not be forgotten that Muslim customers, like their non-Muslim counterparts, are looking for banking services that offer the best value for money. To accomplish this, financial institutions must rethink their operations to lower their operating costs, streamline business processes to be customer-centric, automate the sharia documentation process and invest in educating customer services representatives. A large portion of Islamic banks offer sharia-compliant wealth management products and services, complete facilities to purchase luxury goods, and provisions for contributions to charity (zakat). As Islamic banks move down the socio-economic pyramid, their value proposition must include facilitating the growing Muslim middle class with aspirations of wealth accumulation; banks must provide a path to wealth accumulation and management services as a further aspect of their value proposition.

The value proposition must incorporate customary issues and beliefs that reflect the interpretations of sharia principles in the context of the local community. The interpretive nature of sharia is the real strength behind Islamic finance, in that it enables it to be dynamic and adapt to the communities it serves. Sharia scholars consider numerous factors during the development of financial products and their subsequent audit of compliance. Many of these factors relate to the environment in which the transaction is to take place, the parties involved and the level at which there is a fair and equitable exchange between the parties. Therefore, the value proposition for Islamic finance must contain a dynamic quality to be applicable to many communities across the world.

Estimates indicate that more than 1 billion Muslims have yet to experience sharia-compliant financial services. The vast majority of these potential customers are considered to be in the bottom half of the economic pyramid

Moving down the pyramid

Estimates indicate that more than 1 billion Muslims have yet to experience sharia-compliant financial services. The vast majority of these potential customers are considered to be in the bottom half of the economic pyramid. This does not necessarily translate to people living at the edge of poverty. A large percentage of these people are small businesses, sole proprietors, people with steady employment, migrant workers, casual workers and individuals who earn money to live from day to day. Providing services to urban and rural populations in the emerging markets is costly.

In some countries, the cost distribution for banks offering services is more than 10 times that of their counterparts in industrialised nations. The higher cost of distribution coupled with the higher cost of processing sharia-compliant transactions presents a major challenge for the next decade in the development of Islamic finance. To accomplish a wider distribution base, sharia-compliant banks will need to perform three key strategic initiatives: develop a clear value proposition for each customer market segment, continually assess their internal business process to reduce costs, and invest innovation to reduce the cost of access to all customers.

In order for sharia-compliant institutions to take advantage of the trends emerging in the marketplace for Islamic banking, several key events must occur. First, governments need to create the right environment for Islamic banks to operate and expand their value propositions by advancing their agendas from the talking about Islamic finance, to actually making determined progress toward such issues as the development of comprehensive interbank mechanisms for both domestic and international markets.

Another trend which can perhaps be seen as detrimental to Islamic finance is that governments need to stop talking about issuing sovereign sukuk and actually issue them, to bolster confidence in investors and customers. Governments and regulators have been preoccupied with the financial crisis, which is understandable. However, this comes at the price of slowing down the momentum for growth in Islamic finance. Organisations such as the Accounting and Auditing Organisation for Islamic Financial Institutions, the Islamic Financial Services Board and many others are working diligently to provide the structures and frameworks that will facilitate a new level of quality, consistency and transparency in the marketplace. Accordingly, the next step is to create the stimulus for sharia-compliant institutions to expand their base and try to bring scale to the market. Banks, governments and central banks have all talked the talk; now it is time to walk the walk.

Joseph DiVanna is managing director of Maris Strategies a strategic consultancy for banks and financial services companies

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