Hussain Al Qemzi, CEO of Noor Bank, discusses the long-term prospects for the Islamic banking sector, describing the valuable role it can play in promoting greater cross-border co-operation and operational harmonisation.

Q. To what extent has the growing internationalisation of the Islamic finance industry contributed to the success of the sharia-compliant banking sector in the Gulf over the past year?

A. Besides the opening of Islamic banking businesses, or windows, by traditional global conventional banks including Citi, Standard Chartered Bank, Royal Bank of Scotland and DBS Bank, a number of new players in the international sukuk segment have also played a role in the internationalisation of the Islamic finance industry, with Gulf Islamic institutions being the direct beneficiaries. Goldman Sachs issued its debut sukuk, as did South Africa, the UK and Hong Kong this year.

While the UK’s sukuk seeks to position London as the Western hub of Islamic finance, Hong Kong’s sukuk listing on Nasdaq Dubai underscores Dubai’s position as the centre of the global Islamic economy.

Overall, global sales of sukuk have surged 39% this year to $33bn, with 24 dollar-denominated sukuk issuances reaching $16.4bn in 2014 year to date [as of mid-September], compared with $11bn for the same period last year. Such numbers reinforce the growing significance of sharia-compliant banking within the global financial industry.

This internationalisation has successfully helped the Gulf-based sharia-compliant banks to increase their reach to international markets and prove themselves as integral players of the global Islamic finance economy. In this regard, regional banks have already started establishing international offices to tap the internationalisation of the Islamic market and remain ahead of the curve.

Q. To what degree are Islamic banks meeting the challenges of digital innovation?

A. Digital innovation is still relatively new to the [Gulf] region. For more than a decade, digital services were focused on internet banking. More recently, with the rapid adoption of smart devices, banking-specific applications or ‘apps’ have been released by banks for their clients to use. By and large these are simply smartphone versions of the existing internet banking service and offer nothing really innovative. There has been nothing disruptive released in the market that would cause the consumer to change their behaviour, or gravitate towards a particular brand. Generally speaking, practically all of the features beyond existing internet banking services can be viewed as marketing gimmicks as opposed to real value-added services to the consumer.

When comparing conventional banks to Islamic banks, Islamic banks definitely lag behind. While some have yet to even release an app, those that have are simply replicating the internet banking services on to smart devices.

The opportunity, however, grows with each innovation that leverages off smart devices. Data is now readily available to determine consumer behaviour, trends and preferences. This, however, has primarily been used to attract potential new customers instead of enhancing the experience of existing customers, ie originations instead of transaction. This is where, in my view, the real opportunity lies.

Banks are swimming in transaction data, all of which can be mined to develop value-added services along existing customer journeys. While this won’t directly attract new customers, it will increase customer stickiness. And, the longer a customer stays with a brand, the greater the opportunities to cross-sell. This means banks need to put short-term onboarding of customers on the backburner, and pay greater attention to enhancing value for existing customers.

Q. What impact will the implementation of Basel III regulations have on the Islamic banking sector? What are the challenges associated with maintaining sharia compliance while boosting levels of liquidity and capitalisation?

A. The primary objective of Basel III is to ensure consistency of regulatory standards across countries and standardise the required deductions and adjustments. The revision of the capital definition, to increase reliance on common equity, will have a limited impact on Islamic banks such as Noor Bank, as the major component of capital is already based on common equity.

The majority of Islamic banks have maintained high capital adequacy levels as compared to the regulatory minimum. The average capital adequacy ratio of the United Arab Emirates' Islamic banks stands at 19.3%. In addition, Islamic banks require lower capital as compared with their conventional counterparts as their business model forbids derivatives and short selling, except for balance sheet hedging purposes. Over the past two years, several of the UAE-based Islamic banks have raised Tier 1 sukuk, which qualifies as additional Tier 1 capital under Basel III. More such issuances are likely from the Islamic banks to boost the capital adequacy ratio.

However, Basel III liquidity requirements will affect Islamic banks for two reasons. The first is the lack of Islamic money market instruments and the second is a lack of liquid Islamic investment instruments with short-term maturities.

Q. What steps can be taken to improve synergies between sharia-compliant debt and capital markets, and the Islamic banking sector globally?

A. Synergies can further be enhanced by undertaking various steps, including placing an emphasis on the cross-border orientation of the Islamic banking sector, especially in relatively unexplored markets, promoting consistency of rules and regulations and various standards across markets, thereby providing clarity and improving market access for potential investors globally, and undertaking responsible innovation to further broaden the limited options of Islamic instruments and structures available to investors.

The deepening of capital markets will play a significant role in helping Islamic banks grow and become regional and international players. Unlike their conventional counterparts, who have a variety of options and can invest and borrow from multiple sources, Islamic banks have a restricted list of instruments to tap and invest in. In the UAE, Islamic banks, with a combined market share of less than 18%, raised more than 70% of the Tier 1 perpetual funding issued in the country in the past 24 months – much more than their conventional counterparts. It demonstrates that a deepening of Islamic capital market liquidity is strategically important for Islamic banks.

Furthermore, the narrowing gap between sukuk and conventional bond yields is also prompting international issuers such as General Electric, International Finance Corporation [IMC] and Goldman Sachs, among others, to tap Islamic liquidity in an effort to diversify the investor base. This, in turn, will help the region’s Islamic banks to grow their balance sheets.

Q. What role can the sharia-compliant private sector play in nurturing greater cross-border co-operation and operational harmonisation within the industry today?

A: Consistency and co-operation across national boundaries is something that we aspire to. As an industry, Islamic finance is relatively young and sometimes we can be hard on ourselves in terms of our sense of achievement in this regard.

Even when you consider something such as the application of Basel III regulations across borders you cannot claim to have global consistency. So ‘one-size-fits-all’ is a lofty aspiration, especially when countries and regions are at different levels of development.

Nevertheless, the sharia-compliant private sector can play a meaningful role in harmonisation. At one level, it can get behind organisations such as the International Islamic Financial Market and support their efforts to standardise interbank documentation and transaction structures.

At a regulatory level, banks and other financial institutions can champion the products that best serve the customer and drive changes through the necessary authorities. In a regulatory sense, momentum will be easier to achieve if the desired change serves the customers’ interests and makes the banking system more efficient and effective.

Q. What are the key challenges facing the development of the Islamic finance industry over the next year?

A. According to Standard & Poor's report released in early October, the Gulf Co-operation Council's [GCC's] Islamic banks have continued to increase their market share and their growth is expected to converge with the conventional peers over the next decade.

Even as Islamic finance globally continues to experience double-digit growth, it is still a niche offering in comparison to the conventional banking system. There is not an Islamic bank with the scale or liquidity and assets that would enable it to compete on its own with the biggest conventional banks. This makes it very difficult for the Islamic banks to compete for cross-border business.

That is why, at Noor Bank, we have a strategy of co-operating with other banks, rather than always competing with them. In that way, we can create the scale necessary to win business that would otherwise have gone to the large conventional banks.

Domestically throughout the GCC, Islamic banks have both a challenge and an opportunity, when it comes to providing funding to small and medium-sized enterprises [SMEs], which are significant contributors to countries’ economies. Islamic banks are inherently conservative when it comes to risk and as a consequence, according to the IFC, about 35% of regional SMEs find themselves outside the formal banking sector because they do not have access to sharia-compliant finance solutions. The IFC also pointed to an almost $13.2bn potential gap in SME Islamic financing in the region.

As an industry, we need to address the issue of access to capital to address the gap between the potential and existing Islamic finance market.

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