The reputation for conservatism among Islamic financial institutions does not extend to the world of digital banking, where many of its leading players are showing an innovative streak that matches anything coming out of their conventional peers.

In recent years, double-digit profit and asset growth have become the norm for many Islamic financial institutions. This blistering trajectory is partly the consequence of the industry’s relative youth. But it also reflects the massive and largely untapped demand for sharia-compliant financial services around the world. With the most populous Muslim majority countries remaining underserved by bank and non-bank financial institutions, there is still some way to go before the industry achieves any real sense of maturity. 

The whole digitisation drive for Hong Leong is done by the Islamic unit. It hasn’t been done in Malaysia like that before – Raja Teh

To get there, Islamic financial institutions are increasingly turning to digital innovations. The recent appearance of a new wave of digital pioneers is an encouraging testament to this market trend, one that is beginning to reshape the way in which Islamic finance is evolving. As most sharia-compliant institutions are relatively young, they have a unique opportunity to harness and benefit from digital innovation in a way that more established conventional players do not.

Out of necessity? 

In many ways, such a strategy might be necessary. For one, the growth of the Islamic finance sector is beginning a gradual convergence in performance terms with its conventional counterpart. As this convergence narrows the performance gap, sharia-compliant lenders in particular will be forced to look for innovative new ways to maintain their competitive edge. Perhaps more importantly, a new range of non-bank challengers are also coming to the fore, adding further pressure to an already crowded market. 

In addition, the large and underserved Muslim majority markets of emerging economies such as Indonesia, south Asia and east Africa are unlikely to be best engaged through traditional banking or financial channels. These young and dynamic populations are emerging as part of a new, global generation of digital natives. Harnessing their potential will demand digital innovation and new approaches to financial inclusion. 

Until very recently, however, progress on the digital innovation front has been slow. In the case of Islamic banks, standalone entities have largely mirrored the efforts of their conventional peers. Meanwhile, sharia-compliant windows are often subject to their parent entity’s digital innovation efforts, leaving little room for independent development. 

“It will take time for the Islamic finance sector to truly digitise, though we are moving in the right direction. It’s an area that we have to stay competitive in, otherwise the gap with our conventional peers will grow too large,” says Adhha Abdullah, CEO of Standard Chartered Saadiq.

Digital pioneers 

Encouragingly, Islamic leaders in the area of digital finance are emerging. From Malaysia to the Gulf and beyond, these institutions are rethinking, as well as reshaping, the contemporary Islamic finance marketplace. In doing so, they are shrugging off old conceptions of the Islamic finance model by actively highlighting its innovative nature. 

“The reasons why you see Islamic banks struggling to drive the digital innovation agenda is in part due to their conservative leadership. In terms of the sharia-compliant component there is no conflict at all with innovation. To the contrary, look at Islamic civilisation 1400 years ago – [innovation] was what it was all about,” says Raja Teh, chief executive of Malaysia’s Hong Leong Islamic bank. 

Hong Leong Islamic Bank is a case in point of an innovative Islamic finance institution. As the Islamic unit of Hong Leong Bank, Malaysia’s fifth largest lender by total assets, it has been given responsibility to drive the entire group’s digital innovation efforts. Recognising that it did not have the financial muscle to compete with existing players through branch expansion, Hong Leong Islamic secured the support of its stakeholders to push ahead with ambitious plans for digital innovation and outreach. 

“The whole digitisation drive for Hong Leong is done by the Islamic unit. It hasn’t been done in Malaysia like that before,” says Ms Teh. “For the bank to grow it is absolutely crucial that we find innovative channels to spread our products and services. We decided that the most efficient method was through digital channels – and I started focusing on those two years ago.” 

Since then, progress has been swift. In the area of mobile payments, Hong Leong Islamic has introduced a new system known as PEx, or Payment Express, which enables customers to send money using their mobile phones. The recipient does not need to be a Hong Leong Islamic bank customer and no intra-user account details are required. If the figure being sent is a round sum it can be collected at an ATM, otherwise users can visit a website to transfer the funds to their account. 

According to Ms Teh, the big winners from this development have been Malaysia’s small and medium-sized enterprises (SMEs), particularly those who lack access to traditional payments methods. The success of this system has led to the roll out of PEx+, which permits consumers to pay merchants through their mobiles. For smaller merchants, who find the expense of card terminals prohibitive, all that is required is to download an app to their existing smartphone or tablet to facilitate a transaction. 

A hive of activity 

These types of innovations clearly have benefits for the lender. More significantly, the implications for financial inclusion are also sizeable. But looking to the longer term digital innovation arms race, these kinds of developments will be vital. “As loan margins compressed, I noticed that the profitable side of the banking business was being disrupted by telcos and other non-traditional players. It was clear to me that Islamic banks were being left behind by these non-bank challengers,” says Ms Teh. 

Nowhere is the presence of non-bank Islamic financial institutions being felt more keenly than in the United Arab Emirates. The creation of companies such as Beehive, a peer-to-peer (P2P) lender offering both conventional and sharia-compliant financing opportunities to SMEs across the Middle East and beyond, is indicative of the country’s vibrant and innovative digital financial sector. 

Following its launch in November 2014, Beehive became the world’s first P2P platform to independently confirm that its processes are compliant with sharia principles. “[We wanted] to adapt the conventional model of P2P and make it fit for purpose in the emerging markets of the Middle East and beyond – which have majority Muslim populations,” says Paul Boots, chief operating officer of Beehive. 

"[In addition], we wanted to help SMEs connect with the very liquid and fast-growing Islamic finance industry and to allow Islamic investors to take advantage of the opportunities this emerging P2P industry has to offer.” 

Beehive has witnessed growth of about Dh12m ($3.27m)-worth of sharia-compliant investments since April 2015. Yet, its path to becoming the first P2P platform to offer sharia-compliant financing was far from easy. Determining an appropriate sharia structure (ultimately settling on murabaha), as well as finding the requisite expertise to implement this system, were the first hurdles. 

Beehive also had to develop a system that could distinguish both conventional and sharia-compliant businesses, create an enforceable sharia-compliant legal framework, and obtain independent sharia certification. While these challenges were considerable, they are commensurate with the role that new players such as Beehive are playing in the industry’s development.

Leading the pack 

By helping to tap into new markets and add much needed depth to the existing pool of sharia-compliant investors, groups such as Beehive can drive the industry forwards in a way that typical financial institutions cannot. “Islamic investors around the world are demanding financial products that carry a greater ethical component and distributed risk, compared with conventional financial instruments. While there is a huge appetite for Islamic finance products around the world, investors do not have many options outside of property,” says Mr Boots. 

These innovations, and others, will be vital if the Islamic finance industry is to meet the twin demands of greater financial inclusion and commercial competitiveness. As the process of convergence with conventional financial players continues, a bolder approach from some of the larger sharia-compliant institutions would be a welcome change. “The landscape is shifting and if we don’t innovate we will perish. Many bankers are still very much dinosaurs in their own age,” says Ms Teh. 


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