How Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey are shaping global Islamic banking

The average return on equity of the 20 leading Islamic banks is currently around the 12 percent level compared to 15 percent for comparable conventional peers, and there still remains no global pure-play Islamic banking leader with a broad or specialised business model of the Citibank or Goldman Sachs ilk. Having said this, according to Standard & Poor’s (S&P’s) and Ernst & Young’s (EY’s) World Islamic Banking Competiveness Report 2013-14, the six-nation QISMUT are at the forefront of the Islamic banking industry’s development currently, and are expected to continue to lead the way in its future internationalisation, together with Bahrain from the regulatory side.

“QISMUT holds a disproportionately large amount of the industry’s financial and intellectual capital,” says Ashar Nizam, executive director and Islamic financial services leader at EY, in Bahrain, “and this finds resonance in the fact [that] two thirds of the world’s 38 million or so Islamic banking customers reside in the region.”

Within this group, Qatar’s overall banking sector has grown around 16 percent over the last five years, with Islamic banks holding around USD55 billion (QAR200.2 billion) in assets and expected to sustain a 20 percent plus growth trajectory over the medium term (according to EY).

Specifically in Qatar’s case, this is likely to be bolstered by ongoing high demand for corporate credit with investment in infrastructure remaining at exceptionally elevated levels ahead of the 2022 World Cup. Moreover, Khalid Howladar, senior EMEA analyst for Moody’s, in Dubai, tells The Edge, Qatar also has an advantage in this banking sector over its Gulf Co-operation Council (GCC) neighbours in that, “It has been the most direct in its support of the sector by forcing conventional banks to divest their Islamic operations, and it is also a volume issuer in the sukuk market which also helps the Islamic banks.”

Indeed, and as echoed in the marketing angles of many of Qatar’s foremost Islamic banks, there has been an especially-stressed demarcation between shari’ah-compliant and conventional ‘Western’ banking since December 2011. Since then, in line with the outstanding success of Malaysia’s Islamic banking and sukuk industry,  Qatar’s commercial banks were required to transfer accounts from their Islamic divisions into a portfolio to be held by the central bank until they matured. “These will be carried in a portfolio, outside the activity of their business,” underlined Qatar Central Bank Governor, Sheikh Abdullah bin Saud Al Thani, at the time “as we are not in the business of mixing the Islamic with the non-Islamic.”

This followed a central bank directive in February of that year to stop commercial lenders from taking new Islamic deposits immediately, and shutting Islamic branches by year-end on concern they may be using funds from the conventional bank for Islamic loans. As a consequence of this, Paris-based Mohamed Damak, global head of Islamic finance, S&P, tells The Edge. “Profit figure-wise, Islamic banks in Qatar compete rather well with their conventional peers, with their main edge being the ability to offer products that are compliant with clients’ beliefs, which conventional banks in Qatar can no longer do.” He adds. “We understand that a portion of the government sponsored projects is to be financed by Islamic financial products alone, and the combination of these two factors means that Islamic banks in Qatar tend to evolve in a relatively protected environment.” So much so, he adds, that S&P estimates the market share of Islamic banks in Qatar grew to 16 percent in 2013, from 13 percent in 2010.

One set of rules

Of course, in order to stress the ethical investment side of Islamic banking in marketing campaigns there needs to be a coherent, singular set of rules, and establishing these has been an ongoing problem for shari’ah finance in general. In this context, says Khairul Nizam, assistant secretary general of the Accounting Auditing Organisation for Islamic Financial Institutions (AAOIFI), in Bahrain, there is nothing per se to preclude the ultimate financial results or effects of a shari’ah-compliant banking product being exactly the same as those of a conventional one. “The key consideration in this respect,” he adds, “is that although the financial effects of, say, an Ijara contract, may be identical as those of conventional leasing, mortgage or loans, whether it is shari’ah-compliant or not depends on how such a product is structured.”

A key point in terms of the psychology of the business approach (or, some might say, morality), is that an Islamic banking or financial product which may be structurally similar to the speculative instruments in Western banking must, by definition, still be based on the concept of partnership which involves equal share of risk and reward.

In this vein, one of the most recent coherent examples of delivering a single shari’ah-focused message, though, is to be found in Oman, which is the only Gulf Cooperation Council (GCC)  country that had not allowed Islamic banking until 2012. In this context, the Central Bank of Oman developed a comprehensive 600-page regulations guide within the space of six months, and drew input from authoritative sources, highlights Nazim. For example, the existing conventional banking framework was based on Omani Banking Law and Basel guidelines (where they do not contradict shari’ah principles). Moreover, the AAOIFI’s shari’ah, governing, and accounting standards were adopted, together with the Islamic Financial Services Board’s guidelines on capital adequacy and risk management.

Providing a clear vision of a shari’ah-focused banking strategy should also have a dramatic knock-on effect on the profits of Islamic banks in Qatar, and elsewhere, going forward, even so far as closing the profitability gap between them and the conventional banking average.

 Untapped opportunities

According to EY’s Singapore-based Jan Bellens, global emerging markets leader for banking and capital markets, Islamic banks need to focus on three key areas. Firstly, he says, typically they have not tapped into the customer cross-selling opportunities available.

“The average product holding per client of 2.1 in Islamic banking compares to 4.9 products in the established conventional banking sector, which would increase profitability by up to an estimated 50 percent, and a targeted cross-selling programme supported by a productivity toolkit for the frontline bankers and by customer analytics can bring about a dramatic uplift in this number.”

 Indeed, much of the increase in the number of Islamic banking clients – to a projected 70 million plus by 2018 – is likely to come from the retail side based on segmentation and cross-selling, according to Bellens, especially through leveraging low-cost, long-term zakat (taxation arrangements), waqf (religious endowments), and government funds to diversify to the mass market and small businesses. “The broader asset strategy would be to pass on funding cost advantage to promote inclusive growth unlike many conventional microfinance models – that invest in under-developed segments to benefit from higher marginal returns,” underlines Bellens.

Secondly, he says, Islamic banks can further enhance their revenue growth by targeting the affluent customers with a segmented value proposition, with a stronger focus on wealth management. To deliver this, though, they need, thirdly, to decide on the segment proposition and its branding, the relationship model, the service model, and efficient infrastructure. “The focus should be on efficiency programmes to address their disadvantaged cost base plus increased service quality, lead-time improvement, and better risk management,” he highlights. “This can be achieved by a tailored ‘lean banking’ programme for end-to-end process improvement, leveraging digital technologies that interface smoothly with legacy systems or avoid their constraints.”

EY concludes that the Islamic banking profit pool across QISMUT will reach at least USD26.4 billion (QAR96.1 billion) by 2018 (48 percent of all banking system profits in the group countries), up from USD9.4 billion (QAR32.22 billion) in 2012, and globally, the Islamic banking profit pool is projected to reach USD30.5 billion (QAR141.5 billion) by 2018.

Renewed focus

This re-focus on the essence of shari’ah finance is all the more important as the exponential outgrowth that had been seen in the early years of Islamic banking has been waning in key geographic regions, including the Middle East, according to AT Kearney Middle East. Moreover, in line with the findings outlined above, any growth in assets has not necessarily been matched by profitability, with several of the smaller Islamic banks in the GCC in particular having struggled for years in this regard.

The key to challenging the newer and improved post-Basel III conventional banking system in the West, says AT Kearney’s Cyril Garbois in Dubai, comes down to two basic choices for Islamic banking. The first is to more fully exploit the shari’ah-compliant niche, whilst the second is to compete with conventional banks head on.

In terms of the former, he underlines, it is vital to target potential customers who care deeply about shari’ah compliance, as well as offering products and services that meet not only general financing but also Muslim-specific customer needs. In retail banking, target customer segments may include religious conservatives, awqaf employees, or employees of ministries of Islamic affairs. An example of such Muslim-specific retail banking is financing for the pilgrimage to Mecca.

The latter approach, meanwhile, requires identifying customer segments least open to Islamic banking (for exclusion), those with needs not fully met in a shariah-compliant manner to address shortfalls, and those open to ethical banking to tap into a wider audience of both Muslims and non-Muslims.