Trends in Islamic Banking

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The World Islamic Banking Conference will be held in Bahrain this month to tackle pressing issues on Islamic finance. Gulf Insider takes a look at the opportunities and challenges of this niche sector.

Islamic banking is banking activity that is consistent with the principles of shariah (Islamic) law, and its practical application.

Shariah laws prohibit the acceptance of specific interests or fees for loans of money (riba), whether the interest is fixed or floating. Islamic law deems this unfair because the borrower has to work harder to return not just the principal loan, but also the interest or mark-up levied on the amount. Investment in goods or services that are considered contrary to Islamic principles such as pork and alcohol is also haraam (sinful and prohibited). Financial transactions in Islamic banks must be supported by underlying “halal” transactions.

The first modern commercial Islamic bank, Dubai Islamic Bank, was established in 1979. After that, there has been considerable growth in the Islamic finance industry. Now existing in more than 50 countries, it is estimated to be worth around $1 trillion and has the potential to eventually be worth $5 trillion in the next three years, according to international credit ratings agency, Moody’s.

A Difference in Approach

Financial justice is the main principle of the Islamic model. Islamic banking creates a balance for the net profit or loss between the lender and the beneficiary rather than throw it all on the entrepreneur. If a project is financed by the Islamic bank, the output of the project will be equally distributed amongst both parties. If the financier is expecting to receive profits for a certain project, he should also agree to carry a share of the loss.

Islamic finance has other important advantages over conventional financial products. Its prohibition of interest and its approach to profit- and loss-sharing, add stability to the financial sector. This way of doing business can enhance financial inclusion, as it incorporates people who, for cultural or religious reasons, are excluded from the traditional financial system (

Another noticeably different approach that Islamic banking takes is its cautious approach to investments. Companies who appear risky are usually kept away from financial institutes. The Academy for Modern Institute Studies (AIMS) believes this is the reason why during the global 2008 financial crisis, the Islamic financial institutes remained untouched. Because of careful auditing and analysis, Islamic financial institutes lessen the occurrence of risk and enhances financial stability.

Financial Service

In the Vatican newspaper Observattore Romano, an article appeared that extolled the virtues of Islamic finance. “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service”, Observattore Romano said. This is in light of the fact that the Catholic Church forbids usury but began to relax its ban on all interest in the 16th century thus allowing modern banks to charge for interest.

Another article published by the World Economic Forum claims that if Islamic finance is used to its full potential, it could play an important role in helping OIC (Organization of Islamic Cooperation) countries meet their development goals.

Taking note of the demand, a number of western countries have recently started allowing Islamic banks to operate in their respective jurisdictions. The UK became the first leading western country to issue a government Sukuk (Islamic bond.) The first full-fledged Islamic bank in Germany was launched earlier this year; while Japanese regulators are considering issuing regulations that will allow Japanese banks to provide Islamic finance products in Japan. In addition, the People’s Republic of China has recently declared its interest to join the industry as a bid to strengthen its ties with Muslim countries (Ernst and Young).

Huge Potential meets Huge Challenges

Abdulaziz Al Sowailim, Chairman and CEO of Ernst and Young (EY), MENA Region said “In the GCC, falling oil prices, jobs-for-nationals and the economic diversification drive is set to transform the role of financial institutions in the region”. Robert Aboud, Financial Services Advisory Leader for EY MENA adds “Saudi Arabia, Qatar, Kuwait and Bahrain are seeing Islamic banks capturing market share by outgrowing their traditional peers”.

However, despite substantial growth in recent years, Islamic banking is facing challenges when it comes to deeper global market penetration. Despite the increased interest, Islamic banking penetration in non-Muslim countries has been slow as Islamic banks find it difficult to expand into different jurisdictions and face regulatory and Shari’a complications in terms of approvals.

Islamic banks are essentially governed by their Sharia boards, the religious scholars that deem a product Sharia compliant. But the challenge is that there is no central authority promulgating Sharia law, and the understanding of what is permissible and what is not varies among Islamic scholars and jurisdictions according to Bavin Shah (Forensic Director) and Saad Qureshi (Forensic Manager), authors of “The Challenges facing Islamic Banking”.

Finally, there is also the challenge of industry infrastructure, talent development, advocacy, applied research, regulations, capital markets, product design, accounting and rating amongst others. Al Sowailim says “The present infrastructure is not fit to support the exciting journey ahead. This requires immediate attention, funding and political will to make it happen”.

Sustaining Growth in the Industry

Emir Hidayat believes that in order to sustain the significant growth of the Islamic finance industry, the development of human capital is key (Islamic Finance News). In addition, business and market innovation can be a key differentiator to capture new business opportunities and sustain growth in this industry (Deloitte).

In an article for Global Finance, Stubing (2016) said that shariah-compliant financial institutions have fully recognized the critical importance of service enhancements and technological advances. Innovation, whether in products or processes, is a crucial differentiator in a market in which Islamic institutions compete with conventional banks as well as each other. The increasing use of mobile banking and apps, for instance is helping Islamic institutions widen their reach to markets and customers that were previously unbanked or underserviced.  In some countries this is helping to diversify and boost opportunities and wealth creation.

Abu Dhabi Islamic Bank, for example, has developed a digital studio in collaboration with IBM. The studio aims to support the digital innovation projects across the bank, including mobile-banking iOS apps that allow for a more dynamic customer experience.

Technology that Delights

EY, in their World Islamic Banking Competitiveness Report 2016 claims that “the future of retail banking in the GCC is a smartphone that delights”. However, they also cautioned that not every technology will be right for the GCC, and urged banks to “place your bets wisely”.

This “digital shift” in banking is also a “cultural shift” according to EY. If Islamic banks are to win over the market, they have to collaborate. EY’s note to banks “Challenge yourself to co-create digital solutions”.

*The World Islamic Banking Conference 2016, which will be held at Art Rotana Amwaj Bahrain from December 5-7, will address issues in Islamic Banking. This year’s conference theme “Economic Uncertainties: Vigilance and Growth” reflects the fact that global economy finds itself at an important inflection point.

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