IT in Islamic Banking – A Comparative Analysis

By Rosie Kmeid | 23 April 2014

Islamic banking is gaining momentum in traditional as well as in non-traditional markets and the industry is likely to maintain the current trajectory in foreseeable future. In many regions, Islamic banking has evolved from being an emerging ethical niche market into being part of the mainstream financial services landscape.

According to a 2012 survey by The Banker, there are more than 716 institutions across the world that are registered as Sharia-compliant. Of these, 511 are fully fledged and 205 operate Sharia-compliant windows within a conventional institution or are partially separated from their conventional counterpart.

While Islamic banks have managed to maintain good revenue levels over recent years, mostly due to a strong focus on retail banking, they have struggled with profitability due to rising costs and operational inefficiencies.

A recent analysis by Ernst & Young indicates that Islamic banks have experienced a decline in profitability and their average return on equity (ROE) lags behind that of conventional banks by 20%. ROE for both Islamic and conventional banks has deteriorated since 2008 in the wake of the financial crisis, but this has dropped to 12% in 2011 for Islamic banks, compared with 15% for conventional banks. The return on assets (ROA) for Islamic banks dropped to 1.3% in 2011 from 1.7% in 2008, while it has risen for conventional banks to 1.7% in 2011 from 1.5% in 2008.

 

Struggling for profitability

According to ‘The Future of Islamic Banking’ report by AT Kearney, there are a number of factors that contribute towards this struggle for profitability; Achieving operational efficiency is a major problem. A more sophisticated leveraging of the Islamic banking potential - much of whose potential has not yet been exploited - is required.

E&Y’s report states that operating expenses are 50% higher for Islamic banks. The report shows that wide-ranging transformation programmes could potentially increase the profit pool of Islamic banks by 25% by 2015. The effective use of modern, flexible technology is key to achieve this.

To compete successfully in an industry known for its IT aptitude, Islamic banks are expected to make appropriate investments in best-in-class core banking software systems with components covering business process modeling, compliance and risk management tools, and multi-channel delivery gateways that would enhance banks’ profitability, performance and ability to innovate.

Technology developments are profoundly influencing the distribution of retail financial services. Day after day, reformatted branches and alternative channels such as online banking, mobile banking and social media are gaining widespread adoption.

 

Winning in a highly promising industry

In an attempt to meet the demands of a growing Islamic financial sector, the industry needs to effectively implement conventional banks’ use of modern day technology. According to Muath Mubarak, Head of Finance & Corporate Strategy at First Global Academy “the emerging and niche Islamic finance market has to stay highly technology driven in order to maintain a competitive edge over others and deliver fast and quality customer service within Sharia parameters”.

“Advanced technology will reduce cost significantly, as well as manual workload, inefficiencies, transaction processing time and so on while enhancing customer satisfaction with sophisticated facilities”, he says.

In a recent financial services survey conducted jointly by the CBI and PwC, the authors noted that technology can play a huge role in helping any organisation to transform and modernise itself.

The quest for operational efficiency and cost reduction becomes a key focal point for Islamic banks worldwide. Indeed, in line with the trend IDC Financial Insights spoke about Islamic banks’ willingness to capitalise on technology innovations and adopt cutting-edge software to improve business agility and remain competitive, and to ensure proper risk management and regulatory compliance.

Financial experts believe that the latest technological developments if incorporated into Islamic banking, the latter will be able to provide the convenience offered by conventional banking.

Example, the development of Internet and mobile banking which proved to be a dramatic shift in the way people conduct their banking needs in the conventional banking system. Thus, Islamic banks will have to incorporate these ideas into their product portfolio to attract additional interest in the system and to offer convenience to the various customers.

An interesting finding of E&Y’s ‘Time for bold action’ survey and one that may deserve further study is that as banking becomes more reliant on technology, the implications of failure are magnified. E&Y explains that tinkering with existing systems or merging multiple legacy platforms will not satisfy increasingly vigilant regulators, and that approach is not likely to deliver what the financial institution needs. The multitude of new regulations is already placing considerable stress on banks’ data and reporting platforms.

The Basel Committee’s recent guidance on data aggregation and reporting will require conventional and Islamic banks to fundamentally upgrade their capabilities in this area by early 2016.

While the competitive financial landscape is being redrawn by the evolving international regulatory reforms, financial innovation continues at breathtaking pace. With much achievement behind it, the industry is now looking forward to a crucial and challenging stage in its development. Making sure that new technology is flexible enough to support more sophisticated requests from regulators will benefit the bank and its customers.

 

Sharia compliance, IT modernization and product innovation top the industry’s priority list

Growth over the past several years continues to generate optimism for the future of Islamic banking. The industry stands out on its own demonstrating remarkable development, expansion, and growing demand. Nonetheless, financial institutions are facing vastly different market conditions and need to develop new sources of differentiation to compete and remain successful in the long run. Indeed, as a new industry predicated on originality and creativity, it must explore potential sources of differentiation for sustained competitive advantage. These ambitious yet realistic targets can only be achieved through partnering with a leading Islamic banking software provider with the expertise to help them transform their business quickly, safely and cost effectively.

There are more than 35 global and regional information technology vendors that offer Islamic banking systems and services for the Islamic financial services industry, but there is just one vendor out there that was certified back in 2008 by a global standard-setting body, the AAOIFI, specialized in the provision of comprehensive Sharia-compliant financial applications and services.

The time has come for financial institutions to consider strategic choices and address operational fundamentals and regulatory and Sharia compliance to capture untapped market opportunities and master the changing dynamics of this massive industry that is Islamic banking.

 

By Rosie Kmeid, Global Head, Corporate Communications & Marketing, Path Solutions

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