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Islamic finance has experienced a meteoric rise in popularity when compared to conventional systems, but can stepping into new digital channels help it go that extra mile?

Whether Muslim or non-Muslim, consumers demand a certain level of service from their bank. Digital initiatives have been a driving force across the globe for inclusive, customer-first technology. Where do digital banking and Islamic finance meet? Those looking from the outside might expect that there is little to no innovation, and that Shari’ah compliance is a by-word for conservatism. In fact, a lack of inhibiting legacy infrastructure can make Islamic banks extremely fertile ground for fresh digital initiatives.

From a retail perspective, enrolment in online banking, mobile banking, online bill pay, person-to-person payments and account-to-account transfers are continuously found to have a positive effect on digital engagement, attrition and transactions. A strong digital strategy has also been found to support cross sales; mobile banking customers hold a higher level of products, while ATM and ACH transactions in the three months after mobile banking enrolment also increase exponentially.

A golden resurgence?

Innovation lies at the heart of Islamic finance. The modern cheque – though probably not a great analogy for digital change – was originally based on an Arabic instrument, namely a written vow to pay for goods on delivery. During the Islamic Golden Age, a businessman could cash a cheque in China drawn up by his bank manager in Baghdad. Arguably, the first modern experiment with Islamic banking occurred in Egypt in 1963, with the establishment of a new savings bank based on profit sharing by Ahmad El-Najjaar. Four years after the bank’s foundation in the town of Mit Ghamar, eight more had joined its ranks. The Islamic sector has seen popularity rise in recent times.

Globally, Islamic banking assets were estimated at around 17% in 2015 according to TheCityUK research, a rise of more than 11% from 2006. Islamic funds and sukuk led year-on-year growth with 14% and 11% respectively. Figures from Tufts University show that Islamic banks’ capital has grown from $200 billion in 2000 to close to $3 trillion in 2016.

Yet, the emergence of digital banking as a priority for Islamic banks comes amidst a slowdown in the issuance of Islamic bonds or sukuk. In 2016, Standard & Poor predicted that the global sukuk market will reach around $50 billion or $55 billion in the next year or so, compared with $63.5 billion in 2015 and $116.4 billion in 2014. The research firm reckons that the complexity of sukuk issuance will weigh on market activity.

Islamic finance customers have become more affluent and are taking advantage of tourism, fashion, health and beauty.

They’re also armed with the latest in tech gadgetry. The GCC has a youthful population of almost 60 million. It’s highly mobile and has better access to global media and technology than ever before. According to EY, mobile-banking usage in the UAE stands at 34%, followed by 27% in Kuwait, 19% in Qatar and 15% in Saudi Arabia.

New model payments

Despite this relatively high penetration of smartphones in the GCC, a substantial amount of transactions are still made on desktop computers, ATMs and in bank branches. In its 2016 report, EY found that 38% percent of conventional banking customers used mobile banking, compared with 26% for Islamic- banking customers and 36% for hybrid-banking customers.

According to Accenture, of the more than $50 billion spent on fintech globally, only 1% has come from the Middle East and Africa.

That hasn’t stopped Islamic banks from trying to encourage their mobile-first users. October 2017 saw Mashreq Bank, the oldest privately-owned bank in the UAE, launch a digital banking

subsidiary, Mashreq Neo. The digital subsidiary will provide credit cards, debit cards, current accounts, personal loans, remittances, global stock trading, gold trading, investment and deposits. Users will also be able to perform free cash withdrawals at all of the participating ATMs.

“We have entered a new era in the digitisation of retail banking,” said Abdul Aziz Al Ghurair, CEO of Mashreq Bank, on the rollout.

“Considering Mashreq’s historical strength in the innovation and digital space, we are confident that customers will respond positively and we will see strong adoption of Neo.” Neo’s goal, he added, is to provide “seamless, convenient, secure and cost-effective banking services.” Customers will be able to open an account in “less than five minutes” by downloading the app from either the Apple App Store or the Google Play Store and scanning their Emirates ID.

In spite of macroeconomic and political challenges, there is an untapped source of new business for digital Islamic banks in the underbanked segments of Islamic countries. Digitisation is helping Islamic banks reach these populations and provide them with products that are more aligned with their ethical codes. Asia is also seeing positive developments such as the formation of the ASEAN Economic Community (AEC), and the Indonesian government’s increased determination to support Islamic banking and finance. Cities across the globe are trying to emerge as hubs for financial technology. The same is true for cities in Islamic countries. Cairo, Abu Dhabi, Dubai and Singapore have all started projects to underpin the development of new technologies in areas like payments and blockchain.

Regulatory boundaries

For all the talk of innovation and a need to create value-added services for clients, there are still several hurdles that banks in Islamic finance sector need to overcome. The highly interpretative nature of Shari’ah means that regulations can differ from bank to bank, let alone country to country. Decentralisation is an issue that crops up in almost any conversation with industry commentators, yet some progress is being made even there. The Central Bank of Bahrain recently announced that it would be launching an external audit for all Islamic banks in the country. The audits, which will be performed to certify whether the banks are properly following Shari’ah law, could make Bahrain one of the strictest jurisdictions for Islamic banking. The move is expected to propel the Bahraini capital, Manama, back into the Islamic finance limelight.

Traditionally, Islamic banks use in-house scholars to determine whether their offerings obey Shari’ah law properly. Proponents of this system argue that this allows more flexibility and diversity in the sector. Detractors argue that it is vulnerable to conflicts of interest, as some of the scholars are employees of the banks which they scrutinise.

Guidelines on just who would be qualified to secure a seat on the new external audit board are expected to be published later in the year. Banks will also not be required to make the results of their audits public. The new system in Bahrain will in place from 2020 onwards, when banks should submit their reports for 2019. The central bank has floated the idea of annual audits in a consultation paper, but it did not mention in a statement what the final decision would be.

Islamic banking is rushing head-first into a digitised world, pressed onwards by a demanding customer base and a growing need for digital initiatives. With the issuance of sukuk and takaful on the downturn in 2017 and beyond, the creation of new digital channels will surely be a method by which Islamic finance can continue its impressive rise in popularity.

By Alexander Hamilton

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Alex Hamilton is Senior Reporter at IBS Intelligence, follow him on Twitter or contact him at: alexanderh@ibsintelligence.com
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