Including an Islamic system bring great benefits for a bank looking to attract Islamic customers, but there are also major cost implications to consider

The inclusion of an Islamic system alongside a conventional one, or vice-versa, helps a bank expand the range of customers that they can onboard. However, there are a series of expenses that come with that transformation – logistics, regulation, integration.

Ashish Mashal, Digital Transformation Strategist at Commercial International Bank (CBI),says: “Cost implications are indeed quite high because banks have to maintain and pay out AMC for both core systems (conventional and Islamic) – examples being RAKBANK which uses Finacle for conventional banking and Flexcube for Islamic – whereas if we have a single consolidated system, it helps bring cost efficiencies. Another example is CBI which uses SIBS (Silverlake) for both conventional and Islamic.”

While countries like Iran and Sudan have already established a full Islamisation of the financial systems, which mainly comes from the intertwining of policy-makers and religion, some others like Bahrain and Malaysia have benefited immensely from the coexistence of both systems.

Islamic lending

The basics of Islamic banking is the shariah disapproval of riba (interest), gharar and maisir (contractual uncertainty and gambling), and haram industries (prohibited industries such as those related to pork products, pornography, or alcoholic beverages).

In order for banks to onboard Islamic systems, they have to familiarise themselves with the types of demands that the religion sets, and comply with them with the help of the Shar’iaha board or counselor. This person, or group, would advise the bank on Shar’iah jurisprudence or rulings, known as fatwa. This is the first additional cost they will face.

Both regulators and Shar’iah boards of foreign supervisor agencies must be consistent across the spectrum in regards to its rulings and decisions. To supervise this internal consistency, two multilateral institutions were created: the Accounting and Auditing Organization for Islamic Financial Institutions

(AAOIFI), which issues internationally recognized Shari’ah standards on accounting, auditing, and governance issues; and the Islamic Financial Services Board (IFSB), which issues standards for the effective supervision and regulation of Islamic financial institutions.

The regulator will have to undertake similar supervisory and regulatory functions regarding Islamic institutions as the one already performed with conventional institutions. It is a somewhat common misunderstanding that, since Islamic banking is largely based on profit-and-loss sharing agreements, Islamic institutions do not need to be supervised at the same level as conventional banks.

Keep them apart, but together

An important principle behind Islamic finance is the desire to maintain the moral purity of all transactions. The funds intended for Shari’ah-compatible investments should therefore not be mixed with those of non-Islamic investments.

Therefore, in order to ensure compliance with Islamic principles, conventional banks wishing to offer Islamic products must guarantee that the funds devoted to conventional activities will not be mixed (commingled) with those destined for Islamic activities. In operational terms, this requires that banks establish different capital funds, accounts, and reporting systems for each type of activity.

Consumers should be duly informed of all the risks they run when entering into new contracts, as the public will have a better understanding of conventional deposits than of Islamic deposits (such as mudarabah, safe-keeping, etc.) Often, a bank will dedicate a part of its activities to implementing Islamic tools, as Othman Abdullah, CEO in charge of Islamic Banking at Silverlake Group, explained in an interview with IBS Journal: “Islamic lending products have distinct requirements that conventional loan systems do not support. Islamic lending products are Shari’ah contract based. For example, Murabaha financing would need to take care of sale and purchase price, amortization of profit margin, rebate of profit margin for early settlement etc. These are demanding accounting processes that the system needs to take care of for it to be fully automated.

An Islamic window is simply a window within a conventional bank via which customers can conduct business utilizing only Shari’ah compatible instruments. Fadi Yazbeck, Product Manager at IslamicSuite at Temenos commented: “Most of our customers in the GCC and some African countries operate an Islamic window along with their conventional operations. An example would be First Abu Dhabi Bank in UAE using our solution for their Islamic and conventional operations on one integrated platform across multiple countries. This reduces their cost and allows them to consolidate their financials easier.”

Full integration

However, the issue when running these systems lies in the costs of redundancies and keeping up with both systems. Othman Abdullah said that: “It’s definitely more cost effective if banks use a single system for both conventional and Islamic businesses provided that the system is properly architected to handle both business seamlessly. If banks use different systems, they will have to manage two different systems – of software, hardware, and people – which will definitely be more costly.”

Mahal from CBI told us that leading banks maintain and run the Islamic banking business through subsidiaries or a separate banks, which are part of the bigger group, whereas smaller banks run the Islamic business through Islamic windows in their existing conventional distribution channels.

“[Temenos] enables the bank to separate Islamic banking operations and products from conventional ones and makes sure that there are no mixing of funds. We always recommend that banks use one integrated solution, that can truly support both types of banking, as this will reduce their integration risk and gives them better visibility,” commented Fadi Yazbeck, Product Manager at IslamicSuite, Temenos.

Othman Abdullah at Silverlake agrees: “We strongly recommend our clients use a single system for both their conventional and Islamic Banking businesses. This approach makes IT operation management more efficient and cost-effective. The same IT infrastructure and skillsets can support both conventional and Islamic businesses.”

Yazbeck added: “If the same bank is offering Islamic and conventional products, then integration between those two systems is a must. However, it must follow the bank’s business model. It depends if this bank wants to have separate tellers and branches for Islamic operations – separate cash accounts and ATMs, and separate customer base and credit limits. In this case, a frictionless system is possible. However, this scenario is highly unlikely because most banks with both types of products want to have one customer base and to see the credit exposure of their customers across Islamic and conventional banks to assess risk. Not to mention sharing the same channels infrastructure.”

The challenges

On top of the costs and intensity of workload that running both systems entails, there are still issues when sharing a database between both banks: “Some regulators allow sharing of databases as long as products and accounting can be logically segregated, but some regulators insist on having a separate database,” said Othman Abdullah.

“The complications come during integration between the systems, as only one system is used to maintain the customer profile (E-CIF) and the GL’s / bank’s ledger is maintained only in one place,” adds Ashish Mahal from CBI.

“The coexistence of both types of systems within the same bank is a search for balance between the compatibility of both styles of lending in one system, and the regulation and core values that each type of lending demands. Even though Islamic banking regulations only affects the end product, it still requires banks to understand it and work around it. However, frictionless coexistence is very much attainable, to the point that some of the largest banks in the Middle East are using our solution for both conventional and Islamic operations.”

by Bill Boyle
IBS Intelligence Senior Editor