Islamic banking could receive boost from fintech innovations

• The Gulf Cooperation Council (GCC) region’s share of participation banking grew to 72%
• KSA, the UAE and Malaysia are the three largest participation banking markets, in terms of assets

According to EY’s recent Banking in emerging markets report, the assets of global participation banking, also known as Islamic banking, has reached US$924 billion in 2015, with growth rates declining across all regions compared to previous years.

The GCC region’s share of participation banking increased to 72%, as the size of assets in the Association of Southeast Asian Nations (ASEAN) countries declined during 2015. KSA, the UAE and Malaysia are the three largest participation banking markets in terms of assets, representing 34.2%, 17.2%, 13.3% of the global market share respectively.

Gordon Bennie, MENA Financial Services Leader, EY, says: “Today, more than 2 billion adults still do not have a bank account. There are also more than 200 million micro, small and medium size businesses (MSMBs) with unmet financing needs. The demand for a responsible, shari'ah-compliant financial system is huge. There is also a wealth of business opportunities offered by fintech innovations for participation banks, particularly in emerging markets.”

In the GCC region, fintech innovations have the ability to enhance market access and profitability of banks, dramatically. A starting point for participation banks is to activate a bold strategy for the finance function – inclusive of advanced data analytics, robotic process automation, the cloud, artificial intelligence and Blockchain.

Ashar Nazim, Partner, Global Islamic Banking Center, EY, says, “The fact that almost one-third of the US$3 trillion global shari'ah-compliant assets are either reported as ‘informal or ‘best estimates’ demonstrates the limitation of participation banks in making sound strategic decisions. Chief Financial Officers (CFOs) need reliable information and we are seeing a strong desire to improve data management and analytics at participation banks through fintech innovations.”

Some of the key areas for fintech innovation that are relevant for participation banks include: SMB and peer-to-peer lending platforms, payment-related innovations such as person-to-person payments, digital authentication and digital wealth management.

“There has been a clear evolution for CFOs from having the primary role of analysing historical data to one whose focus will be providing forward-looking insights. In-memory computing and big data are the clear direction forward, with predictive analytics being a key driver of these changes. Given that there is more fintech innovation going on outside of the banks than inside, the opportunity is for participation banks to win through collaboration. The bank of the future could be a consolidation of fintech boutiques under a single brand,” comments Ashar.

If banks were to consolidate with fintech companies, it could propel participation banks to become mainstream across 20 promising markets by 2021, up from five markets today, representing a jump from 100 million customers to 250 million customers over the same period.

Source: EY report.

Digital-only banks for Millennials are another fintech trend. The Millennial generation has a clear preference for conducting their financial services on an end-to-end digital platform. Using fintech innovations, banks worldwide are stepping forward to offer digital-only banking services to meet the differentiated needs of this customer segment.

Digital-only banking could become a significant client segment for participation banks. There is a case for participation banks to evaluate collaborative ventures with fintech firms to launch digital-only banks in their respective countries.

“The adoption of fintech innovations is not an option, but an absolute imperative for participation banks to continue to gain market share. Consumer technology penetration (mobile phone, tablet, laptop) in the GCC region is now comparable with that of consumers in most developed countries. Based on their familiarity and use of consumer technology, their behaviour patterns are modifying, with increased expectation to interact with banks using digital channels. Participation banks cannot realistically expect to gain sustainable future growth in their market share if they lag behind their conventional counterparts in digital transformation through the use of fintech innovations,” concludes Ashar.

Interested?

Download the Banking in emerging markets: GCC FinTech Play 2017 report (PDF)

Read the TechTrade Asia blog post about DBS' mobile-only bank in India

Global Islamic banking activities to continue apace in 2016

• Global Islamic banking assets expected to reach US$1 trillion in 2015
• By 2020, the global Islamic banking industry profit pool is expected to reach US$30.3 billion
• Islamic retail and commercial banking assets continue to grow at 16% in 2014 and 2015
• Islamic banking assets in six key markets set to exceed US$801 billion in 2015
• Gulf Co-operation Council (GCC) countries added US$91 billion in shari’ah compliant assets in 2015
• Approximately 80% of international banking assets are based in Qatar, Indonesia, Kingdom of Saudi Arabia (KSA), Malaysia, UAE and Turkey (denoted as QISMUT)

The World Islamic Banking Competitiveness Report 2016*, which aims to inspire and inform the business strategies of Islamic banks through specific, actionable insights, has been published by EY. According to the consultancy, global Islamic banking assets are expected to reach US$1 trillion in 2015, with the profit pool for the global Islamic banking industry reaching US$30.3 billion by 2020.

Source: EY. 

Islamic banking continues to be upbeat, as assets are growing at 16% in 2015. EY said that GCC countries added US$91 billion in shari'ah compliant assets in 2015, with the lion's share (80%) coming from the QISMUT region - comprising the countries of Qatar, Indonesia, KSA, Malaysia, UAE and Turkey. The nine core markets — Bahrain, Qatar, Indonesia, Saudi Arabia, Malaysia, UAE, Turkey, Kuwait and Pakistan together account for 93% of industry assets,
estimated to exceed US$920 billion in 2015, notes Abdulaziz Al Sowailim, Chairman and CEO of EY MENA.

Al Sowailim listed several broad trends which will drive growth and change for the Islamic banking sector, including:

• Large Muslim populations in 10 of the 25 rapid-growth markets (RGMs) currently reshaping the world economy 
• The coming together of ASEAN Economic Community (AEC) in 2015 
• Falling oil prices, jobs-for-nationals and economic diversification in the GCC
• The launch of the China-led Asian Infrastructure Investment Bank (AIIB)
• China’s Belt & Road Initiative

“Leading Islamic banks have done well to mainstream with a competitive, sizeable business in their home markets. The combined profit pool of Islamic banks across QISMUT was estimated at US$10.8 billion in 2014, which is a notable milestone. However, the return on shareholder equity could be significantly enhanced, by at least 15% to 20%, and this need becomes more pressing in the context of the prevailing macro-economic environment," said Ashar Nazim, Partner, Global Islamic Banking Center, EY.

“The external operating environment is certainly getting tougher, given the prevailing oil price and the resulting impact on banking system liquidity and infrastructure spend. Islamic banks are in a better position to weather this storm due to the simpler nature of their balance sheets, basic products and localised operations. However, they do not appear to be ready for the digital changes that are impacting the way customers engage with banks. A fundamental review of their operating models at this stage will be critical to the success of Islamic banking across the Organization of Islamic Cooperation markets,” added Muzammil Kasbati, Director, Global Islamic Banking Center, EY.

Interested?

Download the report (PDF)

View more infographics (updated to 2014) and dive into country reports

View the Suroor Asia blog post on the 2014-2015 report

*Global Islamic banking assets are estimated based on publicly available data from 15 participation banking (Islamic banking) markets. The research and insights are primarily based on the EY Participation Banking Universe (EY Universe), which is proprietary, based on samples and is not meant to be fully exhaustive. The EY Universe analysis covers 69 participation banks and 45 conventional banks across participation banking markets. Insights are also based on interviews with banking executives and industry observers, to identify key trends, risks and priorities. Limited disclosures on participation banking windows, subsidiary operation and offshore businesses was a limiting factor.

GCC pension funds may give greater role to Islamic retirement products

GCC governments are relooking at existing models of both public and international pension funds to ensure they are sustainable, according to EY’s GCC Wealth and Asset Management 2015 report – Fast growth, divergent paths, launched at the FundForum Middle East 2015. Across the GCC, public pension funds amount to US$397 billion, representing nearly a quarter of GDP and US$15,000 per national, said EY.

George Triplow, MENA Wealth & Asset Management Leader, EY, says: “Public pension funds in the GCC are only just coming of age, just over a fifth is invested in local equities. Two big issues are currently driving significant rethinking in the sector. The first is the sustainability of public pension funds for nationals, given the relatively small size of the funds, demographics and the gap between contribution and benefit levels. Secondly, there is a growing recognition by many employers that end of service benefit (EOSB) payments received by expatriates are neither adequate nor suitable as an alternative to a pension.”

The size of GCC pension funds is relatively low, compared with employer-provided pension funds in the UK, for example, where these assets are larger than GDP and funds per individual are nearly four times the GCC average.

Kuwait has the best capitalised fund relative to the size of its economy and citizen population. This follows an initiative to recapitalise the pension fund from the budget since 2008, filling an actuarial deficit that had been estimated at nearly US$40 billion. In international terms, its assets relative to population are similar to those of the UK’s pension funds.

Qatar’s pension assets are also sizeable relative to the population, following a capital injection from the Ministry of Finance in 2012. Since then, Qatar’s General Retirement and Social Insurance Authority appears to have focused heavily on investment in local equities, including stakes in major companies.

Saudi Arabia naturally has the largest pool of pension assets. Assets are split between the Public Pensions Agency (for public sector workers) and the General Organization for Social Insurance (for private sector workers). The two often co-invest in companies together and alongside the Public Investment Fund. Aside from stakes in dozens of major listed companies, they also invest in private companies. However about 85% of the pension assets are invested abroad, mainly in US treasuries managed by the Saudi Arabian Monetary Authority.

“To address the concerns over the sustainability of the industry, Gulf countries will have to relook at the retirement ages, benefit levels and contribution requirements. This could require further recapitalisation of the funds and reforms to benefits and retirement age. Where fiscal means are limited, it may also involve the kind of three-tier system that is increasingly common elsewhere, combining a minimal state pension, defined contribution workplace pensions and additional personal contributions — but a wholesale shift in this direction is unlikely. More systematic reform is also possible in the most fiscally strapped countries to incorporate additional pension insurance elements. Recent changes in Gulf healthcare, with a steady shift towards private insurance, may set a precedent for such reforms,” commented George.

The report highlights three key areas which can benefit the GCC pension funds industry: new levels of regulation and governance, expanded EOSB schemes and shari'ah-compliant retirement products.

The emergence of Islamic retirement products is a development that is relevant to both expatriates and nationals in the GCC, says EY. To ensure that pension savings under Islamic schemes are in accordance with Islamic law, they need to be invested in shari'ah-compliant assets. However, there are concerns about annuities, which are typically purchased at retirement using pension fund pots, and the concept of a longevity sukuk has been developed as a shari'ah-compliant alternative.

“There will be significant changes in the way GCC pension provision is looked at in the coming years because the current system may find it difficult to cope with the needs of GCC residents. We expect a shift in the retirement ages of GCC nationals and changes to be made to the EOSB schemes to make them more relevant to the actual retirement needs of expats. There will be a lot of opportunity for local providers in the region, especially in the Islamic retirement product arena,” concluded George.

KSA clients satisfied with Islamic bank branch experiences, UAE clients like the customer service

The Islamic banking industry in the Kingdom of Saudi Arabia (KSA) is set to achieve US$683 billion of shari'ah-compliant assets by 2019, according to EY’s World Islamic Banking Competitiveness report.

EY notes that KSA has been a key market for growth in the Islamic banking industry. The first Islamic bank with equity in excess of US$10 billion is headquartered in the country. A strong demand from customers, both retail and corporate, has led to significant growth in Islamic banking in KSA, resulting in 54% of all financing being shari'ah-compliant in 2013. Overall, the size of Islamic banking assets in KSA has nearly doubled from 2009 to 2013.

Ashar Nazim, Global Islamic Finance Leader at EY, says: “The Islamic banking industry is preparing to go mainstream globally. KSA is the largest Islamic banking market in the world, representing 31.7% of the global market share. The country has been a pioneer in the Islamic banking industry and we expect it to continue being a driving market for the industry, as Malaysia, Turkey and Indonesia also establish themselves as populous Islamic banking centres.”

In the study, EY monitored 567,071 Islamic banking customer sentiments in KSA on social media as part of a wider study, which looked at 2.2 million customer sentiments dispersed across various online sources in nine key markets (KSA, Bahrain, Kuwait, the UAE, Malaysia, Indonesia, Turkey, Qatar and Oman). Out of the sentiments analysed in KSA, one in three of the positive sentiments were about branch experience, indicating that customers were generally satisfied in this area of service.

“The experience however varies by banks and types of customers. The younger customers are openly challenging the status quo and asking for more digital solutions,” says Muzammil Kasbati, Director, Global Islamic Banking Center of Excellence, EY.

While online and mobile banking services has taken off well in Saudi Arabia, sustainability remains a cause of concern, EY said. “The retail banking proposition of several banks was found struggling between the legacy people culture and the tech-savvy business model required to win new customers. Islamic retail propositions of conventional and Islamic banks still appears to be operating in silos, which unfortunately hampers their customer satisfaction ratings,” says Muzammil.

“Saudi retail banking customers like the fact that some banks are investing to improve the branch experience. There appears to be a healthy takeup of digital banking on offer, and there is anticipation for more. Islamic banks will need to increasingly shift their expenditure from running the bank to developing the bank. Learning from the customer’s journey can provide very important insight that can be applied in everyday operations. Digital adaptation will be vital when upgrading services,” said Ashar.

EY also shared that the UAE is en route to achieve US$263 billion of shari'ah-compliant assets by 2019, another prediction from its World Islamic Banking Competitiveness report. The industry was estimated to be worth US$127 billion in 2014, making it the third largest Islamic banking market by value after the Saudi Arabian and Malaysian markets.

Ashar said: “Islamic banks in the UAE, also known as participation banks, are eyeing revenue growth through experience-led transformation of their domestic business. Stronger capital position is also driving their international expansion. Initiatives in mobile payments are likely to cause positive disruption to banks’ traditional operating models. Looking at the positive performance of Islamic banks in the UAE, the country is expected to be one of the main markets that drive the future internationalisation of the Islamic banking industry.”

Shari'ah-compliant assets in the UAE crossed the US$100 billion milestone for the first time in the study period. Islamic banking penetration in the UAE currently stands at 21.4% and represents a 14.6% share of the global market. The industry in the UAE is growing at more than twice the rate of conventional banking. Due to high demand, there is increased pressure on efficiency as more Islamic banks attempt to go mainstream in the country.

EY monitored 55,884 Islamic banking customer sentiments in the UAE on social media as part of the wider study, and found that banking clients were most satisfied with customer service. Positive comments on social media outnumbered negative comments by more than 5%. Half of all the positive sentiments monitored were around customer service levels and complaint handling.

Customer feelings were mixed with respect to branch experience, online banking and phone banking. Out of the sentiments monitored on social media for all the three experiences, there was almost an equal number of positive and negative comments.

The study of social media comments has revealed an improvement opportunity for shari'ah-compliant UAE banks with respect to products and services, which were ranked the lowest in terms of customer satisfaction. Half of the overall negative sentiments monitored were about disappointing experiences with regard to product and service offerings.

“The call to action for Islamic banks in the UAE is to build rich insights into customers’ delight and pain points, and break operational silos. The time is right for analytics; banks need to challenge their channel capabilities and push for more customised products and services. Regulatory intervention on product design can help to both attract and protect consumers. The reputations of Islamic banks today will depend on the way banks engage with their customers,” concludes Ashar.

Want more context?

Read the Suroor Asia blog post on EY's take on Islamic banking challenges.

EY predicts maps the challenges for Islamic banking

Source: EY.

The Islamic banking industry has gone mainstream in several core markets. The combined profit of participation banks, or banks which adopt an interest-free model, crossed the US$10 billion mark in 2013 says EY. By 2019, the consultancy expects collective profits to touch US$37 billion as the industry continues its double-digit annual growth. 

According to EY, global Islamic banking assets attained compounded annual growth rate (CAGR) of around 17% from 2009 to 2013. Approximately 95% of international Islamic banking assets of commercial banks are based out of nine core markets, five of which are in the GCC (Saudi Arabia, UAE, Qatar, Kuwait and Bahrain). The market share of Islamic banking assets in Saudi Arabia, UAE, Qatar, Kuwait, Bahrain and Malaysia is now between 20% and 49%*. 

Islamic banks in Saudi Arabia, Kuwait and Bahrain represent more than 48.9%, 44.6% and 27.7% market share respectively.  Positive progress has been has made in Indonesia, Pakistan and Turkey, with 43.5%, 22% and 18.7% CAGR respectively from 2009 to 2013.

Gordon Bennie, MENA Financial Services Leader at EY, said:
“The six rapid-growth markets (RGMs) – Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey (QISMUT) –commanded 80% of the international Islamic banking assets at US$625 billion in 2013. QISMUT Islamic banking assets are expected to continue to grow at a five-year CAGR of 19% to reach US$1.8 trillion by 2019.”

Source: EY.

The 2014-15 World Islamic Banking Competitiveness Report – Participation Banking 2.0 from EY explores how digital innovation is set to positively disrupt traditional banking models. Key findings for the report include:

• International Islamic banking assets with commercial banks are expected to exceed US$778 billion in 2014.
• The global profit pool of Islamic banks is set to triple by 2019.
• Islamic banking assets in the six core markets of Qatar, Indonesia, Saudi Arabia, Malaysia, UAE, Turkey (QISMUT) are on course to touch US$1.8 trillion by 2019.
• Islamic banks in Saudi Arabia, Kuwait and Bahrain represent more than 48.9%, 44.6% and 27.7% market share respectively.
• Positive progress has been has made in Indonesia, Turkey and Pakistan, with 43.5%, 18.7% and 22.0% CAGR respectively from 2009-2013.

The report states that the time is ripe to transition to "Participation Banking 2.0", or technology-based, service-driven value propositions. EY analysed the sentiments of over 2.2 million customers’ social media posts on their banking experiences with Islamic banks in Saudi Arabia, Bahrain, Kuwait, UAE, Malaysia, Indonesia, Turkey, Qatar and Oman. The results showed that customer satisfaction is mediocre for many Islamic banks, which shows how critical it will be for Islamic banks to invest in raising quality of service and understand digital banking. 

Ashar Nazim, Global Islamic Finance Leader at EY, observed during the launch of the report in late 2014 that the Islamic banking industry demands a fundamentally different approach to profitable growth. 

"Customers have mixed emotions about their experiences of dealing with Islamic banks. In the future, growth will be most significant for the banks that are able to strengthen customer experience through the use of digital technology. Banks that do not keep pace with technological advances are expected to face serious pushback from mainstream customers who will gravitate toward the larger conventional players who can deliver on digital,” he said.

In its research, EY found that:

• Four out of every 10 participation banks are not “listening”.
• Better retail banking experiences could attract a sizeable majority to switch banks.
• Customers do not just want their bank to have a digital presence. They want it be tailored to their lifestyle relationships and connections.
• Migration from physical to digital channels requires more attention. Half of the banks surveyed did not have a Twitter account and only one in 18 banks offered full customer engagement on social media.
• Banks should invest in analytics to build rich insights into customers’ delights and pain points and personalise user experiences.

Ashar added: “Customers are increasingly active online and vocal about their experiences. Going mainstream and building a customer base that is based on added value to the customer has not been easy for Islamic banks. Bridging the performance gap requires listening to customers. The transformation of customers’ banking experience across channels and all touch points is going to be crucial as digital and social banking and customer expectations continue to evolve. Understanding and analysing changing customer patterns can help anticipate needs, and encourage desired behaviours. Most importantly, user experience conversations have to be an ongoing activity and not a discrete project. Institutionalisation of these core capabilities requires boards and executives to efficiently shift their spending from running the bank to developing the bank.”

EY also noted that the returns on equity (ROEs) of Islamic banks remain approximately one-fifth lower than those of traditional banks in the same markets. This performance gap could cost its shareholders, and to some extent the investment account holders, up to US$17 billion in total forgone profit over the next five years. Structural transformation and scaling up are therefore becoming critical to improve shareholder returns.

The consultancy predicts that trade finance, mobile payment solutions and managing the cost of regulatory compliance will drive the next phase of profitability. Most Islamic banks remain underweight when it comes to their role in trade finance business.

Ashar said: “The key driving markets for Islamic banking will continue to be Saudi Arabia and Malaysia, with Turkey and Indonesia also establishing themselves as large Islamic banking centers. With increasing market size and greater propensity for the adoption of technology-based, customer-centric solutions, the industry can be expected to further reduce its profitability gap with respect to conventional benchmarks. The challenges of going mainstream will be eliminating operational silos and leveraging customer insights to improve risk management, pricing and channel performance.”

Interested?

View the complete infographics.

*The research and insights are primarily based on the EY Participation Banking Universe (EY Universe), which is proprietary, based on samples  and is not meant to be fully exhaustive. The EY Universe analysis covers 114 banks across participation banking markets. Insights are also based on interviews with banking executives and industry observers, to identify key trends, risks and priorities. The analysis excludes Iran. 

Bright future for QISMUT through to 2018

In a February 2014 newsletter, EY's Global Islamic Banking Excellence Center noted that the strong fundamentals for Islamic finance in Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey, collectively known as QISMUT, could lead to much more by 2018. 

According to EY, some of the favourable drivers for QISMUT include:

• Combined GDP set to cross US$4.8 trillion by 2018
• Average per-capita income range between US$5,500 and US$103,000; 
• a bankable population of 252 million, 
• banking penetration of 90%, and 
• a volume of trade that is expected to increase by 49% in the current decade.

There are challenges, however. Sociopolitical stability is critical, as is regulatory clarity; an Islamic financial regulatory framework is required, covering supply mechanisms, demand management and infrastructure. Islamic banks are relatively small, EY says, and have yet to convert significant megatrends like mobile banking into a business advantage.

According to EY, the misuse of commodity murabahah and tawwaruq practices has also disillusioned proponents of Islamic banking. "Banks, multilaterals and Islamic infrastructure institutions should grab this (small) window of opportunity to help drive and sustain product development efforts," EY said in the newsletter.

In an analysis of the challenges for various countries in QISMUT, EY said the primary risk for Dubai in the UAE is the "quality of execution". In Istanbul, Turkey, it is a "supply-side bottleneck" that is the challenge; more regulatory clarity and additional financial institutions are required for growth. EY believes that financially independent Islamic subsidiaries will help to sustain strong performance in Kuala Lumpur, Malaysia.

EY forecasts a CAGR of 19.7% through 2013 to 2018 for QISMUT, with total assets reaching US$1.6 trillion by the end of the forecast period, provided economic stability is maintained in certain Islamic finance markets, the larger Islamic banks transition successfully to a new phase of development; and there is connectivity across high-growth markets and sectors. Globally, EY said the Islamic banking profit pool is projected to reach US$30.5 billion by 2018.

Read the full document here.

QISMUT and Bahrain are the new BRICS for global Islamic economy

The next wave of Islamic finance will be driven by rapid growth markets identified by the Bahrain and those identified by the QISMUT acronym: Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey, according to EY's World Islamic Banking Competitiveness Report 2013–14.

Doha by night, with the FANAR minaret in the distance.

"By 2018, these rapid growth markets will represent GDP of US$4.8 trillion, a mostly young population of around 419 million, trade flows of US$3.6 trillion, and banking assets of US$6 trillion," said Abdulaziz Al Sowailim, Regional Managing Partner, MENA region, EY, in the foreword. "With expanding economies and a fast-growing customer base for financial services, QISMUT is an attractive prospect for any bank looking to grow its revenues."

"Islamic banks are already serving 38 million customers globally, two-thirds of whom reside in QISMUT," added Ashar Nazim, Global Islamic Finance Leader, EY and Jan Bellens, Global Emerging Markets Leader, Banking and Capital Markets, EY, in a joint executive brief. "We expect Islamic banking assets with commercial banks to grow at a CAGR of 19.7% over 2013-18 across the QISMUT countries to reach US$1.6 trillion by 2018."