How to bring Islamic Banking through FinTech disruption to 1.3 billion people? …
Banktotal is focussed on providing financial services to the unbanked and underbanked in Africa and the Asia-Pacific Countries of Indonesia, Pakistan and Bangladesh.
A quarter of the worlds Muslims live in Africa, with another 300 million in Indonesia, 197 million in Pakistan and 167 million in Bangladesh. This represents around 1.3 billion people.
The large unbanked Muslim populations in these countries present a huge opportunity for Islamic financial institutions, with Africa’s infrastructural shortfall providing a particularly fertile ground for the sukuk market.
The frontiers of the global Islamic finance industry are expanding. From competitive home markets such as Malaysia and the countries that make up the Gulf Co-operation Council (GCC), sharia-compliant financial institutions are now pushing outwards to tap into the higher growth opportunities on offer elsewhere in the Islamic world. This has come as global demand for sharia-compliant financing options is on the rise. With massive Muslim majority markets, including Indonesia, lacking significant sharia-compliant financial coverage the opportunities for growth are substantial.
Encouragingly, national governments in these underserved markets are increasingly aware of the benefits of Islamic finance. This awakening has emerged in the form of new sovereign sukuk issuance, positive regulatory reforms as well as training initiatives for regulatory agencies. As a consequence, momentum is now building behind the development of a truly globalised industry.
Africa is in the midst of a historic acceleration that is lifting millions of people out of poverty, creating an emerging consumer class, and propelling growth in many economies. Reflecting this broader economic progress, Africa today has the second-fastest-growing banking market—taking retail and wholesale banking together—in the world. Between 2012 and 2017, African banking-revenue pools grew at a compound annual growth rate of 11 percent in constant 2017 exchange rates. We expect the African banking market to remain a growth leader going forward, growing at a rate of 8.5 percent over the next five years.1
Beyond Indonesia, Africa is seen by many as a natural growth opportunity. With the likes of Abu Dhabi Islamic Bank already operating in Egypt and Sudan, many Islamic banks are now looking to gain a foothold in key markets across the continent. For Islamic institutions, this advance offers huge potential in terms of Africa’s demographic potential. The International Monetary Fund estimates that about half of the population of the sub-Saharan Africa region is unbanked. Moreover, the Muslim population in this area is expected to increase from its current 250 million people to about 386 million by 2030.
As Africa’s economic growth develops in conjunction with these demographic changes, demand for financial services is expected to spike. Here, the opportunities for Islamic lenders are expected to be vast. “Over the longer term, I think Africa can become a source of massive growth for the Islamic finance sector. The opportunities are considerable and Standard Chartered Saadiq could one day transfer some of our expertise and knowledge to assist in the development of sharia-compliant finance across the continent,” says Adhha Abdullah, CEO of Standard Chartered Saadiq.
Yet, it is clear that sharia-compliant finance can also deliver real benefits to Africa’s economic and social growth trajectory. Even in markets with large Muslim populations, the number of Islamic financial service providers remains limited. An increasing number of Islamic banks will therefore improve financial inclusion across the continent, both for Muslims and non-Muslims. This is particularly true when it comes to small and medium-sized enterprise financing by increasing the options on offer.
Just as significant is the potential for Islamic finance to address Africa’s yawning infrastructure funding gap. The African Development Bank estimates that the continent’s annual infrastructure investment deficit is $50bn. Increased sukuk issuance is seen as one way of addressing this problem. Not only do sukuk provide a natural fit for infrastructure and project financing, by virtue of the fact that they are asset backed, but they are also an excellent means of attracting surplus liquidity from Islamic investors in the Middle East and Asia.
Encouragingly, a number of African sovereigns are now turning to the sukuk market. In 2014, both Senegal and South Africa debuted sovereign issuances, while Nigeria, Côte d’Ivoire and Niger are all actively exploring a transaction. In doing so, these countries will effectively broaden their traditional investor base. Moreover, this wave of sovereign issuances could potentially ease the way for further transactions from African corporates, state-owned companies, financial institutions and others, to benefit from a new funding source.
What is required moving forward is greater regulatory and political support for the development of Islamic finance in Africa. Here, things seem to be moving in the right direction. In June 2015, Uganda introduced amended financial institution legislation that will open the country up to Islamic banking. In Nigeria, the central bank issued guidelines for the creation of a centralised sharia authority in February, while in late 2014 the Moroccan parliament approved an Islamic finance bill permitting the operation of sharia-compliant banks.
As the regulatory environment incrementally improves, so are the regulators’ understandings of Islamic finance. Kenya recently signed a memorandum of understanding with the Qatari government to support the development of the Nairobi International Financial Centre, of which Islamic finance will be a key component. Meanwhile, the Kenyan School of Monetary Studies, part of the country’s central bank, has partnered with Malaysia’s International Centre for Education in Islamic Finance (INCEIF) to deliver training programmes on Islamic finance.
Similar training arrangements involving INCEIF and the governments of Tanzania and Uganda have also been agreed, while the central bank of the West African Monetary Union is also developing a francophone Islamic finance education body with the Malaysian institution.
These developments and others point to the growing momentum behind Islamic finance in Africa. An improving regulatory environment and rising demand are playing their part in driving change across the continent. As this process gathers pace in the larger African markets, as well as jurisdictions such as Indonesia, the prospects for unlocking another period of sustained growth for the industry appear ever brighter. For sharia-compliant banks across the GCC and Malaysia, these dynamics are undoubtedly promising and point to the potential for a new phase of global expansion.
Nowhere is this dual trend of commercial interest and positive regulatory reform more evident than in Indonesia the Islamic world’s most populous country. “Indonesia is a sleeping giant in the Islamic finance marketplace. We believe that if Indonesia does get all the infrastructure in place, it can really emerge as a genuine heavyweight in the Islamic finance industry,” says Mohamad Safri Shaul Hamid, senior managing director and deputy chief executive of CIMB Islamic.
Yet, Indonesia’s potential has been touted for some time. Banking sector penetration in the country currently sits at about 30% of the population, according to local consulting firm Cekindo. This lack of financial inclusion on the part of both conventional and Islamic lenders is partially a result of the low levels of financial literacy in the country. This is particularly the case when it comes to sharia-compliant finance, according to research conducted by the country’s financial services authority Otoritas Jasa Keuangan (OJK).
To address these issues – and others – the OJK released a roadmap in June 2015 to chart a course for Islamic banks to hold about 15% of system wide assets in Indonesia by 2023. The fact that Islamic lenders currently have about a 5% market share in the country means that reaching this target will be difficult. But it nevertheless provides a strong indication that Indonesia is now taking Islamic finance seriously.
Indeed, most lenders operating in the country, both domestic and local, are enjoying strong levels of profit and asset growth. “CIMB Niaga Shariah currently has close to 30 branches in Indonesia and we see huge growth potential there. With a population of about 250 million, where more than 90% are Muslims, the scope for retail Islamic finance is enormous,” says Mr Safri.
Despite exchange rate challenges around the rupiah, total sharia-compliant assets in Indonesia increased from $19.1bn last year’s Top Islamic Financial Institutions report to $21.04bn this year. And it is more than just Malaysian banks – traditionally the most active in Indonesia – that are looking to tap into this growth opportunity. A number of the Gulf region’s sharia-compliant banks are now paying greater attention to the country.
Dubai Islamic Bank received regulatory approval from OJK in October 2015 to increase its stake in PT Bank Panin Syariah Tbk to 40%, up from 25%. Meanwhile, according to a number of Indonesian press reports, as well as statements from the OJK, Dubai’s Emirates NBD is considering a move into the country through the establishment of a new sharia-compliant lender.
And in a growing sign of cross-border developments between Indonesia and the markets of the GCC, Indonesia issued four sovereign sukuk at a value of $6bn on Nasdaq Dubai in September 2015. Not only was this the largest sovereign sukuk transaction executed in Dubai, it also points to a much-needed process of convergence between the Islamic finance markets of south-east Asia and the Gulf, as well as Dubai’s growing status as a global centre of Islamic finance.
The share of Pakistan-based Islamic banks in global Shariah-compliant banking assets stands at a meagre 1%, according to the State Bank of Pakistan (SBP) on Monday.
Islamic banks in Pakistan own assets worth Rs2.48 trillion ($19.93 billion) as of June 2018, which comes close to 1% of the global Islamic banks’ assets of $2.05 trillion by the end of 2017, the SBP said.
The central bank, however, reported that Pakistan’s Islamic banking industry had continued to expand its market share in the overall banking industry with its asset base and deposits growing significantly in the last one year.
‘Pakistan can become hub of Islamic finance’, say experts
Total assets of Shariah-compliant banks in the country increased 21.9% to Rs2.48 trillion in the year ended June 30, 2018. With this, the market share of Islamic banking assets surged to 12.9% in the overall banking industry compared to 11.6% in June last year.
Similarly, deposits at Islamic banks grew 18.2% to Rs2.03 trillion, showing the market share of their deposits in the overall banking industry surged to 14.8% in June 2018 compared to 13.7% in June 2017.
The network of Islamic banking industry consisted of 21 Islamic banking institutions – five full-fledged Islamic banks and 16 conventional banks, having standalone Islamic banking branches by end-June 2018.
The network of Islamic banking industry increased by 96 branches. “This addition was mainly due to demerger of 90 branches of MCB Bank Limited and their merger into MCB Islamic Bank Limited,” it said.
Islamic Banking: IDB to launch $2.5b benchmark Sukuk
Branch network of the Islamic banking industry was recorded at 2,685 spread across 111 districts by the end of June 2018. The number of Islamic banking windows, operated by conventional banks having standalone Islamic banking branches, stood at 1,284.
Profit before taxation of the Islamic banking industry stood at Rs15 billion for the quarter ended June 2018 compared to Rs12 billion in the same quarter last year.
Profitability ratios like return on assets and return on equity (before tax) were recorded at 1.3% and 20.9% respectively by the end of June 2018.
During the period under review, operating expenses-to-gross income ratio declined 3% and stood at 64.5% by end-June 2018, it said.
Net investments of the Islamic banking industry reflected an increase of 4.8% (Rs26 billion) during the period under review and were recorded at Rs555 billion by the end of June 2018 compared to Rs529 billion in the previous quarter.
Client-wise financing shows that the corporate sector accounted for a 74.5% share in overall financing of the Islamic banking industry, followed by consumer financing with a share of 10.5% by the end of June 2018.
The share of small and medium enterprises’ (SMEs) financing and agriculture financing in overall financing of the Islamic banking industry remained low.
Asset quality indicators of the Islamic banking industry, including non-performing finances (NPFs)-to-financing (gross) and net NPFs-to-net financing were recorded at 2.7% and 0.4% respectively by end-June 2018.
“It is pertinent to mention here that both these ratios were better than those of the overall banking industry’s averages,” the SBP said.
Liquid assets-to-total assets and liquid assets-to-total deposit ratios were registered at 24.6% and 30% respectively by end-June 2018.
Financing-to-deposits ratio (net) of the Islamic banking industry was recorded at 65% by end-June 2018.
Capital base of the Islamic banking industry increased to Rs156 billion by end-June 2018 compared to Rs146 billion in the previous quarter.
Capital-to-total assets and capital minus net non-performing assets to total assets ratios of the Islamic banking industry were recorded at 6.3% and 6.1%, respectively.
As the third largest Muslim country in the world, Bangladesh was a prime location for Islamic banks to take root. Very quickly the banks found themselves in a powerful symbiotic relationship, where they were able to provide services to the millions of Bangladeshi people escaping abject poverty. In this way, the rise of Islamic banking in the country parallels the economic rise of Bangladesh itself.
The banks’ success continues to be driven, in large part, by their ability to appeal to the traditional Islamic values of the country’s populace. Islamic banking codes are structured in compliance with Sharia law, known as Fiqh al-Muamalat, or Islamic Rules on Transactions. This arrangement produces an alternative to conventional banking systems that rethinks long-established principles of finance. Most noticeably, Islamic banking takes issue with the idea of charging interest, called riba. According to the Quran and the Sunnah, riba is forbidden because it is considered exploitative, potentially trapping borrowers in a debt cycle. Without interest, Islamic banks instead turn to a number of financial instruments that allow them to turn a profit from their transactions.
One of the most common of these instruments, known as Musharakah, is often used to replace the standard practice of a home mortgage. In a typical mortgage situation, the bank will loan a buyer enough capital to purchase a house, and then enter into an agreement where the buyer will pay the bank back, with interest, over an agreed span of time. Musharakah, on the other hand, is a completely different model designed to avoid charging interest. When a customer of an Islamic bank wants to buy a home, the bank purchases the home and rents it out to them. As rental payments accrue, the bank slowly hands over possession of the house and when the last payment is made the buyer has ownership of the house.
Aside from avoiding interest rates and debt cycles, there is a deeper philosophical viewpoint on transactions that Islamic banks take, namely that money has no intrinsic value and thus can’t be sold at a profit. All three of the major Abrahamic religions share this belief and used it to guide early financial practices. Islamic banking simply reincorporates this ancient practice into the modern financial system, which it accomplishes through the use of instruments like Musharakah. In Musharakah, when the bank buys the house it has a commodity of tangible value. When the banks rent the house back to the buyer it is providing a service based on a valuable commodity that the bank owns. Conventional mortgages, on the other hand, lack an exchange of tangible value. The banks loan money to you and charge interest on your debt payments, which effectively generates revenue from nowhere. The service the bank is providing you is not based on any value exchange but rather uses existing money to generate new revenue. Islamic banks pride themselves on operating only in positions where they are providing services based on real value as opposed to speculative value.
In addition to these philosophical views on commerce, Islamic banks make a poignant moral argument as well. In contrast to conventional banks, Islamic institutions will only provide service to enterprises they consider ethical. This means absolutely no business ties to alcohol, tobacco, adult entertainment, or weapons companies. Investing in these industries is considered haram (off-limits) according to Islamic sacred texts. For example, Islamic banks in Bangladesh will finance the import of fertilizers, but will not finance what’s used to grow tobacco—a very lucrative crop in the country.
However, the appeal of Islamic banking manifests itself in more ways than just as a more pious alternative to conventional banking. Islamic banks are often viewed by their clients as highly efficient and less corrupt, especially in Bangladesh. This reputation stems from that the fact that these banks generally have far fewer ties to the Bangladeshi government, which is widely regarded by the populace as severely corrupt. In fact, Islami Bank, the most influential Islamic bank in the country, was described by the executive of a prominent think-tank as the only bank where “bribery was not institutionalized.”
In terms of efficiency, Islamic banks boast much lower rates of non-performing loans (NPLs) than their competitors in the country. NPLs at conventional banks hovered around 9.2%, compared with just 4.3% at Islamic banks. This too can be partially attributed to government interference; many of the non-performing loans at conventional banks are from deals with politically-connected businesses. The other key to their efficiency is that Islamic banks are also generally more risk-averse than their competitors. In fact, high degrees of risk, or gharar, are not allowed. In technical terms, this means that Islamic banks will not invest in conventional derivatives since they require speculation about the future and could lead to excessive risks. This is largely why, following the international recession in 2008-2009, Islamic banks fared much better than their conventional counterparts.
While Islamic banking, in general, has been on the rise in Bangladesh, one bank in particular is surpassing them all. As the largest Islamic bank in the country, Islami Bank Bangladesh is currently unmatched. Founded in 1983 by Saudi and Kuwaiti hedge fund investors, it rose to prominence during the economic boom that swept through the country. Over the past twenty years, Bangladesh developed a flourishing manufacturing economy, especially in the production of textiles, where it comes second only to China. In fact, Bangladesh’s economic rise can be attributed to what many analysts have dubbed the “two Rs”: Remittances and Ready-made garments. By taking advantage of these industries, Islami Bank was able to distinguish itself, and today accounts for 90% of Islamic-banking assets and deposits. It also rose to become the largest private lender in the country, with a balance of over $10 billion.
Following up on these impressive figures, Islamic banking in Bangladesh still has a lot of room to grow in the future. According to Azizul Huq, a former vice-chairman of Islami Bank, Islamic banks will eventually overtake conventional banks in the country. Currently, Islamic banks only have a 20% market share. However, with public approval ratings for Islamic banks above 80%, it certainly appears within the realm of possibility. It also helps that Bangladesh’s population of 170 million is 90% Muslim, and only one out of every three people in the country currently has a bank account. In other words, Islamic banks are primed to take advantage of opportunities that will allow them to outcompete conventional banks in the country.
Competitors are starting to realize this and aren’t waiting to be left behind. With the explosive popularity of Islamic Banking in the past few decades, more conventional banks are beginning to offer a wide range of Islamic banking services themselves. Well known international banks, like Citi and HSBC, first broke into the field by creating so-called Islamic “windows,” where they offered Islamic banking services alongside their more standard services. Once these “windows” received enough attention, they considered opening up brick and mortar Islamic branches. This strategy has worked quite well for conventional banks, and now they have currently around 25 Islamic “windows” and 18 Islamic branches in operation around the country.
DVC Consultants is a market leader in transformative consulting. It creates and consults to disruptor, disrupted and challenger brands.
It is clear that brands and their owning companies have no room for complacency, and need constantly to evolve, or risk becoming extinct.
DVC Consultants has therefore developed LOAF (Leadership and Organisation in Anarchic Flux) as a proprietary consulting process for supporting our clients in being disruptors and challengers, rather than being on the receiving end of companies more innovative.
Challenger and Disruptor brands succeed because they emerge from developments not properly observed by market incumbents.
LOAF works because it builds on DVC’s expertise and experience in an eclectic and wide range of sectors and disciplines, including branding, economics, politics, government affairs consultancy and new technologies.
Thought Leadership- Cogitare
Cogitare-The Latin for “To Think, ” is the collective name for DVC Consultants thoughts, insights and perspectives on a broad and eclectic number of subjects. From Brexit to Global Poverty, Islamic Banking to Subsistence Agriculture, Disruptive Technologies to The World Bank. It reflects the wide range of sectors and issues we consult on. We hope you enjoy reading them.
Quentin Anderson is Co-Founder and CEO of banktotal.org