opportunities for growth in the islamic finance market · pdf filepage 2 | opportunities for...

Opportunities for growth in the Islamic finance market

An Experian white paper

| Opportunities for growth in the Islamic finance market

Islamic banking and finance ‘...has shown resilience at a time when the global economy has slowed and conventional banking in Western countries has been under pressure. By contrast global assets of Islamic finance have doubled since the start of the economic downturn1.’ posits UK Islamic Finance.

Not only do Islamic instruments offer an interesting and perhaps more socially acceptable face of finance, but the appearance of Islamic banking globally is set to significantly increase as Islamic populations increase, prosperity rises and the industry coalesces around a narrative that appeals to consumers. Several emerging hubs are staking their place in the newly emerging ecosystem of the Islamic economy, with the decade ahead set to be a mixture of competition and cooperation. Those that can use information and technology strategically to position themselves favourably, as in conventional banking, stand to gain the most in this emerging ecosystem.

Economic drivers

Population and demographic dividends

The world’s Islamic population is projected to grow by 30 percent by 2030, with Asia and Africa seeing the biggest rises2. Since an Ogilvy Noor study reveals that for 90 percent of Muslims, faith affects consumption3, the prospects for Islamic finance appears bright.

Economic growth in Muslim economies and other core economies

Overall population growth numbers are only partially revealing, however. There remains an untapped opportunity within the current populations. Across the Middle East North Africa region, only 18 percent of adults have a formal bank account, with religious beliefs one of the most commonly cited reasons.

Figure 1: Population growth of Muslims by region4

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The World Bank estimates that developing financial products compatible with religious beliefs could see this figure rise by 10 percent5. The Islamic economies of the world represent more than $8 trillion in gross domestic product (GDP), and a disposable income of $4.8 billion6.

Rise of the middle class

10 of the world’s 25 rapid growth markets are Muslim-majority countries7. US Muslims alone have a buying power of around $200 billion or $25,000 per capita. If the average Muslim populations’ spending reaches even one fourth of the US Muslim consumer spending level, global Muslim consumer spending would be ~$10 trillion per annum by 20308.

As a sign of the need for greater integration, imports and exports of the 57 member states of the Organisation of the Islamic Co-operation (OIC) totalled $3.9 trillion in 2011, but only a small portion was financed through Islamic finance9. Ashar Nazim, global Islamic finance leader at EY adds that another major opportunity for Islamic banks is to assist the small and medium enterprises (SME) sector with their cross-border business growth10. It is these areas in which significant scaling of Islamic finance holds the greatest promise. The impact made through responsible banking, inclusive growth and alignment with the broader halal asset class will be the defining features.

Islamic finance

From the present to the future

Islamic finance accounts for only about 1 percent of global assets (end of 2012), but it is growing 50 percent faster than traditional banking11. Were the Islamic finance market optimised it had potential at the same date to total $4.09 trillion – or 3.3 percent of global banking assets12.

Total Islamic financial assets are growing 17 percent per year (19.7 percent in QISMUTA,13) and are set to reach a value of $2.67 trillion in 2017, according to PwC14. EY believes that global Islamic banking assets with commercial banks are on course to exceed $3.4 trillion by 201815.

Regionalisation and operational transformation of banking operations are two key drivers of this increase. There are an estimated 38 million customers who bank with Islamic retail banks globally, yet the average number of Islamic banking products per customer is just over two, whereas leading traditional banks have an average of five products per customer.

Service excellence, it is estimated, could increase the market share of Islamic banks by 40 percent from these customers16; whilst by 2018 there will be an estimated 70 million customers17. Greater levels of product and hence consumer data will enable better decisioning at the operational level, and drive growth.

Religion notwithstanding, Islamic bankers may have a product and service offering broadly in line with many consumers’ wishes. Some believe that incorporating environmental, social and corporate governance principals would help Islamic fund managers capture the estimated $33 trillion market of socially responsibly investments, particularly in Muslim minority markets18. Even in Malaysia, 80 percent of sharia-compliant assets are held by non-Muslims.

Moinuddin Malim, CEO at Mashreq Al Islami states that in the ‘…next five years, Islamic banking and finance will witness tremendous growth...only (when it has) product offerings that are at par with the conventional banking in terms of servicing, delivery channels and efficiency19.’ As the competitiveness amongst Islamic lenders is now increasing and customer expectations on faster lending decisions and access to credit increases, Islamic lenders will see the importance of risk investment. In particular, building capacity for granular risk and data analysis to improve development and pricing of products will become increasingly important.

Market structure indicates a heavy concentration, both institutionally and geographically. For example, in 2013 the largest 10 Islamic funds represented 44 percent of total fund assets under management (AUM)20. Likewise, Islamic banking is concentrated within a few countries, with the top three accounting for 61 percent of industry assets21. The top ten countries make up 95 percent of the total. Under the optimised aforementioned scenario, Turkey could have been the world leader with $775 billion but in reality failed to enter the top five, with less than $80 billion. It is likely that as countries such as Turkey develop their sectors that such concentration will dilute. Naturally, demand will also grow.

A: QISMUT – Qatar, Indonesia, Saudi Arabia, Malaysia, UAE, Turkey

...Islamic finance accounts for only about 1 percent of global assets (end of 2012), but it is growing 50 percent faster than traditional banking...”


Global demand for sukuk (Islamic bonds) is expected to reach $421bn by 2016 from $240bn in 201222. The sukuk supply and demand gap is expected to reach its peak by 2014 amounting to $230 billion23. The gap is expected to then drop steadily as market issuance is predicted to reach $187 billion by 2018.

Takaful (Islamic insurance) globally is expected to grow by 16 percent annually in coming years compared to an average 22 percent rate between 2007 and 2011.

All told, 150 new Islamic financial institutions may be needed by 2020 to satisfy global demand says consultancy firm Oliver Wyman24.

The emergence of a global industry: players, plans, and places

Abdulaziz al-Ghurair, chairman of the authority overseeing Dubai’s financial centre, predicts the global Islamic re-insurance market could grow to $20 billion by 2020 from $11 billion at present25. The government of Dubai declared its intention in early 2014 to make the city the global capital of the Islamic economy within three years26. Muneer Khan, a partner at the law firm Simmons and Simmons Middle East, who specialises in Islamic finance in London and Dubai, believes ‘...what Dubai recognizes is that the local population is relatively small and the corporate community is not huge, so they want to be able to cater to a wider community as Islamic finance grows in popularity regionally and internationally27.’ Despite the growth of the industry in the Gulf Cooperation Council (GCC), further optimisation is needed. In the five years to 2012 average return on equity for the GCC Islamic banking industry stood at 7 percent, versus 14 percent for conventional banks during the same period28. PwC suggests that ‘...greater customer centricity, operational efficiency and innovation is needed to improve financial performance of Islamic banks29.’ The use of effective and efficient technology platforms (operation and risk orientated) is central to all three of these goals.

The reward for implementing effective decisioning tools is significant. The three main GCC markets – Qatar, United Arab Emirates (UAE) and Saudi Arabia – ensured that QISMUT Islamic banks surpassed $10 billion in profit for the first time in 2013. The Islamic banking profit pool across these markets is forecast to exceed $25 billion by 201830.

In addition to traditional leader, Kuala Lumpur, London and several other competitors are positioning themselves for market share.

Hong Kong has declared its intention to sell its debut sukuk to spur the city’s development as an Islamic finance hub whilst Singapore has undertaken several initiatives in areas such as taxation, capital markets, real estate investment trusts (REITs), Takaful insurance, and Islamic equity indexes, in order to improve Singapore’s attractiveness for Islamic finance. Besides Dubai, in the GCC there are at least three other cities such as Manama, Qatar and Riyadh that are angling for a share of Islamic financial services business but with limited success31.

In Turkey, the share of Participation banks, those whose practices are structured in accordance with Islamic law, has increased from 2 percent a decade ago to 6 percent, and the Turkish government is looking to increase this to 15 percent over the next decade32.

Promoting Islamic finance in Turkey is part of government plans to boost commercial ties with the Gulf and diversify the country’s investor base33. Islamic bank assets in Turkey could reach between $80 billion and $120 billion by 2017; the lower estimate would give them a 9 percent share of total banking assets, on track to meet a government target of 15 percent by 2023 (which would equate to about $200 billion34 )

Islamic banking challenges

Talent

Widely cited as a significant barrier for both short and long term development of Islamic finance, in 2012 a non-Muslim majority country held the position of being the largest proponent of Islamic finance training.

However, risk experience within almost all conventional and Islamic lenders is predominately held by expatriates with both western lending experience and a forward thinking structured risk approach; as a result the appetite to risk decisioning and automation is now at last beginning to be more progressive.

Estimates show that across the world, Islamic finance will need about 50,000 additional personnel by 201536.

...greater customer centricity, operational efficiency and innovation is needed to improve financial performance of Islamic banks... ”


Figure 2: Education and Talent pipeline35

Regulation

30 countries have stand-alone Islamic finance regulation37. Differing regional interpretations over what constitutes Sharia compliance and what does not represent one significant barrier to harmonising such diffuse regulations. Kuwait Finance Centre notes the industry’s, and regional ‘...lack of standardization38.’ There is little regulatory convergence in the GCC39. Camille Silla Paldi of Diaz Reus notes that ‘...each state has developed its own regulatory system for banks and financial institutions, and in the UAE and Qatar the financial centres have their own laws and regulations.’ As of December 2013 even though all six GCC states hosted Islamic financial institutions, Bahrain was the only GCC with a centralised national Shariah board.

Although the Bank for International Settlements cites the work of the Islamic Financial Services Board and key advances in the provision of a robust liquidity management infrastructure for Islamic finance, it acknowledges ‘...significant regulatory challenge remains in terms of having efficient cross-border liquidity risk management40.’ Against this backdrop is an incremental centralised approach to supervising Islamic finance globally. The UAE is advancing an independent authority which will supervise the country’s Islamic finance industry and replaces a loose federation type structure41. Malaysia has introduced a new single legislative framework for both its conventional and Islamic financial services sectors42.

Chris Cummings, Chief Executive of TheCityUK notes that, ‘...considerable potential exists for expansion of the Islamic finance industry worldwide, although appropriate legal and regulatory structures are crucial for its development in individual countries43.’ Indeed Hussain Al Qemzi, CEO of Noor Investment Group and CEO of Noor Islamic Bank states that ‘...there should be greater collaboration and cooperation among, and between national economies in which Islamic finance participates. It is a real concern that there is no authoritative global body to regulate and promote Islamic finance44.’

Speed of decision

Despite a strong set of drivers indicating future growth, the Islamic finance and banking sectors have a host of challenges to overcome in order to realise such potential.

As new regulatory requirements take effect, Islamic banks will need to become more risk orientated, customer-centric and data intensive.

The competitiveness amongst Islamic lenders is now increasing and as customer expectations on faster lending decisions and access to credit increases, Islamic lenders will see the importance of risk investment. In particular building capacity for granular risk and data analysis to improve development and pricing of products.


Strategy

Several structural issues have the potential to impede growth. For example, a current lack of western experience or knowledge in advanced credit risk decisioning and static or policy driven strategies, as opposed to risk driven decisions, both feature prominently in Islamic banks. Opportunities already exist for changing this paradigm and capitalising on first-mover advantage. Experian Decision Analytics’ advanced and global leading products cater for Islamic lending and help deliver your strategy for growth.

Technology

Given that most modern Islamic banks are only approximately 20 years old and have rapidly changed and invested in growth programmes within the last 10 years, current legacy systems are now struggling to keep up with the pace of Islamic legislation and product innovation. Newer entries can leapfrog the legacy issue but still need to plan for future changes.

To bring systems up to standard and make the banks more competitive requires significant investment and customisation in data centres, networks, servers and storage. Islamic banks know that they have to invest in order to become more competitive against conventional banks and their rivals within their own sector; however emphasis is still on the core banking areas as opposed to credit risk. Few Islamic banks to date have invested in credit risk or have the knowledge and experience to fully apply customer insights to innovate product development and decisions. Going forward, emphasis on customer excellence and speed will be the key differentiator that will separate successful Islamic banks from others. Indeed, EY recently noted ‘...Islamic banks need to implement new systems for effective collection, management and mining of customer data45.’ EY also note that 69 percent of Islamic banks admit they can’t measure product profitability, and hence customer profitability46.The quality and extent of future data expected, the required level of connectivity between internal functions, as well as the level of risk assessment and the speed of delivery required, will prompt organisation-wide change programmes.

Importantly, banking organisations that offer both conventional and Islamic products generally do so governed by 1.) a single risk organisational structure, and 2.) single risk orientated systems, models and software. Lenders tend not to now distinguish and separate the risk orientated procedures and systems between conventional and Islamic products. Since Experian Decision Analytics’ services and solutions are product agnostic, a single deployment caters for both conventional and Islamic lending.

Credit risk management

It has been noted that within Islamic banks, market risk and credit risk are, in effect, bundled together47. In order for Islamic banks to remain competitive and achieve scale, it is important for them to ascertain their credit risks, control or mitigate them, and monitor them on a routine basis48. 62 percent of Islamic banks do not segment customers49. This means developing the capability to make fast, accurate and profitable decisions is of increased importance. The more granular the insight, the better Islamic banks will be able to target small groups and even individuals and compete with conventional finance.

Despite a perception of Islamic finance being based upon “Lending on good faith”, across all the varying Islamic products being applied for, the risk assessment process and governance is generally assessed in exactly the same way between Islamic and conventional products. The observation remains that the applicant, and thus the borrower, are still liable for the debt, whilst the lender i.e., the bank, carries a degree of risk and provisions for loss.

Several components of credit risk management show little difference between Islamic and conventional lenders. One area that does, however, is in documentation. Similarly to the commodity transaction process, Islamic lenders perceive that the delivery of such Shariah documentation should be produced by the data capture, decisioning and loan workflow solution, i.e., the equivalent of Experian’s PowerCurveTM for Originations.

Regulatory change

There is a perception within Islamic banking to measure less by the growth of assets and more by the quality of this growth, thus more emphasis is now on regulatory and risk decision optimisation. With both Basel III and IFSB (Islamic Financial Services Board) liquidity now prominent in Islamic banking agendas experience in the areas of capital optimisation, data management, regulatory reporting and compliance risk management, ensures provisioning is sufficiently managed and delivered.

...emphasis on customer excellence and speed will be the key differentiator that will separate successful Islamic banks from others...”


How Experian can help

In addressing the above banking challenges the Experian Decision Analytics suite of services caters for and delivers:

•Islamiccreditriskdecisioning

•Increasedcross-productIslamicpenetration

•Islamicbankingserviceexcellence

•Dataandcustomer-centricity

•Operationalefficiency

Products and services

PowerCurve™ Strategy Management: Drive profitability with confident decisioning

Shariah compliance is often derived by the way in which liability is assigned and how the debt or facility is funded, not the core risk assessment stage. Anywhere within a lender’s origination process PowerCurve™ Strategy Management automates the critical judgemental Probability of Default (PD) risk assessment and decisioning strategies (segmentation, models, policy rules etc.), ensuring a rapid and consistent decisioning process, vital in portfolio stability. It enables organisations to:

•DrivehigherdecisioningperformanceandROI

•Acceleratetime-to-marketwhileboostingoverallproductivity

•Reducedemandsoninternalresources,analystsand IT

•Easilyincorporatenewdecisioningcapabilitiesintoyour existing environment

•Quicklydesign,test,executeandrefinedecisionstrategies in-house

•Achieveabetterbalanceofriskandreward

•Betterunderstandandmeetcustomerneeds

PowerCurve™ Originations: Cost-efficiently acquire good customers

Bringing the Islamic data capture process, screens, internal and external data and decisioning policy into the single PowerCurve™ Origination platform, not only delivers service excellence but operational and decision efficiency. It enables organisations to:

•Improveprofitability

•Gainflexibilitytoquicklyrespondtochangingmarket conditions

•Increaseefficiency

•Reducetime-to-decisionsandenhancethecustomerexperience

•Decreasecustomeracquisitioncosts

•Managecreditriskandfraudmoreeffectively

•Satisfycompliancedemands

PowerCurve™ Customer Management: Build lifetime relationships profitably

Islamic lenders focussed on increasing profitability and revenue on their existing customer base through creating customer (as opposed to account) decisions can use PowerCurve™ Customer Management to fully optimise their current customer base and portfolio performance. It enables organisations to:

•Matchcustomerstothebestoffertomaximisevalueand drive loyalty

•Executecross-sellandup-sellcampaigns

•Identifyandqualifythecross-sellandup-sellpopulations at both acquisition and throughout the life cycle

•Improvecustomersatisfactionandgenerateadditional revenue

Hunter: Identify fraudsters before they attack your business

Even though the foundation of Islamic finance is based upon “Lending on good faith”, across all the varying Islamic products being applied for, the risk assessment process is often subject to fraudulent individuals or circles that can be identified using Hunter. It enables organisations to:

•Increasefrauddetectionratesandachievefraudsavings

•Streamlineandautomateoperationalprocesses

•Enhanceinvestigationenablingteamstoworkmoretargeted referral cases and maximise resources

•Maintaincustomerservicelevelswithareducedturnaround time for cases

•Deliveraddedvaluewithadditionalrecordingandrejection of suspect policies and claims, improving future investigations


Tallyman: Increase cash flow while minimising collections costs

Within Tallyman, Islamic lenders have the ability to design, automate and execute their compliant collections treatment/strategy, on any early, mid or later stage accounts in arrears. It enables organisations to:

•Improveoperationalefficiencybyreducingcollections costs

•Improvecashflowwithearlierrecoveryofdebt

•Maximiseprofitbycollectingthemostamountofdebtat the lowest cost

•Increasecustomerretentionwithtargetedandappropriate communications and activities

•Controlriskwithcontinuousimprovementstooptimise the collections operation Ensure rapid return on investment with a pre-configured set of proven strategies that can be implemented quickly

•Optimisecapitalallocationandsatisfyregulationswith better assessments of risk levels, predictions of recovery rates and estimates for lower levels of provisioning

Analytics: Extract insight from your data

Experian uses analytics and scoring technology to help organisations all over the world extract value from data and make better decisions. Combining new thinking with existing methodologies helps clients to predict a wide variety of outcomes across all stages of their exposure to credit.

Consulting: Experian’s business consultants provide Islamic lending clients with exceptional strategic credit risk management insight, detailed enhancement opportunities, and deployment strategies. We capture project learnings and best practices across regions and translate this information into valuable global benchmarking used to drive innovative thought leadership in key markets. Selected results have included:

•Increasedclient’srevenueby25percent

•Reducedclient’smarketcostsbyupto10percent

•Reducedclient’sattritionandchurnbyupto25 percent

•Increasedcollectionseffectivenessforourclientsbyup to 35 percent.

Conclusion

There are a host of drivers that individually and cumulatively suggests there is ample room for expansion of the Islamic finance world. The scale is such that it is unlikely that any single hub will dominate, but those countries who can educate their populations, establish a clear position as a thought leader in education and training, but also on how to entrench global standards and also integrate Islamic finance with the wider Islamic economy, stand the best chances of success. It is likely that hubs will co-exist in relatively close geographic proximity – much as Frankfurt and London do in conventional banking, and certain synergies may appear between major players. In a similar vein, partnerships and collaboration will be vital for individual institutions looking to establish or grow in this ecosystem.

The window for success in the emerging ecosystem is shrinking however as established and emerging players embark on significant plans to corner market niches and even the wider Islamic economy. 150 new institutions may be needed by 2020, and the composition, location and impact of these new entrants will be determined in no

small part by the geographical scramble for success in the intervening years. One constant will remain: success at the institutional level will not occur without a solid customer and technology platform. In amongst the embryonic global competition, certain areas of cooperation – from talent sourcing, public education and most importantly, regulatory issues, will become ever more important. Only when regulatory issues are harmonised and consumer banking issues are on a par with, or above, conventional equivalents will the process of integrating both Islamic finance and the Islamic economy accelerate. This will, at the institutional level, require a new appreciation of technology, data, analytics, of credit and risk decisioning, and of a commitment to provide better customer service than conventional banking. Once these criteria are met however, the impact could ripple far into conventional banking processes and practices and the wider global economy as a whole.

About Decision Analytics

Experian Decision Analytics enables organisations to make analytics-based customer decisions that support their strategic goals, so they can achieve and sustain significant growth and profitability. Through our unique combination of consumer and business information, analytics, decisions, and execution, we help clients to maximise and actively manage customer value.

Meaningful information is key to effective decision-making, and Experian is expert in connecting, organising, interpreting and applying data, transforming it into information and analytics to address real-world challenges. We collaborate closely with clients to identify what matters most about their business and customers, then create and implement analytics-based decisions to manage their strategies over time.

In today’s fast-paced environment where developing, implementing, and sustaining an effective strategy is imperative, Experian Decision Analytics helps organisations unlock a wealth of benefits immediately—and set the stage for long-term success.

Increased revenue: Our products and services enable clients to increase revenue by providing the insight and agility they need to find and engage the right customers, target products more effectively, and grow market share.

Controlled risk: A broad range of risk-management products and services help organisations verify identity and manage and detect fraud, optimise collection and recovery, and balance risk and reward.

Operational efficiency: Experian Decision Analytics helps organisations quickly integrate various information and processes to enhance operational efficiency and boost agility. Our flexible, collaborative approach helps organisations increase speed to market, enhance business agility and improve the quality of customers’ experiences.

Compliance as differentiation: Proven expertise lets clients use compliance as source of competitive advantage. Experian Decision Analytics helps ensure compliance with essential regulations, while helping organisations better understand customers.


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