The 5 trends that will shape Islamic finance in 2018

From geopolitical issues in Gulf Cooperation Council countries to the unsavoury default in sukuk blaming non-Shariah compliance, 2017 was an interesting year for Islamic nance. Now, as 2018 begins, here is a non-exhaustive list of five trends which may shape and reshape the contours of the Islamic banking and finance industry.

Trend 1: Impact of Industry 4.0, fintech and digital banking

“The Fourth Industrial Revolution” (Industry 4.0), title of the book by Prof Klaus Schwab, is the notion of an industrial revolution that will alter the way we live, work and interact with one another, including how we utilise and deploy highly disruptive technologies such as artificial intelligence, robotics and blockchain technologies. This impact is clearly evident in the banking industry.

The banking industry is facing competitive threats from two sets of technology-driven companies that have arisen from this Industry 4.0; one set consists of large technology companies such as WeChat, Alibaba Group Holding Ltd and Apple Inc, and the other set comprises new financial technology (fintech) companies. These large companies have used the loyalty and reputation of their core product offerings such as

smartphones, technological gadgets and social media platforms to penetrate and disrupt the traditional product offerings of banking institutions. On the other hand, the new, and often startup, fintech operators are leveraging on their lower operating costs and absence of regulatory burden to offer differentiated and convenient value propositions to solve traditional financial problems that would otherwise require lengthy processes and documentations by traditional banks.

It is imperative for banking institutions to decide whether digital investments are meant to be a new source of business growth, which diversifies sources of income or alternatively, meant to improve cost efficiencies within the existing business operations. One example of a digital journey is in finding new ways to improve customer engagement. Establishing an omni-channel platform is one approach of how digitisation can improve customer origination and engagement. Digital initiatives may also be driven by a need to improve processes through automation to enable, say an online paperless account opening by cloud-based documentation management system. Data cleansing solutions to improve the sophistication of customer analytics to enable mining the wallet size of the customer is another digital initiative too. These examples, related to customer engagement, automation and data analytics, may not have an immediate and direct impact to revenue, but offer long-term capabilities towards strengthening the current business model.

On the other hand, there are also digitisation projects which are primarily revenue-based innovations or entirely new business lines, such as offering of online transactional banking services, robo-advisors, innovative mobile payments and other similar value-added products and services. The point is, the range of digitisation is so diverse, cutting across every market, every product line and every distribution channel.

On that score, the Islamic banking industry has to brace itself to face the unprecedented scale of onslaught of these digital and fintech disruptions. The challenge for Islamic banks now is to put in place a flexible and robust business model that is relevant and efficient, while keeping intact the sanctity of Shariah governance and Shariah compliance within the changing landscape of banking technologies, and the increasingly loud call out for banks to be more ethical and value-based.

Trend 2: Value-based Intermediation

That leads to the second trend that will shape the Islamic banking industry in 2018 — value-based intermediation (VBI). VBI is an attempt to realign the focus of Islamic finance towards creating greater socioeconomic impact. This is a ground-breaking initiative by Bank Negara Malaysia (BNM), which produced a strategy paper in July 2017 that proposes several strategies for the Islamic

banking industry to adopt. BNM governor Tan Sri Muhammad Ibrahim said VBI is “the next frontier, and the major milestone would be positioning Islamic finance to become more prominent and a leading agent of positive change for the financial system, built upon shared values of integrity, inclusivity and sustainability”.

The VBI initiative supplements the Sustainable Development Goals, which cover a wide spectrum of development challenges including poverty, inequality, climate change, sustaining ecosystem and cities, health and education, among others. To achieve most of these objectives, finance plays a pivotal role to facilitate and intermediate capital allocation. For example, to achieve clean water and sanitation or affordable and clean energy, finance plays the part in designing financial structures such as green bonds or sustainable and responsible investment funds, that allow funds to be mobilised towards funding these sustainability projects.

But following several financial crises over the past decade, including the subprime-lending into the residential mortgage sector that gave rise to the global financial crisis in 2008 and later in 2012 the London interbank offered rate-rigging scandal, to name a few, doubts have been raised on the finance sector. The finance sector is blamed to have lost its way, strayed from its stewardship role into activities totally unrelated to the real economy and its needs. Too many people remain excluded from the financial system and from access to fair finance. To a certain extent, Islamic finance is not entirely excluded from this malaise.

It is high time Islamic finance steps up to the plate and become the beacon of light for the financial industry. Being a financial system that is inspired by the principles of fairness and justice that balance rewards and risks in an equitable and transparent manner, linking finance with the real economy, Islamic finance is the most suitable proxy to win back the confidence of the consumers to the financial sector. Having said that, the pressure will be on Islamic financial institutions to improve their policies, processes and product offerings to be more proactive in ensuring they create a positive and sustainable impact to the economy, communities and the environment, towards building a credible reputation that Islamic banking is ethical and value-based in all ways.

The challenge will be in assessing the cost of all this exercise, while also managing the rising costs within the turbulent global financial sector, which brings us to the next trend that will shape the Islamic banking industry in 2018 — managing costs and yields. (To be continued.)

  • Syed Alwi is Bank Muamalat Malaysia Bhd executive VP of strategic planning division. The views expressed are of the writer and do not necessarily reflect the stand of the newspaper’s owners and editorial board.