Managing yields and wealth to shape Islamic finance in 2018


In this second of a three-part series, I look at two more trends that may shape and reshape the contours of the Islamic banking and nance industry.

In Part One entitled “Five Trends that will Shape Islamic Finance in 2018”, I had discussed the impact of the fourth industrial revolution, financial technology and digital banking, as well as value-based intermediation.

Trend 3: Managing Costs and Yields NSFR Impact to Cost of Funds and Margins

In the aftermath of the global banking crisis of 2008, where taxpayers’ money had to be used to bail out banking institutions which had been flagrant in their risk-taking activities, the banking industry has seen greater regulatory controls on capital and liquidity.

One such measure is the Net Stable Funding Ratio (NSFR), which basically stipulates that every dollar of assets in the books of the bank must be funded by an equal dollar amount of stable funding in the form of liabilities and capital.

Stable funding, meanwhile, means the banking institution’s capital and liabilities that qualify as stable over a time horizon of up to one year. As such, the longer the tenor of the liabilities, the more stable the funding.

Additionally, funding provided by retail customers and small business customers are assumed to be more stable than wholesale funding of the same maturity. Funds, which are considered less stable, will have a run-off factor, which basically dilutes the weightage of the funding.

The NSFR effectively compels banking institutions to raise more stable funds to fund its activities and be more mindful of matching its liabilities to grow its assets. In a more practical sense, as banking institutions head towards the implementation date of the NSFR by January 2019, there is going to be a deluge of promotional campaigns to attract every dollar of retail deposits to satisfy the NSFR requirements, which in turn would cause the cost of funds to rise and consequently, the net yields to decline.

Observations of Bank Negara Malaysia monthly statistics reflect that the compounded average growth rate of savings accounts at Islamic banks on a monthly basis between January 2016 to October 2017 was a meagre 0.46%. This compares to a growth rate of 1.17% for Islamic fixed deposit accounts over the same period, which is a sign of the tendencies of Islamic banks to shift their deposit strategies to the stickier form of fixed deposit accounts, albeit at a higher cost of fund. The differential margin between returns paid to fixed deposit account holders (12-month tenor) and savings account holders is almost 260 basis points in October 2017, a staggering gap which has largely been the culprit in the decline in yields of the Islamic banking industry.

Smaller-sized Islamic banking players, especially the standalone full-fledged Islamic banks with a smaller network of branches and delivery channels, will find it hard to compete with the bigger players. (This may call for a consolidation of the Islamic banking industry, which is not offered as a trend in 2018 in this article, but may happen over time eventually.)

So generally, Islamic banking players will have to gear up to weather the turbulence that is looming, as the target date of NSFR compliance draws closer. Conserving liquidity, repricing of assets to manage yield, shortening tenor of risk exposures, strengthening recovery efforts to improve writeback of impairments, more robust credit discipline, expansion of deposit base and cross selling of products will be the key business mantra.

At the same time, there will also be a push towards growing and expanding the wealth management and fee-based income products and solutions, which is explained as the next trend that will shape the Islamic banking industry in 2018 — the rise of wealth management business.

Trend 4: Wealth Management Business as a New Source of Growth

As the banking industry faces the prospect of margins being squeezed to its last bits of pulp amid challenges from various fronts — digital, regulatory and general economic headwinds — it is imperative that banking institutions identify newer sources of income, profits and growth to sustain their value.

In recent times, the forays of major banking institutions in the South-East Asia region into the wealth management business give a glimpse of the strategies taken by major banks towards being battle-ready to face challenges within the financial sector in coming years.

In October 2016, DBS Bank Ltd, the largest bank in South-East Asia, announced its acquisition of the wealth and retail assets of Australia & New Zealand Banking Group Ltd. Earlier in the same year, another

major player in the Asian banking industry, Oversea-Chinese Banking Corp Ltd, made headlines when they tipped DBS into buying Bar- clays plc’s wealth and investment-management business in Singapore and Hong Kong.

These acquisitions reflect the conscious initiatives taken by major financial institutions to consolidate their market position and ensure sustained value creation for their shareholders through diversification of their business into the private financial wealth of high-networth customers.

According to Boston Consulting Group, global private financial wealth grew by 5.3% in 2016 to record a size of US$166.5 trillion (RM656.01 trillion). For the past couple of years, the largest growth in private financial wealth occurred in the Asia Pacific.

Asia Pacific’s rich grew their wealth by 9.5% in 2016 to record a size of US$38.4 trillion and this is projected to grow to US$60 trillion by 2020. This is mainly contributed by the rising wealth and affluence of China and India, where economic reform and transformation are taking shape in earnest.

Within this backdrop, Islamic wealth management appears to be just a blip on the radar screen. The Islamic wealth management industry has a size of about US$100 billion, offering products such as takaful, Islamic equity and sukuk funds, gold, commodities and more recently, investment accounts, among the asset classes.

The Islamic Financial Services Board 2017 Stability Report stated that 73% of the Islamic funds have less than US$25 million assets under management (AUM), while the average size of conventional funds is US$394 million AUM. This means

that a considerable number of Islamic funds do not reach the critical mass necessary for efficiency and sustainability, which hinders their potential to grow and source for a wider pool of investors.

Ironically, the potential opportunity for the Islamic fund industry is humongous if we take the US$2.5 trillion total size of the sovereign wealth funds of Muslim nations as an indication of potential demand. Therefore, the Islamic wealth management industry needs to seriously and quickly diversify its range of products and solutions to tap into the growing affluence of Muslim investors (and ethical- based investors).

In this regard, the initiatives by Malaysia’s Employees Provident Fund in setting a dedicated pool of Shariah-compliant funds and several other initiatives by Islamic Development Bank, Islamic Corp for the Development of the Private Sector and other global fund management players in forming Shariah-compliant funds for various sectors such as small and medium enterprises, infrastructure, gold, commodities and others, offer huge potential opportunities for the growth of the Islamic fund and wealth management industry in 2018.

It is imperative for the Islamic wealth management industry to remake itself to become an important component of the next growth momentum in Islamic finance.

  • Syed Alwi Mohamed Sultan 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.