Digitising to drive growth of Islamic banks

Islamic banks need to embrace technology and invest as the returns will follow


THE digital banking reality has landed hard on the laps of financial institutions. Today, digitising the banking services are no longer a luxury, but a commercial necessity.

For Islamic lenders in Malaysia, embracing technology could very well help them sustain growth and profitability.

Hong Leong Bank intends to spend up to RM150m for its digitilisation drive in the current financial year

“Digitalising services is no longer an option, it’s a matter of survival,” Othman Abdullah, CEO of Islamic banking and innovative services delivery at Silverlake Sprints Sdn Bhd, told The Malaysian Reserve (TMR).

However, the path towards digitalising in the financial sector does not come cheap. For many of the smaller players, the price tag can be a major hurdle.

“The investment is huge. The bigger banking groups like Maybank and CIMB may have more resources than smaller and standalone Islamic lenders like Bank Muamalat and Bank Islam,” he said.

Malayan Banking Bhd (Maybank) and CIMB Group Holdings Bhd are two of the bigger financial institutions in Malaysia with Islamic bank subsidiaries. On the other hand, Bank Muamalat Malaysia Bhd and Bank Islam Malaysia Bhd are standalone Islamic players.

Regardless of size, Othman said the Islamic banks need to embrace technology and invest as the returns will follow.

He cited Bank Islam Brunei Darussalam Bhd as an example. The Brunei-based bank saw its business growing after its investment in technology enabled the bank to reach out to new customers at a lower cost. In the process, it expanded and improved on its processes and product offerings.

Silverlake Sprints is a company under the Silverlake Group, a major banking and financial solutions and services provider in the Asia-Pacific region.

On the Malaysian shores, Bank Islam saw a 80% growth year-on-year in Internet banking-related fee income in 2018, as Internet banking users and transactions showed significant growth under the bank’s multi-year digitisation initiative, a Moody’s Investors Service’s report stated last week.

Bank Islam’s Internet banking users grew 25% to 1.2 million users with online transactions rising 133% in 2018.

Money remains the core issue with digitalisation. Major technology spending can run into the hundreds of millions of ringgit. Faced with such huge spending, board or directors of smaller Islamic banks tend to be more cautious in giving their approval stamp.

On its part, Hong Leong Bank Bhd, for instance, intends to spend up to RM150 million for its digitilisation drive in the current financial year.

CIMB Bank Bhd has set aside RM2 billion for 2019 to 2023 to invest in enhancing technology and data analytic capabilities for operational digitisation, inclu- ding Islamic banking.

CIMB Bank’s conventional and Islamic banking’s digital users grew 23% to 4.9 million users last year, while digital transactions grew 35% to 209 million transactions.

As customers opt for the convenience of online banking, Bank Islam, the largest standalone player locally, has committed RM300 million for digitisation for 2019 up to 2021.

In 2019, it plans to triple its spending to RM150 million from the year before.

MBSB Bank Bhd, which became a full-fledged Islamic bank after taking over Asian Finance Bank Bhd last year, has earmarked RM250 million for a new platform that will help it develop a technology-centric business model and accelerate business growth. MBSB Bank will convert five out of its 46 branches into digital branches.

With Islamic financing growing in the double-digit level annually, Moody’s expects digitisation to accelerate among Islamic banks and help expand at lower cost due in part to reduce operating expenses, as a result of streamlining and automation of internal processes and lowering costs to acquire and serve customers.

Another benefit of digitisation is access to the public as it can help them overcome their small physical or network presence to boost revenue, the international rating agency stated.

Blockchain technology can also be used to automate and streamline contract execution for Shariah-compliant financing and investments, which tend to be complex and involve voluminous documentation.

“Blockchain adoption can improve cost efficiency. Some fintech companies, such as Blossom Finance in Indonesia and HelloGold in Malaysia, have pioneered the use of the technology for this purpose. Banks have started experimenting with it as well, though more slowly than their fintech competitors and peers in the Gulf Cooperation Council (GCC),” Moody’s said.

Fintech Players
From a market perspective, Islamic banks may have little choice as the market is getting more competitive with newcomers moving into the lending space with the help of technology.

Peer-to-peer (P2P) platforms like Funding Societies Malaysia have tied-up with e-commerce giant Lazada Malaysia to offer short-term and e-commerce financing, while transactions undertaken by e-wallet service providers continue to bloom.

Despite the many changes to the market environment, Moody’s noted digitisation among local Islamic banks, coupled with continued government commitment to developing Islamic banking, will drive sector growth.

The rating agency stated, while the emergence of fintech will intensify competition, it will also facilitate the expansion of Islamic banking — rather than stifling it — by driving banks to increase investment in digitisation and keep up with evolving consumer demand for financial services.

It noted as at end-2018, Indonesia had the largest number of fintech start-ups offering Islamic products and services globally, ahead of Malaysia and the United Arab Emirates.

Moody’s said competition from fintech start-ups providing Islamic financial services will increase beyond digital payments and e-wallets, with growing numbers of fintech companies now offering Shariah-compliant pro- ducts for P2P financing, equity crowdfunding, remittances, personal finance and wealth management.

Bank Negara Malaysia (BNM) is also expected to have a virtual banking framework ready by end-2019, which could increase competition for deposits — particularly among Islamic banks with weaker deposit franchises.

“Compared to their conventional peers, Islamic banks in Malaysia have smaller physical networks and fewer resources to gather low-cost retail customer deposits. As a result, Islamic banks in the country are often reliant on large corporate depositors that tend to be more sensitive to rate changes and hence are a less secure source of funding than retail depositors,” Moody’s said.

In this area, Fintech Association of Malaysia president Mohammad Ridzuan Abdul Aziz believes there is room to grow for traditional lenders, as long as they recognise the benefits of working together with digital players.

“The proposal by BNM to licence virtual banking alongside the traditional players must not be seen as a competition,” Mohammad Ridzuan told TMR.

He said traditional players and virtual banks should take this opportunity to collaborate in order to serve all segments of society, blending the traditional banks’ long history of services, transactions data and trust from the middle and upper class with virtual banks’ ability to attract younger consumers, the under-banked and un-banked, and migrants due to their value-adding and convenient services.

On the bright side, Moody’s believes conditions are favourable for fintech development in Malaysia, as the country has a large, young and fast-growing population, with increasing Internet access and mobile penetration that will spur adoption of digital financial services.

Malaysian regulators have also been steering banks to tackle emerging environmental, social and corporate governance (ESG)-related risks while pursuing growth, a credit positive move in Moody’s books.

“Malaysia, which has led the Asean region in regulatory efforts to support Islamic banking, has introduced a framework to incorporate ESG values in Islamic banks’ operations and risk governance. This will create new growth opportunities for banks that follow Shariah principles,” it said.

Domestically, most Islamic banks operate as subsidiaries of larger conventional banks. While some experts believe more Islamic banks should be publicly-listed as separate entities in order to provide more Shariah-compliant stocks, Moody’s said Islamic banks will be digitised faster this way as they will benefit from their parent lender’s overall digitisation investment.

Government support will remain a key growth driver for Islamic finance, with Malaysia on track to meet its “ambitious” growth target for the sector.

The country aims for Islamic banking assets to comprise 40% of total banking assets by 2020, from 33% as at end-2018.

Maybank and CIMB Bank have adopted an “Islamic-first” approach in growing their domestic business, by offering Islamic products to all new and existing customers across business lines for individuals, small and medium enterprises, and corporates.

As a result, Maybank’s Islamic banking contributed 59% to total financing in Malaysia last year, up from 57% in 2017.