Islamic Finance has great potential, but is being held back by technology

The Middle East and North Africa (MENA) is the birthplace of Islamic Finance, and the region continues to have a significant impact on the sector’s development across the world. Even though the global Islamic Financial Services Industry (IFSI) is relatively young compared to the conventional finance industry, it is already present in over 80 countries. With an estimated size of US $3.1 trillion in 2021, the IFSI is large and growing. Notably, the sector is expected to reach a value of US $4.94 trillion by 2025 and Saudi Arabia, the UAE, Kuwait, and Qatar are among the top five countries with the highest proportion of Shariah-compliant assets. However, a lack of true understanding about Islamic Finance from many software vendors is limiting its growth.

The complexity of operating models

The IFSI has established a strong position in many markets around the world and the industry’s ethical principles are increasingly attractive to a growing share of the population. This provides a strong opportunity for growth.

However, the Islamic Finance operating model tends to be more complex than that of conventional banking. It has stricter and more specific procedural controls to ensure and invoke compliance with Sharia, and to address the cycle in providing the right financing product. This is tremendously important because in some instances, violations during the financing process would impact Sharia compliance and could cause significant risks.

The exact definition of what is and is not Sharia compliant varies from region to region, and indeed from IFI to IFI. This lack of uniform standardization is a challenge but also an opportunity. To capitalize on the opportunity, IFIs must strike the right balance between innovation and standardization.

This added complexity creates a challenge from a technology standpoint. While technology is rapidly transforming financial services all over the world, its impact on the IFSI has been less pronounced. With a few significant exceptions, the IFSI has mostly been poorly served by many technology vendors.

For banks running both conventional and Islamic banking businesses, the standard approach has been to deploy two core banking systems. One system to operate the conventional business and a second one for the Islamic banking business. These are typically conventional systems that have been modified for Islamic Finance, or pure-play Islamic systems.

A problem with modified systems is that there is often a lack of real understanding from these technology vendors about the challenges faced by Islamic Financial Institutions (IFIs) in offering Sharia compliant products and services. Workarounds may remove prohibitions such as the calculation of interest, but the absence of true understanding means that these systems may not fully support the Islamic Finance operating model. They also amplify issues and risks, for example in the way they book and manage Murabaha contracts.

To avoid these problems, some banks turn to systems designed specifically and exclusively for Islamic Finance. However, these are usually built with limited functionality and/or outdated technology. These issues have limited the ability to grow for IFIs and, in some cases, added unnecessary risk and needless complexity.

The right technology

Clearly, conventional banking systems cannot comprehensively address the needs and challenges of Islamic Finance. IFIs need a solution that meets the sector’s requirements, placing special focus on what makes it comply with Sharia guidelines and principles: how financing is managed, and how profit calculation and distribution for depositors are performed. They need a modern, proven, and resilient platform which has been created through extensive research and development.

The capacity to support both conventional and Islamic banking operations is another fundamental feature since banks will only need to deploy one solution. To fulfill the increasing customer and market demands, however, this ideal solution must also combine rich, broad and deep banking functionality with advanced technology. Such solutions do exist – it’s all about finding the right partner. Only then will IFIs be able to shift their focus from everyday activities that just keep the bank running and concentrate on innovating for customers.

They can spend time collaborating, dedicating their attention to delivering differentiated value for their customers and growing their business. By leveraging the power of the cloud, they can reduce operating costs and increase agility. And by tapping into the growing ecosystem-driven nature of financial services, banks can deploy innovative applications that deliver additional value, while reaching new customers through new routes to market.

The right technology can help propel IFIs to new heights, attract new customers and tap into new growth opportunities. To create banking platforms that meet the sophisticated and specialized requirements of Islamic Finance, deep domain expertise is needed. Workarounds such as deleting the word ‘interest’, are not enough - it requires a deep understanding of the principles and practices.

But it takes more than that. The pace of change of technology continues to accelerate. Customer expectations continue to evolve, and financial services must evolve with them. To deliver a technology platform to provide a competitive edge today and tomorrow requires technology expertise and a vision for the future.

To capitalize on this opportunity, IFIs need to combine their business expertise with the right technology partner – a partner with the right skills, experience and robust technology to deliver success today, combined with the vision and flexibility to enable even greater success tomorrow.

Article appeared in Riyadh Daily here.