Technology in Islamic banking

Western banks operating in the Islamic banking market need to understand the cultural differences to implement technology sucessfully, says .

The question about whether differences arise when implementing technology in an Islamic bank in comparison to one that operates under a Western ‘conventional' model attracts a mixed and sometimes contradictory response. There are clearly some similarities: the goal of achieving high levels of customer satisfaction and the need to deliver increases in sales and profitability are among the shared drivers, and technology can play its role in helping them to achieve goals like these. However, modern Islamic banking is only about 40 years old and it has developed the most within the last 10 years. This means that it is comparatively immature, and so it has some catching up to do.

Jeff Wolfers has recently returned from a two year contract as a chief information officer and board director of the National Commercial Bank in Jeddah, Saudi Arabia. NCB is the largest bank in the region and it's very advanced in how it applies information technology to Islamic banking. So he's well placed to comment on the differences.

He says that the challenges fall into two distinct categories: the first is about how to deliver banking technology in the Middle East, and the second challenge is the need to create financial and banking products that comply with Sharia law - the application and interpretation of which varies from country to country.

The use of banking technology is quite nascent too. He says that telecommunications networks can be quite fragile and prone to failure in the Middle East. This means that "branches can be off air for a week while the local telecoms companies fix the problems, and technology vendors often operate through agents that have few skills", he explains. These problems aren't that easy to solve, and that's because he says it can be hard to bring the necessary IT talent to the Middle East as it's not the most attractive employment destination for some Westerners.

Adding fire to this issue is the fact the region's governments have visa regimes that restrict the number of foreigners that can live and work in their respective countries. This doesn't mean that local world class talent doesn't exist. It does and Wolfers says that it is growing, but it is scarce. With all of these challenges in mind he comments: "I would say that few in the Islamic banking world deploy advanced technology as the banks are so young, and so they are generally deploying first or second generation systems across their estates."

As a CIO he thinks it's important to support and deliver solutions that are solid, dependable as well as supportable, but they don't have to be leading edge ones. "My philosophy is to stick with established names like Microsoft, Cisco, HP and so on whenever I source solutions," he says. Yet life isn't so simple even with these big IT names in play, and that's because the regulators are finding it hard to keep up with the growing demand for Islamic banking products (the Financial Times reported on 27 March 2012 that Saadiq, the Islamic banking arm of Standard Chartered Bank, saw revenue grow by 65% in 2011 compared with 2010).

Under development

As a result products are still being developed. The key aim is to make a profit without exploiting the less well off in society. Islamic banks and financial institutions, for example, are not permitted to sell loans that charge interest and nor are they permitted to buy the kind of toxic debts that saw the downfall of many conventional banks. The permissible methods of transaction are described in Infotech's Modern Islamic Banking whitepaper. They are ‘cost-plus-sales' (murabaha) where the buyer knows the mark-up cost of the product and the seller's profit is fixed; credit sales where an added percentage of profits can be charged for a deferred payment period; leasing (Ijarah), where the customer is not required to pay any interest although they have to pay a fixed fee that takes into account an array of factors including the customer's creditworthiness; and partnerships (musharaka or mudaraba) are permitted in which ownership is shared by the bank and its customer.

Due to the complexity of all of this, domestic property mortgages are among the Islamic products that are yet to be approved by the regulators. The key difference with conventional mortgages is that no interest can be charged by the banks, but a fixed price is agreed and the lender become effectively a tenant of the bank until the loan for the house he's bought has been paid off. Islamic banking aims to be fair to both parties, but without a clear definition of the Islamic financial products Wolfers says there is no way that "purchased software products can support them".

Technology customisation

For this reason product features often developed in-house. Yousif Alkhan, assistant general manager of information technology at Ithmaar Bank, says that conventional products tend therefore to be more standardised than Islamic ones. "As a result technology customisation amounts to most of our implementation effort," he says, explaining that from his point of view there are otherwise no fundamental differences between conventional and Islamic banking. That's even though the implementation of technology can take longer than within a conventional bank, but he's right to point out that both types of banks need to adhere to regulatory compliance.

Wolfers nevertheless adds that the traditional retail banking delivery channels are 10 years behind those deployed in the West. The respective first and second most popular customer channels remain the branches and ATMs. The third most favoured channel is the call centre. The internet and mobile banking channels are the least preferred ones. "Cash remains king and credit card lending is almost non-existent, and this is why branches and ATMs are the most important channels," he says.

He also argues that service levels fall well below Western standards in Islamic banks, and this is often caused by a lack of investment in core banking technologies - including a lack of back-ups. "To bring systems up to par with 99.5% availability levels can require significant investment in data centres, networks, servers and storage," he explains. All of this is vital because technology is critical today to all retail, commercial and investment banking alike. Islamic banks know that they have to invest in order to become more competitive against conventional banks and their rivals within their own sector.

Driving competitiveness

"We are like any other banks as we use technology for all of the areas of our lives - including risk management, back-office operations, for the delivery of financial products and services to our customers and so on," says Alkhan. For this reason he puts much of his bank's effort into the implementation of technologies for channels like ATMs, mobile and internet banking. "We intend to remain ahead of our competitors in terms of the implementation of technology; we think that all of Ithmaar Bank's stakeholders benefit and we want to continually improve our services," he says.

Bryan Foss, visiting professor at Bristol Business School and a non-executive director at Source Global, says that niche banks demonstrate best practice in the Islamic banking market. "They have proved to be effective as they may be able to better focus on driving change, but customers need a broad range of Sharia-compliant and other financial service solutions," he says, adding that "this provides a role for those firms that can operate across multiple product ranges and offer services across geographies that have varied Sharia-compliance regulatory regimes".

The ‘broad range' that he refers to also means that banks like HSBC and Standard Chartered Bank are developing conventional and Islamic products that sit along aside each other in the same geographic markets, and to succeed they need to clearly understand their risks and objectives in order to create and implement an effective development strategy.

Clarity is also about knowing where there are conflicts of interest between compliance with Sharia and international regulations. Alkhan says that technology helps to ensure compliance by recording transactional and customer data, but the integration of both systems is often quite demanding. In the past a lot of the reporting was completed manually, taking a lot of time and effort to finish. Reliable IT systems and solutions are nevertheless available to help Islamic banks to manage it today in a more efficient and timely way.

"I have experienced the differences between AAOIF, the accounting standards for Islamic banking, and IFRS, which is used by the conventional banks, and there is a mapping process to help us to bridge the differences and we have to support these standards during the development phase, which requires us to consider the different entities we have operating in different regions and their different reporting requirements," he says. These arise due to cultural and regulatory differences within each market, whether it be Malaysia or the UAE. Each has its own regulatory regime.

Learning from Islamic banks

Alkhan concludes that conventional banks can learn from their Islamic counterparts by behaving ethically, being aggressive and moving quickly as the focus needs to be, in his opinion, on being innovative rather than just on what's currently happening within the market. In contrast Wolfers says that it's a touchy subject as he doesn't believe that conventional banks can learn from Islamic banks. However, Western banks or CIOs operating in this market (which the FT says will be worth $990 billion by 2015) do need to comprehend the cultural differences in order to be able to successfully manage the implementation of
new technologies which will bring about change in its many guises.

Technology is often disruptive and Mohammad Harb, head of Islamic banking business development for retail and corporate banking at IT vendor Misys, concludes: "The cultural difference between Islamic and conventional banks is a very important aspect of which the technology implementer needs to be aware, and even though some differences may be trivial." Change and how Islamic banks are going to adapt to their growing market by implementing advanced IT is therefore going to be perhaps one of their key challenges, and Western banks should use IT increasingly to enforce their own markets' rules and regulations to prevent the excessive risk-taking that led to the recession.

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