Banking World

European Islamic Banks- Unlocking the Full Potential

When walking through the heart of London’s financial district, it is impossible to not look up and see one of the most iconic buildings of London’s skyline; The Shard. Since its inauguration in 2012, The View from the 78th floor of The Shard has become one of the most famous points to admire London from. While enjoying the landscape, many fail to notice that The Shard is actually a symbol of the success of Islamic Finance in terms of financing infrastructures in the UK. “When it comes to Islamic Finance, Britain thinks big”, former Prime Minister David Cameron once said.

While enjoying the landscape, many fail to notice that The Shard is actually a symbol of the success of Islamic Finance in terms of financing infrastructures in the UK. “When it comes to Islamic Finance, Britain thinks big”, former Prime Minister David Cameron once said.

The Kingdom thinks so big that to this day it is well known that Britain is unquestionably the western leader of Islamic finance. If London is considered the European center of Islamic finance, it is not only due to its commitment to promote the development of the industry, but also to the lack of competition from the rest of Europe. While countries such as Luxembourg, Germany and France have made an effort to promote progress in accommodating Islamic financial products, the presence of the Islamic finance industry is almost insignificant, and this is not because of a lack of potential. The industry offers a great potential for growth in Europe, both at the wholesale and retail banking level.

At a wholesale level, the Islamic finance industry has developed in Europe mainly through the capital markets. Sukuk’s potential as an instrument for sovereign debt issuance has been demonstrated following the successful experiences of the United Kingdom and Luxembourg in 2014. But probably the greatest potential in Europe for sukuk comes from its ability to finance infrastructure. “The asset-backed nature of Islamic financial instruments make sukuk well suited to infrastructure assets”, states a G20 and an OECD note. This note considers sukuk as one of the alternative sources of funding to invest in European infrastructure. This therefore, makes sukuk perfect for working with other financing instruments with the same purpose, such as syndicated loans or the structuring of project finance operations. Sukuk could also be an additional source of funding for European companies. According to Reuters, Italy has begun to study the possibility of adapting its “mini bonds” legislation in order to provide Italian companies with Shariah-compliant funding options as an alternative to bank lending. It is of great importance that regulatory authorities value the benefits of the issuance of sukuk so that they make the effort to promote reforms that adapt the regulation. The potential of sukuk can only be realized through a level playing field.

 

With respect to the business opportunities at the retail banking level, there is a potential that, if properly exploited, could contribute to the growth of Islamic banking in Europe. Given that the traditional banking model is being questioned, it would be useful to consider the advantages of using exclusively digital channels in order to capture the interest of millennials, who are essential to the growth and future survival of banks. According to Gemaltos’ study Generation mBanking over a quarter (27%) of young people never visit their branch in person and nearly four in five (77%) use online banking services. The importance of this data is magnified when The Millennial Disruption Index reveals that millennials will account for 75% of the world’s workforce by 2025. Among the European millenials, there is a young Muslim population with great growth potential who deals with conventional banks, possibly due to a lack of a solid Islamic alternative. At first, these Muslim millenials are probably the most predisposed segment to test the service of an Islamic bank. In accordance with Gemalto, 94% of millenials have a smartphone, and are accustomed to having everything at their fingertips. In view of the above, it cannot be conceived that an Islamic bank intends to capture the market without a digital offer as competitive as the one of conventional European banks, many of them placed at the digital forefront worldwide. For instance, the British Islamic bank Al Rayan Bank started a digital program in 2013 to enhance its online presence. After a year, Al Rayan Bank achieved a 70% increase in website visitors, and an 80% increase in sales leads received via the online channel. Additionally, more than double the number of sales was completed online and it experienced an increase in its reach to over 8 million consumers through online advertising. Moreover, following the implementation of a social media strategy, the Bank has reached an additional 6.5 million consumers. The results of this program show the importance of using digital channels to interact with the market and the potential of the Muslim consumer base.

Additionally, the complex underlying structure in Islamic financial products should not be reflected in a higher cost to the client in the form of commissions, because how many millenials would be willing to take an extra cost for ensuring that their financial transactions are Shariah-compliant? Therefore, presenting an avant-garde digital experience with competitive pricing is a necessary requirement to attract the market. However, meeting this requirement would not be sufficient to guarantee success. The European banking system is very mature and competition is very high, so Islamic banks must explain very clearly what their value proposition is in order to stand out. A study by Schroders concludes that Millennials are more likely to engage with brands when issues of social responsibility are important to the company. In this sense, the Shariah-compliant label alone is not a determining factor. It would not be enough for Islamic banks to claim that their operations are based on Islamic values, but it is necessary to externalize how these values are reflected in their daily operations. They must demonstrate, not only in theory but also in practice, how Islamic principles can contribute to a fairer and more sustainable progress. It is about promoting a true value-based bank that, through its actions, demonstrates that it is concerned with encouraging entrepreneurship, financial inclusion, environment protection, etc. and in an ethical and profitable way. Thus, not only the Muslim millenials would be attracted to a bank based on Islamic values, but any citizen who worries that his bank will manage his money in a socially responsible and profitable way, without needing to renounce to an excellent digital customer experience.

A relevant fact to note is that recently the Islamic finance industry has seen the birth of FinTech startups based on Islamic principles. The digital revolution is causing a paradigm shift in the financial ecosystem, including the Islamic one, because of the emergence of new business models that challenge the traditional intermediation role played by banks. Equity crowdfunding presents itself as a great opportunity to foster the risk-sharing contracts of Mudaraba and Musharaka, and to channel direct capital into the real economy. A notable case is that of Ethis Ventures based in Singapore, a conglomeration of Islamic crowdfunding platforms specialized in different market niches. In Europe, it stands out as the first Shariah-compliant authorized FinTech Yielders, a London based real estate crowdfunding platform. These examples anticipate some of the advantages that FinTech startups can bring to the Islamic finance industry: democratisation of access to finance through an agile, simple and convenient way.

Traditionally, Islamic financial transactions have been characterized by a great complexity derived from the use of multiple contracts in a single transaction and the participation of several agents. This complexity greatly increases operational and counterparty risk, as well as administrative and legal costs. Blockchain technology could make the process of designing and executing Islamic financial transactions more efficient through the use of smart contracts. Smart contracts could automate the entire contractual process and streamline the operations of Islamic financial institutions. The use of blockchain technology would also allow exploring new possibilities in the industry such as the use of digital currencies and distributed cloud storage, while ensuring the Islamic values of trust and transparency.

In conclusion, the growth of the Islamic finance industry in Europe involves adapting the nature of its products and services to the digital environment. Digital banking, blockchain technology, FinTech startups and in the near future RegTech and InsurTech offer new possibilities that could contribute to the growth and expansion of the industry. In any case, to take advantage of these opportunities adequately, the industry must overcome one of its biggest challenges: regulatory homogenization. To this end, the Islamic Development Bank (IDB) has called for the creation of a global advisory board that can offer greater uniformity to the industry. On another note, the creation of the Islamic FinTech Alliance promises “foster safety and trust by establishing, promoting, and enforcing shared standards for Islamic financial technology”. Given the speed with which changes in the digital revolution era are taking place, it will probably not take long to observe the results of this initiative.