LONDON, 14 March 2005 — Islamic banking has emerged as a unique differentiation strategy for Gulf financial institutions by focusing as a niche segment or market, stresses a report published recently by Standard & Poor’s (S&P), the international credit rating agency.
This is partly because of non-price competition dominated by the big banks in each of the Gulf Cooperation Council (GCC) countries including National Commercial Bank in Saudi Arabia; National Bank of Kuwait; Qatar National Bank; and Bank Muscat. “The GCC’s banking systems, which are modernizing quickly but opening up slowly to competition,” explains the report, “face some strategic decisions. As these systems are key assets for local economies, most of them, with the exception of those in Bahrain and the UAE, remain fairly protected and concentrated. In such an oligopoly, the banks have very limited incentives to compete purely on pricing and so far have not done so, which has safeguarded margins and has kept profitability at high levels.”
The Islamic (banking) alternative, thus, says the report, is a kind of specialization, which is all the more interesting as a natural market exists in the Gulf for Islamic products and services, whose potential new foreign entrants and even some existing regional competitors could hardly afford to deliver. “The Islamic option is also viable in the long term because it fits very well with the retail-banking and borrowing needs of a growing population eager to rapidly improve its living standards.”
Despite the fact that there are currently 17 commercial Islamic banks in the Gulf, the S&P report suggests that the sector is not yet crowded and that there is room for some of small banks to transform themselves into Islamic banks. Some mid-size banks such as National Bank of Sharjah (NBS) and Kuwait Real Estate Bank have successfully converted into Islamic banks, not merely retail banks but also offering corporate finance, asset management, and securitization products and services.
These banks have also recently increased their capital as their outlook and strategies take in potentially cross-border GCC expansion. NBS has even changed its name into Sharjah Islamic Bank so as to consolidate its identity as a dedicated Shariah-compliant bank and to avoid confusion in the market.
The S&P report seems to extol the so-called “Emirates Model” following the successful conversion of Middle East Bank, a wholly-owned subsidiary of the Emirates Banking Group, into the Emirates Islamic Bank. The subsidiary model is favored because a full transformation of large conventional banks into Islamic financial institutions apparently is not seen as an option because these banks are seeking universal banking status. The Middle East Bank, which is a retail bank, says S&P, confirms the close link between retail and Islamic banking.
At best the S&P report is a seemingly informed cursory discussion of some of the issues relating to the Islamic banking market in the Gulf region. At worst, it completely ignores the underlying issues relating to Islamic banking regulation, supervision, corporate governance, compliance, conflict of interest, over-exposure to certain asset classes, market entry barriers, ownership structures, and banking policy both from a nationalistic and a political point of view. Indeed, there are many serious issues relating to the above that is surfacing currently in Gulf and global Islamic banking.
As such some of the assertions in the report are over-optimistic.
While the driver of the contemporary Islamic banking movement has been a resurgence of Islam and its manifold heritage (including a system of financial and economic management) over the last sixty years; in recent years this has been complemented and some would say taken over by the sheer increase in liquidity in the Gulf region due to higher oil revenues.
Unfortunately this increase in Islamic banking activity has not been matched by a systemic approach to Islamic banking by Gulf governments. How for instance can Islamic banks operate in Saudi Arabia if there is not a stand-alone Islamic banking law which govern their operations. Cynics might stress that this is exactly what the UK is doing following the authorization of the Islamic Bank of Britain last September. But then, the Shariah is not the claimed constitution of the UK.
So when Bank Al-Jazira eventually converts into a fully-Islamic bank, it will only have to satisfy its own internal processes and its Shariah board; and not the Saudi Arabian Monetary Agency (SAMA). For how can it satisfy the provisions of an Islamic banking act which does not exist? Yes it will have to satisfy SAMA on the normal provisions of capital, reserves, capital adequacy, management quality, compliance and so on, which are required of all banks incorporated in the Kingdom.
Similarly, it took Kuwait more than three years to adopt and ratify an Islamic banking law. Bahrain, armed with the ambition of being the international Islamic financial center, has belatedly been trying to reform its regulatory and supervisory regime, and has adopted a more systemic approach.
However, in sheer scale, policy, R&D, human resource, political will, monitoring and enforcement, and strategic thinking, it is light years behind the Malaysians, to whom Islamic banking is an alternative system of financial management — yes ingrained in the religious heritage of the Malay and other Muslims, but always a financial system which needs to be properly regulated, for both banking and ethical reasons.
Dr. Ishrat Husain, governor of the State Bank of Pakistan, has confirmed that Pakistan has abandoned its policy of Islamization of the banking system; and has instead adopted the dual-banking model of Malaysia — where an Islamic system operates side-by-side a conventional banking one, and where the two systems cooperate but do not interact so as to pre-empt the co-mingling of halal (permissible) and haram (non-permissible) funds.
“We started pretty late. We learnt a lot from the Malaysian model. We are adopting a three-tier approach: One is that we allow stand-alone Islamic banks; secondly, we allow banks to set up dedicated Islamic subsidiaries; and thirdly, we allow conventional banks to open Islamic banking windows and branches,” explained Dr. Husain.
The “Emirates Model” similarly may not be suitable for all conventional banks. NCB, for instance, does not have a smaller retail subsidiary to transform. Instead it is converting parts of its business into Islamic such as the retail division.
There are those who stress that NCB may go the whole way and convert fully into an Islamic bank, which is logical, given that its retail activities is now going down that route, and its asset management portfolio is overwhelmingly Shariah-compliant already.