Fintech OS: The demand for Shariah banking and how to meet it

By Teodor Blidarus, CEO and Co-Founder at FintechOS

The Islamic finance industry is worth GBP 1.6 trillion globally and is set to grow 12% this financial year. This is a huge, largely untapped market for Western banking – but it’s also a complex one. Islamic finance is unique. Followers of Islam must adhere to the principles of Shariah law, a system of rules that determine what is acceptable in Islamic culture. Shariah includes a strict set of guidelines regarding economics and the lending of money, which must be adhered to by banks hoping to cater to Islamic customers.

These restrictions are implemented by Shariah advisory or supervisory boards such as, the International Islamic finance boards including the Accounting and Auditing Organization for Islamic Finance Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB), who have the final say on what is permissible for Islamic banking.

What is Shariah banking?

The rules for Shariah banking essentially comprise a different way of doing business that isn’t compliant with most Western banking policies. This means Muslim customers need to use specialist banks or banking products to meet their needs. This leaves a huge number of customers and a large pool of wealth in need of Shariah-compliant services. Moreover, many commentators are championing Islamic finance as a more-ethical alternative to traditional banking. Shariah finance encourages lenders and banks to act unselfishly in an equal partnership with their customers.

It’s no wonder that Islamic banks are becoming more prominent in the market for example, the UK has five Islamic banks, and over 20 banks offering Islamic products.To access this growing market, banks need to be able to offer Shariah-compliant financial products – but this is easier said than done.

The basic requirements for Islamic finance

• Riba: Perhaps the biggest difference between Western finance and Shariah banking is that making interest on loans and savings is considered unethical. Riba, in Islamic culture, is where earning interest is seen as an unfair advantage to the lender at the expense of their customer. Shariah law rules that money has no intrinsic value and is merely a means to an end. Banks are expected to take fair payment for the services they offer in the acquisition of a specific asset.
• Murabaha: Instead of interest, Islamic finance works on the basis of murabaha. Rather than taking out a loan, the customer is hiring the bank to act as their agent in acquiring an asset. The customer will then pay the bank back for the cost of the asset, along with a fee for their services. This is known as ijarah.
  There can be no fluctuation in the amount the customer pays on top of a Shariah loan, as the fees are agreed beforehand. There can, however, be trading involved, with profits and losses shared between you and your customer. Rather than earning interest on your customers’ loan, you’re essentially investing in them and their future prosperity, becoming their business partner in life.
• Gharar: Shariah prescribes banks must be altruistic in their service of customers. Islamic banks need to make an active effort to ensure their customers are aware of risk. Islamic banks need to make an active effort to warn their customers about any possible adverse outcomes to their lending. This means having clear conversations with customers about how likely they are to benefit from any investment to avoid contractual ambiguity – known as gharar. This is the kind of culture that regulators are fighting to instil into the Western banking world yet are struggling to find a way to standardize that across the industry.
• Ihtikar: Islamic finance must also avoid any kind of ihtikar – monopoly. Not only must that industry remain fair and competitive for customers, but also make sure that there’s no barriers to entry for Western banks willing to offer Shariah-compliant products.

Western banks can offer an ethical alternative

While Islamic banks, such as Gatehouse and Al Rayan, are end-to-end Shariah-compliant, Western banks may own a Shariah-compliant subsidiary, such as Emirates Islamic. However, what’s more common is the so-called Islamic Window option. So long as the process remains compliant with most Shariah provisions on ethics, banks can use their existing funding to offer Shariah-compliant products to both Islamic and non-Islamic customers.

This means your Islamic offering will be acceptable under Shariah and offer a potentially more ethical alternative to your entire market. Banks in the UK offering Islamic Window products include HSBC, Barclays, Deutsche Bank, and JP Morgan. It’s a straightforward way to enter the lucrative Islamic market without a top-down restructure of your organization.

Making the transition

The Islamic banking industry is a showcase for the ethical banking opportunity and the industry must listen to the demands of its customers if it wants to stay ahead of the curve. So how can other financial institutions in the West follow suit and offer Islamic window products?

By leveraging the right technology through the right technology partner to build these products. Partners that offer technology such as low code, can enable financial institutions to deliver new capabilities to customers, such as ethical loans, on their own and more easily and launching products to the market faster than ever before. Rather than a huge overhaul of ripping out old technology or a major reliance on technical teams, low code can empower innovators within financial services institutions to make better use of their resources to create new business streams, offer new products and open new relationships with different audiences.

Western banks must define a customer persona for the Islamic market to be able to create a portfolio of Shariah-compliant products. With the right partner and technology, like low code, it’s possible for banks to evaluate custom business rules automatically and tailor its services for Islamic customers. Personalisation is key, so creating the right engagement strategies for this new customer segment has never been more important.

Through a focused effort, it’s possible for banks across the world to build a more innovative, diverse, and inclusive marketplace to meet the needs of every part of our society, put the customer at the heart of everything they do, and to stay relevant in the digital age.