By Narendra Mistry, Chief Product Officer, Finastra Universal Banking
Unlocking the potential of Islamic finance

Islamic finance first emerged in the 1970s in the Middle East and North Africa (MENA), and although a relatively young industry, it has registered accelerated growth throughout the years. It is already present in over 80 countries, and according to The Islamic Financial Services Board Stability Report 2023, the industry was worth an estimated US $3.25 trillion in 2022, recording a 6.2% year-on-year growth rate. 

There are three main ways in which the industry can grow further: by gaining market share in existing markets, expanding into other Islamic markets, or using the esteemed reputation and ethical principles that underpin Islamic banking to support growth in markets that are not traditionally associated with it. 

Technology is a crucial prerequisite in achieving this growth, and only the right technology combined with a deep understanding of Islamic finance can enable agility and lead to steady growth. This enables Islamic Financial Institutions (IFIs) to offer market-leading products and seamless customer experiences and leverage the enhanced distribution capabilities of truly digital banking.

Running two core banking systems

The standard approach for banks running both conventional and Islamic banking is to deploy two different core banking systems. This approach can lead to increased complexity, risk, degraded customer experience, data exploitation difficulties and enterprise agility limitations. Deploying two different systems usually means that the systems are not based on the same technology stack, so even if deployed in the cloud, two IT teams are needed. This added complexity often translates into a tremendous cost. 

The use of two core banking systems also means that compliance measures with national and international regulations need to be implemented twice. This is also an ongoing exercise as rules and regulations continue to evolve and new products are introduced. Managing credit risk in a timely manner is another challenge, as having to view and extract data from two different systems is more time-consuming and resource intensive. 

With a few exceptions, technology vendors have poorly served IFIs, offering mostly slightly modified versions of systems designed for conventional banking or Islamic banking systems built on outdated technology that can't keep up with the unique needs of IFIs. Notably, most IFIs (74%) have expressed their concern about the limitations imposed by legacy infrastructure and outdated technologies. These constraints are making it difficult for them to adapt to the evolving market dynamics and stay competitive in the face of technological advancements. The outdated applications and legacy infrastructure can also hinder the ability to use data and increase cybersecurity risk. A CIBAFI study highlighted that among the most cited risks mentioned by Islamic banks are technological and cybersecurity. 

The right technology equals new opportunities 

IFIs tend to pick systems designed to be pre-play Islamic core banking systems with the assumption that they will reduce risks, but these systems are often developed with limited functionality and can hold back growth and even increase risk. 

The great news is that choosing a system that can support both conventional and Islamic banking doesn’t have to cause a Big Bang effect. This journey doesn’t need to include a wholesale architecture transformation straight away. Instead, Islamic banks can improve their performance, security, and scalability by adopting the best solutions in a gradual manner. Microservices-based architecture and composable banking support this approach, enabling banks to quickly integrate new functionalities and solutions from third-party fintechs to promote agility and innovation. 

IFIs need a modern, proven, and resilient platform that meets the sector’s requirements, has the capacity to support Islamic banking operations, and facilitates the adoption of innovative technologies to improve customers’ experiences, streamline processes, and enable innovation in their products and services and hence pursue growth.

Cloud, for instance, enables banks to become more agile, collaborative and customer-focused. The adoption of cloud technologies is an efficient way for Islamic banks to scale their operations, reduce costs, quickly adapt to new regulations, and improve data management and security. By tapping into the growing ecosystem-driven nature of financial services, banks can also implement innovative applications that deliver additional value, while reaching new customers through new routes to market.

Open Banking, AI, and ML are also becoming more prevalent. Open Banking enables the secure and free movement of customer data through APIs, with customers’ permission, making financial services more personalized and accessible than ever before.  At the same time, AI & ML can facilitate the analysis of rich customer data to identify preferences or trends. This is important for IFIs to understand what their customers want from their bank and offer services that truly meet their demands. In fact, according to a study conducted by Boston Consulting Group, 79% of Saudi customers would share their data to improve banking services. 

Islamic banks, and all banks in general, need to have the flexibility to deliver differentiated value for their customers while continuing to grow their business. Partnerships are crucial for banks to remain agile and implement these offerings at a quick time to value. By partnering with software companies and fintechs who have the right skills, experience and robust technology, IFIs can continue to innovate and quickly deploy new solutions that truly accommodate customer needs. To stay ahead of the game, collaboration is key for banks to embrace the future while delivering success today.

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