Islamic Private Banking

This article discusses market drivers supporting private banking in the Islamic world.

Before the credit crisis hit banks around the globe, southeast Asia and the Middle East were booming with high and ultra-high net worth individuals seeking to invest their wealth in domestic markets. This caught the eye of many Islamic banks, which began to turn their attention to private banking. Now with the credit crisis biting into the global markets, banks that used to lend and offer credits to individuals in the Islamic retail banking sector are now aiming to substantially increase customer deposits to level the value of their credit/deposit ratios.

Alternatively, when looking at corporate finance in Islamic banking, we can see that this area is more concerned with the risks associated with deploying finance than in conventional banking. However, it can also be said that Islamic banks providing finance to corporates are less affected by the credit crisis, merely because they did not lend to businesses operating in some of the high-risk sectors such as real estate and luxury goods. Despite this, those Islamic banks focusing on corporate finance are now looking to spread the risk by moving to commercial banking, addressing not only corporate but also retail customers. So how does this contribute to the increased focus on Islamic private banking?

In the quest to increase customer deposits, many feel that the solution resides in offering Islamic private wealth management services to attract deposits and shift the income to become commission-based as a result of portfolio management. However, few are unsure what form this should take and what it will entail. In the absence of any concrete industry vision, there is an opportunity for entrepreneurial banks to carve a niche by defining the market. Until they do, here’s one perspective on what Islamic private banking could look like in the future:

Customer-level Shariah

In the same way that individual Islamic banks have their own Shariah committee, Islamic asset managers could well construct portfolios around individual client ethics. In traditional Islamic private banking practices, this personalised level of service is only delivered to ultra-high net worth clients with exceptionally large portfolios. If Islamic banks have to deliver individually customised services to all their clients, the cost of providing this service may skew the market in the direction of ultra-high net worth individuals. Islamic banks, however, can also target small- to medium-size customer portfolios by offering participation in Mudarabah mutual funds. These funds are based upon trading assets that are appreciating during the recessionary periods, such as precious metals and agricultural products, or post-recessionary periods, such as equities and real estate.

Company indexing

Like ethical funds, Islamic private banks will need to ensure that the companies in which they invest comply with Islamic law. In fact, some data providers have already started to add an Islamic marker to company statistics. However, banks will have to create their own indexes to reflect their individual interpretations of Shariah law. To do this, advanced Islamic banking systems will be required to filter the non-Islamic Shariah-compliant companies and ensure trading and investing activities are exclusively focused on those that are Shariah-compliant.

Community matters

Since the remit of Islamic finance in general is to serve the community as a whole, should Islamic private banks take a more social view of their investments, beyond the mere accrual of investor wealth? If the answer is yes, it would have an impact on the way portfolios are managed. It would also pose a conundrum for asset managers, because to deliver significant returns for their clients while benefiting the community, they will need to be both creative and flexible. One can imagine the imposition of charity in Islam (zakat) on funds that remain in the possession of the owner for a full year, which could create charity funds to serve the community as a whole. This is particularly relevant to those sectors more exposed to the negative consequences of the financial crisis.

Looking Ahead and Getting Ahead

With Islamic private banking set to boom once the financial crisis has receded, there is a real need for sophisticated asset management technology and expertise in the Islamic banking arena.

While the world weathers the financial storm and as Islamic banking becomes more attractive as one of the lesser affected markets, it will evolve to form a diversified landscape of traditional players and new market entrants via greenfield start-ups and cross-border expansion. Increasingly competitive markets will call for substantial improvement in the quality of customer service provided by Islamic banks.

Traditional Islamic banks’ adoption of technology to support private banking has to at least match that of their conventional counterparts looking to penetrate the market. As a result, the traditional players will need to turn their attention to advanced technology solutions that can fully support personalised and customised investment policies and strategies.

In doing this, portfolio information can be stored, continually monitored and automatically adjusted against the relevant investment profile allocated to each client portfolio. Valuations, performance calculation and risk versus return analysis of each portfolio can be conducted to objectively measure the success of an investment policy.

Reports can be generated in high quality format, including graphics and colours, to match the expectations of high net worth Islamic private customers. It is well known that there is shortage of skilled relationship managers compared to number of private banking clients, which plays a key role in customer acquisition and retention. By equipping staff with the right client information, staff productivity, quality output and customer satisfaction will increase. These will undoubtedly be differentiating factors in the Islamic private banking market in the current and post-credit crisis world.

To remain competitive, these banks will ultimately need to offer superior private banking services via a customer-centric systems architecture to meet the satisfaction levels of the high net worth market. As the sector comes into its own, Islamic banks require advanced, globally recognised systems that encompass conventional private banking best practice expertise. Localised system dependence will no longer suffice as Islamic banking grows out of its traditional realm and transcends onto an increasingly globalised product and service platform.

The additional constraint the crisis is bringing is that modern systems must enable banks not only to increase their efficiency and enhance their customer service, but most important to considerably cut the cost of their operations. A system that can be implemented in a short time span and at a low cost will be sought by Islamic banks under the current market conditions. Today, Islamic banks expect, as a result of deploying such systems, to streamline their operations, efficiently mitigate their operational risks and above all to have a quick return on their investments from technology.

Article by Dr. Goneid's has been Islamic banking strategy manager at Temenos for the past 10 years. Prior to that he was CEO at PK Technology. He has worked both vendor side and in banks including, Bank Bumiputra and Al Rajhi Bank. Dr. Goneid's has been working in Islamic banking for the past 30 years