Featuring research from
Issue 2
Islamic Banking &
Technology Challenges
How ETHIX financial solutions ensures “Sharia Comp...
Contemporary Islamic banking has gained significant traction in recent
years with an estimated annual growth rate in exc...
Islamic banking may have its idiosyncrasies but its technological
requirements are no different. Therefore, an IT soluti...
Islamic Banking: Opportunity or
Money Pit for Conventional Banks?
As many conventional banks search for ways to boost re...
In addition to the lack of a single set of Islamic banking standards and
correspondingly low adoption rates, banks that ...
The information in this research was supplemented by several sources,
such as previous Gartner research studies...
About ITS
Market leader
ITS is a full service company, with 25 offices worldwide, covering all
geographical locations in...
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Islamic Banking and Technology Challenges: How ETHIX Financial Solution Ensures Shariaa Compliance


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An IT solution that supports seamless and rapid establishment of a startup Islamic bank from the ground up, or allows the conversion of a conventional bank without operational hindrance, or...

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Islamic Banking and Technology Challenges: How ETHIX Financial Solution Ensures Shariaa Compliance

  1. 1. Featuring research from Issue 2 Islamic Banking & Technology Challenges How ETHIX financial solutions ensures “Sharia Compliance”
  2. 2. 2 Contemporary Islamic banking has gained significant traction in recent years with an estimated annual growth rate in excess of 15%. Islamic banking continues to make its mark far beyond its traditional majority Muslim nation base, making considerable strides into the well-rooted conventional financing sectors. Having weathered the challenges of the recent financial turmoil due to their prudent investment strategies and driven by strong investor demand on both the individual and corporate sides, the total Islamic industry continues to be the beacon for socially responsible banking. With this increased interest in Islamic finance comes an increased demand for Islamic banks. Due to the huge logistical, regulatory and economic challenges of establishing a new bank, many well- established players across the Middle East and North Africa have opted to convert undercapitalized, non-performing banks in a bid to tap the rising demand for Shariah compliant products and, most importantly, avoid the heavy investment and logistical requirements to launch a completely new bank. As in the case of the National Bank for Development in Egypt (acquired by Abu Dhabi Islamic Bank). • Meanwhile, other banks such as the Kuwait International Bank (for- merly Kuwait Real Estate Bank) and Ahli United Bank (formerly The Bank of Kuwait and the Middle East) have sought to gain a competi- tive advantage by relaunching themselves as fully fledged Islamic banks. Overcoming hurdles One of the greatest challenges in launching an Islamic bank is having access to a well-established independent and active Shariah board. While this process can be rapidly increased by utilizing already existing Shariah boards, it is the implementation of the Shariah board’s rulings into the day-to-day running of banking operations, product development and product rollout that serves as the greatest hurdle to Shariah compliant operations and transformation. Islamic Banking & Technology Challenges 2 Islamic Banking & Technology Challenges 4 Gartner Research: Islamic Banking: Opportunity or Money Pit for Conventional Banks? 7 About Us Islamic Banking & Technology Challenges is published by ITS. Editorial supplied by ITS is independent of Gartner analysis. All Gartner research is © 2011 by Gartner, Inc. All rights reserved. All Gartner materials are used with Gartner’s permission. The use or publication of Gartner research does not indicate Gartner’s endorsement of ITS’ products and/or strategies. Reproduction or distribution of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The opinions expressed herein are subject to change without notice. Although Gartner research may include a discussion of related legal issues, Gartner does not provide legal advice or services and its research should not be construed or used as such. Gartner is a public company, and its shareholders may include firms and funds that have financial interests in entities covered in Gartner research. Gartner’s Board of Directors may include senior managers of these firms or funds. Gartner research is produced independently by its research organization without input or influence from these firms, funds or their managers. For further information on the independence and integrity of Gartner research, see “Guiding Principles on Independence and Objectivity” on its website, http://www.gartner.com/technology/about/ombudsman/omb_guide2.jsp.
  3. 3. 3 Islamic banking may have its idiosyncrasies but its technological requirements are no different. Therefore, an IT solution that can enable business conversion from conventional to Islamic, at the same time allowing the existing business model to continue without hindrance, is a serious proposition. As a result, technology and, more specifically, Islamic IT solutions are major factors in leading the transformation process. This is where technology experts like International Turnkey Systems (ITS) take front stage in easing the transformation. As a complete broad-spectrum Islamic information technology and banking solutions provider, their mandate is to provide banks with technological solutions and technical services required for the conversion of conventional banks, allowing banks to increase product development and rollout across the entire enterprise while offering reduced cost of total ownership and implementation. When a chief technology officer speaks to a service provider, one of the main issues tackled first is the core banking system. More often than not, a bank would prefer to choose a service provider that offers a one- stop solution like ITS’s ETHIX. Tailor-made solutions ETHIX is an Islamic banking solution that enables the restructure and launching of new Islamic products in a timely and efficient manner. ETHIX solution is a web services based solution that offers services and functions for Islamic finance, Islamic investment, core banking, delivery channels, trade finance and other banking services, which in turn enhances the bank’s competitive edge. Haitham Abdou, group director of marketing & Banking Business Solutions at ITS, states that the ETHIX solution was developed from scratch, specifically for the Islamic banking industry rather than a conventional solution that has been fine-tuned to meet specific Shariah requirements. He goes on to state that the principal behind the ETHIX solution is that it is a fully customizable, tailor-made product allowing for complete flexibility. Existing solutions have parameters that allow each individual Shariah board to specify differing products in accordance with their Shariah interpretation; these rigid predefined parameters can, however, have a tremendous impact on dictating bank workflow and operating procedures, limiting productivity and hindering scalability. ETHIX Financial solutions was Designed to ensure the basic principles of Sharia Compliance, However, the product does not “Dictate” sharia compliance. Due to the diversity of compliance between sharia boards, ETHIX was designed to allow the definition of Shariaa compliance from the ground up, thus ensuring 100% sharia compliance as per the decisions of each bank’s Shariaa board. Such a concept has allowed for the quick deployment of the product for banks converting to Islamic, startup Islamic banks, or Islamic windows coexisting with a conventional environment while maintaining all the rules and guidelines of a sharia compliant process. Shariah compliance Haitham further elaborated: “ITS realized that it would be impossible to ensure that our product could accommodate every single Shariah board; for vendors like ourselves, a rigid platform would require considerable customization on behalf of the customer.” Thus, ETHIX was created from the ground up to offer complete flexibility in defining Shariah compliance, so that the product would not be limited by rigid constraints. The ETHIX solutions main advantage lies with its certification by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). This was achieved by creating an Islamic piece of clay on which the main principals cannot be broken, allowing the customer to start building Shariah compliance from the ground up. It is this “novel approach that has allowed ITS to have the same system running in over 30 financial institutions in different countries and regions, all adhering to different Shariah rulings, while running on one line of code”, Haitham elucidates. As a completely customized product created with the considerations required for Shariah compliance, the customer is therefore not required to wait for product updates and development from the solutions provider. By dispensing with box-ticking measures, the customer is able to update and create products on the fly, allowing the customer to launch products and services very quickly and bringing them to market without hindrance. ETHIX is a culmination of ITS’s business knowledge and know-how, synthesizing their technological expertise and product flexibility. Ease of integration with conventional systems has also been a central feature. Taking conventional product structures and mapping them into their Islamic counterparts has allowed ITS to implement the first Islamic window for a conventional bank in the Middle East, such as the Commercial Bank of Dubai. ITS looks set to continue this trend by signing up to assist Libya’s largest bank, Gumhouria Bank, in creating its first Islamic window. Source: ITS
  4. 4. 4 Islamic Banking: Opportunity or Money Pit for Conventional Banks? As many conventional banks search for ways to boost revenue, some may turn to Islamic product offerings that have the potential to contribute significantly to their business growth strategy. CIOs need to be ready to deliver an informed technology assessment of this new market opportunity. Key Findings • Islamic banking is experiencing higher market growth rates in African and Western countries than in other regions of the world. • Standardization of Islamic banking processes is at an early stage of maturation; this will increase the risk associated with the selection of core banking systems. • For most Western countries, the real potential of Islamic financial services is located in the securities and wealth management space. Recommendations • Include distinct branding – similar to direct banks spawned from conventional banks – and stand-alone core banking technology support within the business case for Islamic banking. • Create a vendor shortlist with a heavy criteria weighting on local bank references; current Islamic banking market requirements can differ significantly by region. STRATEGIC PLANNING ASSUMPTION Through 2014, core banking systems will be unable to simultaneously support conventional retail and Islamic banking businesses without significant customization. ANALYSIS Introduction Gartner defines Islamic banking as a system of banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the payment or acceptance of interest fees for the lending and accepting of money. Also, recognizing that the prevailing model for banking worldwide is non-Islamic, this research will use the term “conventional” to describe this predominant banking approach. Market Information Islamic financial services are nearing $1 trillion in reported managed assets, with about 700 Islamic financial institutions (IFIs) spread throughout every region of the world. The Islamic banking system (IBS) market – that is, the market of the technologies that enable these financial products to be bought, sold and distributed – is predicted to be a $1.2 billion market in 2011 and to grow at a 10.9% compound annual growth rate (CAGR) between 2009 and 2014, while the external IT spending component will have a higher CAGR, at 18.1%. The IBS market is expected to reach $1.6 billion in 2014 . As consumer trust in conventional banking waned during the recent economic downturn, Islamic banking enjoyed marked market expansion. Islamic banking is perceived by its customers as a mutually beneficial partnership, and is regarded by some banks as an opportunity to re-establish a connection with consumers. Whwth? Growing demand is evident for Islamic products from new markets such as African and Western countries. An increasing number of conventional banks will open Islamic banking windows (see Note 1) in a conventional branch environment, mixing both conventional and Islamic banking capabilities. The Islamic banking market will continue to grow at a double- digit pace. This is based on (1) the increasing Muslim population in particular regions, (2) newly available assets from unbanked populations, and (3) the relatively low effect of the financial downturn in the high economic growth regions such as the Middle East and Asia/Pacific. Moreover, Western countries – as a consequence of new legislation already introduced or about to be – will encourage higher adoption levels of Islamic financial services although these changes will primarily impact the Islamic bond (Sukuk) market. For example, in France, fiscal instructions for Sukuks, Murabaha, Ijara and Istisna were published in August 2010 (see Note 2). What’s the Technology Impact? Similar to retail banking technology trends, the replacement process of in-house Islamic banking software with commercial off-the-shelf (COTS) systems is accelerating, especially in mature Islamic banking markets such as the Middle East. Drivers for Islamic banking core replacement align closely to those of conventional banks. However, the Islamic banking market lacks consensus industry product definitions, such that the core banking offerings of this market differ considerably. For example, if a vendor develops product support for a Middle Eastern bank, an Indonesian bank may find these product supports inadequate for their local market. This situation increases the risk associated with the selection of core banking systems, as banks may purchase systems that have to be highly modified to gain approval (a fatwa) from certified Islamic scholars. However, there are signs that the Islamic banking market is on a path of progressive maturation, with an undercurrent of activity to establish standard policies and corresponding products beyond the proprietary and localized approach currently in practice. For example, an emphasis on standardization of processes that comply with Islamic law (Sharia) is gathering momentum among more than 150 Islamic financial institutions that are members of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI; www.aaoifi. com/aaoifi/). This group of financial institutions and other member stakeholders, such as vendors and consulting firms, are expected to consolidate business requirements for Sharia compliance, but this is not expected to become effective for the next few years, and regional differences may persist beyond this time frame. Gartner Research:
  5. 5. 5 In addition to the lack of a single set of Islamic banking standards and correspondingly low adoption rates, banks that enter this market are faced with the choice of distributors offering Sharia-compliant products or two vendor technology model choices (see Figure 1): • Conventional core banking systems with an Islamic banking module • Pure-play, Islamic core banking systems Gartner believes that leveraging a single core system for simultaneous conventional and Islamic banking support for multiple regions is not feasible at this time without increasing operational risk and raising higher levels of deployment and operational complexity. The underlying architecture of these core systems is not yet sufficiently advanced to accommodate the component granularity required to easily leverage multiple go-to-market models. The full and true integration between the Islamic and conventional core banking systems within banks supporting an Islamic window is a major pain point. Achieving such full integration between products from the same provider is the minimum expected requirement; however, many banks are requesting full integration of coexisting products from different providers. FIGURE 3 Representative Vendors for Islamic Module and Pure-Play Core Systems Source: Gartner (June 2011) TCS = Tata Consultancy Services Gartner predicts the evolutionary track for core system design, especially those supporting retail banks, won’t be available to support this “dual deployment” model through 2014. In the interim, increased levels of customization will be required to bridge the integration gaps. Bottom Line The Islamic financial services market is steadily maturing and is experiencing increased growth. Based on Gartner’s 2010 Islamic Banking Survey (see Evidence), Islamic banking windows seem to be enjoying less success than the pure-play business model. Given that consumer trust remains low, it shouldn’t be surprising that prospective Islamic banking consumers have a perception that an intermingling of conventional and Islamic banking may occur – this model will stunt market penetration. Not unlike the opportunity for direct banks that spawned from conventional banks with separate branding, Gartner predicts that the need to maintain a separate identity and brand for Islamic banking centers – and IT systems, too – will be most effective. Ensuring that proper assumptions are established and expectations set for technology, deployment into the Islamic banking market is crucial. Getting this right will determine whether this market proves to be a genuine revenue opportunity or an investment money pit.
  6. 6. 6 Evidence The information in this research was supplemented by several sources, such as previous Gartner research studies, anecdotal evidence from client inquiries with vendors and end users, the results of two dedicated surveys, and the analysis of more than 300 Islamic banking deals signed in the past five years. It was also tested through Gartner’s usual rigorous peer review process. In particular, results from two surveys have been used in this research: • The 2010 Islamic Banking Survey was a global study of 13 leading IBS providers that accounted for 82% of the market share in IBS spending. This survey was conducted in early 2010. • The 2010 Islamic Banking Update Survey was the annual update of the previous global study to reinforce the view of the market and the positioning of the IBS providers. Fourteen leading IBS providers that accounted for 85% of the total market share in IBS spending were included in this update. This survey update was conducted in January 2011. • More than 300 Islamic banking deals have been monitored and tracked by Gartner during the past five years. Key contract metrics have been analyzed for more than one-third of these deals and have enabled Gartner to better define the market and its behaviors. Source: Gartner Industry Research, G00213298, Don Free, Vittorio D’Orazio, 20 June 2011 Note 2 Islamic Product Definitions Murabaha is the sale of goods with an agreed-to profit markup on the cost. Murabaha sale is of two types. In the first type, the Islamic bank purchases the goods and makes it available for sale without any prior promise from a customer to purchase it. In the second type, the Islamic bank purchases the goods ordered by a customer from a third party and then sells these goods to the same customer. In the latter case, the Islamic bank purchases the goods only after a customer has made a promise to purchase them from the bank (source: Accounting and Auditing Organisation for Islamic Financial Institutions; AAOIFI). Ijara means letting on a lease. It refers to the sale of a definite usufruct of any asset in exchange for a definite reward. It refers to a contract of land leased at a fixed rent payable in cash and also to a mode of financing adopted by Islamic banks. It is an arrangement under which the Islamic banks lease equipment, buildings or other facilities to a client, against an agreed rental. (source: Association of Islamic Banking Institutions Malaysia) Istisna is a contract whereby the purchaser asks the seller to manufacture a specifically defined product using the seller’s raw materials at a given price. The contractual agreement of Istisna has characteristics similar to that of Salam in that it provides for the sale of a product not available at the time of sale. It also has a characteristic similar to the ordinary sale in that the price may be paid on credit; however, unlike Salam, the price in the Istisna contract is not paid when the deal is concluded. A third characteristic of the contractual agreement of Istisna is similar to Ijarah (employment) in that labor is required in both (source: AAOIFI). Note 1 Islamic Window The Islamic window is the practice set up by a conventional financial institution that provides Islamic financial services in compliance with the Sharia law.
  7. 7. 7 About ITS Market leader ITS is a full service company, with 25 offices worldwide, covering all geographical locations including a centralized state-of-the-art managed data centre. This network of on-the-ground resources allows ITS to offer 24/7 local support. Haitham continues by saying: “ITS is not just an Islamic banking solutions provider, we are the IT partner of an organization.� Through their suppliers they are able to provide everything from hardware and security through to storage and document management solutions. �This gives us an extra unique value proposition over any other provider,” Haitham summarizes. ITS has received numerous awards over the last year or so for its Islamic solutions from its instrument definition engine, Islamic product definition engine, and its workflow and accounting solutions. The solutions company looks set to continue this trend with ETHIX, which has been widely tested throughout its existing partnerships. ITS’s global launch should see expansion across the far east into Asia Pacific, as well as moving into new areas in Europe and the United States. ITS’s objective is to become the global leader in Islamic banking solutions. If initial success is anything to go by, the proven status of ITS’s Islamic solutions will guarantee that the future is indeed technologically driven.