Islamic banks demand dedicated core systems

By Chris Chong

A study by Asian Banker Research shows that Islamic banks’ consider investing in core banking systems to support product innovation and improve customer service

A dedicated Islamic core banking system is crucial for product development, a top business priority for Islamic banking institutions
Risk management takes a back seat among Islamic banking institutions as business growth takes priority
Interoperability is the most important IT requirement when implementing Islamic core banking systems in a heterogeneous applications environment

Islamic finance is taking Asia by storm. According to Asian Banker Research, the world’s top 100 Islamic banks are growing assets at an average annual rate of 26.7 percent. In Malaysia, Islamic institutions are even beginning to challenge their smaller conventional cousins.

Asian Banker Research recently conducted a study on institutions offering Islamic banking services in the region and found that investing in next-generation core banking systems is a top priority for many.

The study, which drew on insights from senior business line leaders and IT heads of the largest Islamic banking institutions in Asia and the Middle East, showed that 61 percent of surveyed institutions have commenced their Islamic core banking system replacement project, and of these more than 60 percent are currently in the early phases of vendor and systems selection.

When asked about the business imperatives underlying core banking system investments, an overwhelming 75 percent of respondents said that a dedicated Islamic core banking system will be the key enabler of more tailored, sophisticated and innovative offerings. The study found that with a new Islamic core banking system, respondents will most urgently focus new product development for their trade finance, corporate lending and consumer lending businesses.

At present, the availability of Islamic financial products and services in the region is relatively narrow. Most surveyed institutions focus on savings deposits, personal mortgages and SME financing, offering limited capacity for differentiation. Additionally, the majority of players target the SME and retail segments, creating a crowded, competitive marketplace.

Although penetration of Islamic banking is still low in many Asia Pacific countries and growth rates are healthy, it is widely recognised that continued portfolio and services expansion are vital for gaining traction as more offerings enter the market.

While risk management and regulatory compliance are getting more attention than ever in the conventional banking environment, the study revealed that it is not top-of-mind for the region’s Islamic banking institutions, which are relative laggards in utilising technology for risk controls. Banks are instead focusing on issues that have more direct impact on top line growth such as developing customer-centric capabilities that improve client relationships. Only 35 percent of respondents ranked risk management and regulatory compliance as a critical objective of installing a new core banking system, as compared to 65 percent for establishing customer service leadership, and 75 percent for improving product innovation.

However, as governments seek to improve transparency, particularly in more progressive Islamic banking markets such as Malaysia and Indonesia, regulatory compliance will become an increasingly important motivator for banking system upgrades and replacements.

As with many organisations, most of the surveyed institutions struggle with the limitations of legacy IT systems. It is no surprise that close to 65 percent of the banks surveyed ranked ease of integration among the top 3 criteria for system selection.

Standards-based systems that allow existing infrastructure to be leveraged and easily integrated with various other disparate systems are already in high demand and will only become more important as the sector increasingly experiences acquisitions and spin-offs that convert Islamic windows into full-fledged Islamic banking subsidiaries. Organisational changes tend to require new banking systems, or drive the convergence of existing systems towards common computing platforms. Additionally, Islamic banking subsidiaries of conventional banks will also need to ensure that their new Islamic core banking systems are compatible with the parent bank’s existing systems.

This study, commissioned by Infosys, reflects the phenomenal growth of Islamic banking and the associated core banking investments required to support its rapid development. Unfortunately, given the industry’s relative infancy, institutions have faced a dearth of options for IT solutions dedicated to Islamic banking. In recent past, Islamic institutions relied heavily on local and regional vendors for country-specific shariah-compliant IT solutions.

However, Islamic banks are starting to require solutions that are more than just shariah compliant. There is an increasing emphasis on innovation, customer service leadership and risk management capabilities as key drivers going forward. In these aspects, global vendors with shariah-compliant solutions have much to offer with their breadth of point solutions that may better address banks’ increasingly advanced requirements.