Before the COVID-19 pandemic took the world by storm, FinTech companies were slowly ramping up to develop a modern, digitized banking experience. Mobile banking was the first step that allowed customers to easily access their traditional accounts practically anywhere. However today, global conditions have forced digital banking services to become the new normal and the increased pace of adoption among consumers points it at being the public demand.  

In a world where more than 1.7 billion people still do not have access to bank accounts FinTech companies are stepping in to offer accessible and safer services. Yet so, there is an increasing number of Islamic Banks who are resistant to capitalize on digitization. While it might not appear to be of significance at first glance, the impact of this far outweighs it costs.  

Thus in today’s article we will investigate why certain Islamic Banks are still slow to capitalization on digitization and also take a closer look at the benefits they tend to gain from the transition.  

The Rise of Islamic Finance 

Islamic Banking is built on the idea of “transparency” and “accountability.” The concept is simple: money is the “property of God,” so you must put it to work to earn a profit. 

The fact is, Islamic banking has an array of unique and different services when compared to their conventional counterparts. For example, loans based on Ijarah (leasing), Mudarabah (profit sharing), Musharakah (joint venture), and Murabahah (cost plus) are all common across Islamic banks. However, the core principle mentioned above that differentiates them from traditional financial institutions is that they cannot charge interest rates. 

Islamic banking is now a mainstream player on the global finance stage, with huge markets like those found in countries across the Middle East. As a result, Islamic banks have expanded into Asian and African markets to capitalize on the growing number of people who want Sharia-compliant financial products.  

According to Mordor Intelligence, Islamic banking is now a $1.99 trillion industry. Although it’s a fraction of the global market, much like Fintech today, there is enormous growth potential. 

Malaysia and Indonesia 

To grasp the extent of this growth, some examples are as shared below. 

Indonesia is one of the countries where the growth of Islamic finance is distinctly visible. Bank Syariah Mandiri is the most prominent Islamic bank and accounts for about 28% of the market share. 

The Indonesian central bank has also stated that all financial institutions should work toward a more digitized experience as soon as possible. Although Indonesia has one of the highest penetrations of Islamic finance, other countries are catching up fast. 

For instance, Malaysia is another country where Islamic banking has skyrocketed, and as a result, the relevant financial institutions are seeking to digitize. A few years ago, CIMB Bank launched an integrated digital app which extends consumers a full suite of financial solutions each of them designed to amplify their personal finances.  

Along with Bank Islam Malaysia (BIMB), Meezan Bank, and Maybank Islamic, are other prominent Islamic Banks boosting their presence in APAC. For instance, Meezan bank which is the largest Islamic bank in Pakistan, was awarded the ‘Best Bank in Asia-Pacific Region’ award by Global Finance Magazine in 2017. 

Why are Islamic banks slow at digitalization? 

Not charging interest rates doesn’t necessarily mean that Islamic banks are more cost-effective. On the contrary, costs to open an account and keep it running are usually higher than the those in conventional banking because the system is not automated enough. But what is holding the Islamic banking sector back is a refusal to change mentalities. 

Older generations in control of Islamic banks have been lagging in adopting deep and transformative digitization strategies than their conventional counterparts. While big banks have adopted essential tools such as automation, many Islamic banks are still traditionally conducting business with higher costs and a lower volume of transactions.  

A Change Will Come 

Gen Z is slowly coming of age and becoming the driving force in the industry. They are more open to change, diversity, and technology than their predecessors.  

In APAC countries where Islamic finance is growing, the focus should be on adopting technology to improve their economies. Fintech can help bring more people under financial inclusion through Sharia-compliant platforms, keeping the banks competitive in today’s market. 

In the past, branches had been the first and predominant point of contact with customers, which was on par with industry standards. Today, Islamic banks have a much lower customer penetration in digital services than conventional banks.  

The high costs have thus kept Islamic banks from serving unbanked populations. But with the arrival of low-cost mobile and internet technologies, it is easier for them to serve a more significant number of customers in remote areas. Thus, technology seems to be a crucial factor in ensuring Islamic banks can compete and serve even more customers.  

What Other Challenges Do Islamic Banks Face? 

Although the challenges of adopting digitalized services are perhaps not as significant for Islamic banks compared to their conventional counterparts, they still face some difficulties that we need to consider. 

Besides dealing with the law of Sharia Fintech, Islamic banks are more likely to face difficulties when it comes to: 

Customer Acquisition 

Reaching customers can be a challenge for digital Islamic banking due to the high cost. Even in countries like Malaysia, where 61% of the population is Muslim, Islamic banks only hold a 34% market share. That’s why tools such as digital onboarding are so essential for Islamic banks. 

Recently, Qatar Islamic Bank (QIB) announced the launch of a new digital onboarding process allowing prospective customers to start a relationship with the bank by opening a Savings or Misk account through the QIB Mobile App.  

This new development allows prospective QIB customers to open accounts in a fast, simple, and convenient way from the comfort of their homes. 

Customer Experience/Retention 

Islamic banks are missing many customers due to a ‘perception problem.’ The perception that the bank isn’t true to Sharia values. 

Even more pressing is the reluctance on the part of Islamic banks to embrace mobile banking. Because of technical issues making it difficult for them to open mobile wallets in compliance with Sharia law, they are vulnerable to losing customers who are used to faster and more convenient digitalized services.   

Compliance Regulations 

Islamic banking operates on a different set of principles to conventional banks. There are many nuances with Islamic finance, which means that the process of compliance is not always clear-cut. 

To follow the law and ensure that their services follow Sharia’s guidelines, Islamic banks must expend more time and effort on the following: 

• Reviewing contracts for compliance with Sharia law 
• Ensuring halal products are available to customers 
• Establishing Shariah-compliant governance and risk management structures 

Risk Management 

Inadequate risk management is often one of the most common reasons Islamic banks fail. When it comes to Sharia-compliant services, many risks arise in this area. 

For example, when an Islamic bank sells a product like Ijarah (leasing), no fixed return is agreed upon with the customer because it is based on Tawarruq (cost plus). Therefore, the risk is that the customer may not be able to pay for an item they have leased. 

The Opportunities of Digitization for Islamic Banks 

Islamic banks can see benefits from digitizing their services across all areas of banking. 

For example, increasing customer loyalty will lead to more business for Islamic banks as customers are more likely to stay with them if they provide a better service overall. 

Furthermore, digitization will help Islamic banks become more efficient and save money in the long term. Many of the challenges they face are time-consuming. 

Islamic SaaS, automation, blockchain technology, and electronic contracts will make banking faster and easier. That means Islamic banks can focus on providing better services to their customers without worrying about losing out to the established competition. 

Conclusion 

Although the challenges may seem significant, digitization can be a powerful tool for Islamic banks and their 1 billion potential customers. The pandemic has caused Islamic banks to realize the need for digitalization. They are now allying with FinTech companies to provide better financial solutions to their customers. The banks need to put up with digitization and the demand of Gen Z and millennials.  

To truly capitalize on this opportunity and gain an edge over conventional banks, Islamic banks should act pre-emptively and start the process now. 

In the long run, substantial investment in digitization will help Islamic banks become stronger, faster, and more efficient.