HSBC’s decision this year to stop offering Islamic products in many of its markets has sent shock waves through the Gulf region, one of the global hubs for Islamic finance.
The move underscored the difficulties facing even the largest conventional lenders that have tried to lure new customers to bank in compliance with Muslim sharia law.
While the Islamic finance industry is forecast to expand at a tremendous pace, a broader question is emerging as to how to make Islamic banking profitable.
“The industry is still in growth mode but where do you make money?” asks one Dubai-based Islamic finance banker.
Ernst & Young estimates that assets under Islamic banking – which rejects the acceptance of interest and demands that products are typically asset-backed – are set to top $1.8tn globally by next year, up from the $1.3tn of assets held in 2011.
But, as the world’s biggest international investment banks are forced to downsize, cut jobs and change their business models, their Islamic finance arms are also facing the axe.
HSBC said in October it would cease to offer Islamic products outside its wholesale banking operations in the UK, the United Arab Emirates, Bahrain, Bangladesh, Singapore and Mauritius, as it reviewed its global business.
Now focused on Saudi Arabia and Malaysia, the bank said the decision “demonstrates the group’s commitment to driving growth and improving returns by restructuring or exiting businesses that do not meet its investment criteria”.
Since then, in Dubai, Morgan Stanley is the latest bank to lose its Islamic finance expert.
Barclays and Deutsche Bank have also lost the architects of their Gulf Islamic banking businesses since the onset of the global financial crisis.
Eyes are focused on Standard Chartered, which offers a large-scale Islamic banking unit like that of HSBC.
“You are not going to have specialists sitting in these banks,” comments the Dubai-based Islamic banker.
“You do not need a dedicated Islamic structuring team.”
Retail Islamic banking is profitable for international banks but the landscape is already extremely competitive, bankers say.
The Gulf’s local Islamic banks have so far been better placed to capture business.
The downsizing of international expertise in Islamic finance in the region is creating an even greater chance for local lenders to try to gain market share.
HSBC’s move “represents an opportunity for local, indigenous firms to progress the industry towards the next stage of its evolution”, says Iqbal Khan, one of the architects of HSBC’s original Islamic business.
He is now chief executive of Fajr Capital in Dubai.
Many of the region’s pioneers of Islamic finance, who helped to build the sharia practices at the world’s biggest investment banks, are working with boutique Islamic firms out of mainstream banks.
HSBC’s decision has reopened the debate over the credibility of conventional banks operating Islamic units.
Last year, Qatar’s central bank forced the closure of Islamic banking units by ordering a separation of sharia-compliant lenders and conventional lenders.
As a result, HSBC Amanah, the bank’s Islamic banking arm, was forced to shut up shop just months after opening in Qatar.
“The credibility issue, is ‘are you an Islamic bank or a conventional bank?’ It is forcing people to make choices,” observes Tirad Mahmoud, the chief executive of Abu Dhabi Islamic Bank.
“Customers will always vote with their money,” he adds.
While retail customers are more concerned about the Islamic credentials of sharia-compliant banks, companies are less likely to differentiate, he says.
International banks can usually make money from corporate lending and then syndicating the loans to earn a margin.
But other activities, such as managing Islamic bond deals, are not as lucrative, bankers say.
Despite the optimism of Ernst & Young’s forecasts, AT Kearney, the management consultancy, pointed in May to a slowing in growth of the industry.
“As competition ramps up, and early warning signs show growth slowing down, Islamic financial institutions have plenty of work to do,” the group said in a report.
“Whether the strategy is to focus on niche positioning, compete with conventional banks head on, or a blend of both, sustaining growth will require most Islamic banks to achieve greater efficiency across the value chain.”
While both international banks and local Islamic banks face difficulties in making to money from the industry over the long term, some still believe there is a good deal of potential.
“Across the Gulf, Islamic finance continues to grow and has passed the critical mass stage,” says a senior Islamic banker in Dubai.
“It has dynamic momentum and society now is getting used to the Islamic proposition.”
source: Financial Times