Product innovation has become imperative for the Islamic finance industry. This is going to be one of the key growth drivers for the industry in the coming years as demand for new products across segments such as Islamic banking, Takaful, sukuk and funds rises thanks to increased understanding and acceptance of Sharia-compliant products.
Islamic banking
Islamic banks are struggling with lower profitability compared to the conventional banks. The estimated 19 per cent lower profitability of Islamic banks compared to the conventional banks can be primarily attributed to higher expenses and lower average product holding (APH) per customer. Islamic banks have an APH of 2.1 compared to the APH of 4.9 for the conventional banks. Higher profitability can be aimed and achieved by Islamic banks by developing new products, which would provide cross-selling opportunities and higher APH. Islamic banks can also benefit from shedding their existing obsolete systems and embracing technological innovation to bring down costs.
Sukuk
Sukuk has been one area of Islamic finance which has experienced constant innovation. Sukuk issuances over the period have shifted from using a single Islamic finance contract to hybrid structures which involve more than one Islamic finance contract. Other innovations in the area of sukuk include perpetual, retail and insurance-linked issuances. Moreover, the implementation of Basel III has led to Islamic firms issuing innovative Basel III-compliant sukuk instruments to meet revised capital standards. However, the industry continues to face hurdles as most of the existing structures are unable to support large size issuances, because of the absence of a viable asset base. The future of the sukuk market is heavily reliant on innovation, where new assets, structures and markets continue to create new opportunities for investors and also serve to widen both the base of issuers, and the frequency with which issuers can access the sukuk market.
Funds
Very wealthy individuals and families in the GCC region are engaged in succession planning and are looking for diversifications to protect their wealth from equity market swings. However, lack of product diversification and the requisite of Sharia-compliant family offices to invest in Sharia-compliant instruments make the task of the wealth and asset management advisors extremely challenging. The answer to this challenge is innovative solutions that provide greater access to conventional funds – feeder fund structures and Sharia-compliant structured investment products. “Socially responsible funds”, which like Islamic funds avoid investment in alcohol, arms manufacture, tobacco and gambling are another area of opportunity for Islamic wealth managers.
Takaful
The low penetration of Islamic insurance in key markets and a limited product portfolio consisting of “plain vanilla” products related to family, medical and motor Takaful post a hurdle in the growth of the Takaful industry in these markets. Innovative solutions to improve its distribution and service capabilities to increase its customer base and innovative products that could expand the existing product portfolio of Takaful operators to include segments such as wealth management, educational planning schemes and retirement plans would be the ideal way forward to overcome the challenges.
Waqf
Waqf refers to a religious endowment. These mostly underdeveloped and poorly managed assets offer investment and finance opportunities for the Islamic finance industry and investors. However, the industry needs to devise innovative instruments and products to benefit from these assets and at the same time contribute to the growth of these assets.
In conclusion, the key requirements to facilitate product development and innovation in the Islamic finance industry are a favourable regulatory framework comprising of comprehensive legislation, dedicated Sharia commercial court, financial mediation bureau and arbitration centre for dispute resolution, tax neutrality policies, Sharia advisory council and Sharia governance framework. Another key aspect that has to be given significance is wider acceptability by Sharia scholars. This can only be achieved by developing products which are Sharia-compliant in substance and not just mimicking conventional financial products by being Sharia-compliant in form or structure.
M R Raghu is the managing director of Marmore, a research firm focusing on economies in the Middle East and North Africa.
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