Islamic banking makes inroads into emerging markets

Islamic banks have been expanding in emerging markets. A cluster of rapid growth markets (RGMs) like Turkey, Saudi Arabia, Malaysia, the UAE and Qatar offer a wealth of optimism, according to a recent survey by Ernst & Young.

Retail banks in more populous markets are growing as increasing affluence drives demand for more financial products and services. But amidst the bullish forecasts lie concerns about the ability of local banks to maintain profitability while they capture new market share.

Balance-sheets of many of the banks remain under pressure. It’s expected they will struggle to service their growing corporate and wealthy customers. As a result of the pressures of funding, competition and declining margins, efficiency is quickly becoming a watchword for bankers in RGMs.

In many of these core Muslim markets, demand for credit from businesses is also likely to outstrip supply. Strong capabilities in debt capital markets are becoming increasingly important to meet growing demands.

Turkish banks are amongst the more optimistic given the policy initiatives and regulatory reforms. SMEs and retail banking are poised to grow sustainably given the large untapped customer pool.

Small share

The more favourable attitude of Turkish regulators may encourage more foreign Islamic banks to enter the Turkish market. Domestic Islamic banks only have a small share of the overall banking market primarily due to their relatively smaller size and limited outreach. These banks need to scale up quickly to prepare for imminent new competition.

Malaysia is another promising market, however industry sentiments there are different. Ongoing regulatory transformation is creating a shortage of skilled professionals, at least in the short term. This certainly requires intense management of available talent pool and attracting talent from international market to plug the gap.

Margin compression is another key concern as retail deposits and lending rates are both under pressure. Banks are focusing on improving penetration rates with existing customers. With 91 per cent of Malaysians banking with multiple institutions, investment in customer analytics can improve profitability through targeted cross-selling. Several Islamic banks are now considering international expansion, especially into high-margin countries like Thailand, Indonesia and areas like the Middle East.

To achieve profitable growth, Islamic banks must balance their desire to expand rapidly with efficient operations. The consolidation of the small Islamic banks operating can help improve efficiency and build capacity.

The future is bright for Islamic banking, but calculated growth plans must be set out to maintain the credibility and sustainability of the sector in the future.

The writer is a partner, global Islamic banking centre of excellence at Ernst & Young.