ISLAMIC BANKING: A SYSTEMS PERSPECTIVE
MUSTAFA M TURKI
All the indications are that Islamic banking as a system has come of age. Since 1970, when the first fully fledged Islamic bank was established, namely the Dubai Islamic Bank, a great deal of investment has been committed to creatively develop Islamic banking products and services. Islamic banking must maintain the momentum and, in a highly competitive market place, must take the initiative.
In all the leading articles on the subject of Islamic banking, one can see a common and predominant message: in order for Islamic banking to gain a competitive advantage, creative and profitable products and services have to be developed.
However, developing products that are truly competitive in many instances is coupled with a constraint on pricing. Therefore, the business case for the product development becomes dependent on reducing the cost baseline, i.e., to maximise the profit margin, the cost of operations must be minimised, whilst maintaining the highest level of customer service.
A target area for cost reduction in any organisation is operational efficiency. Optimum use of IT to support overall baseline cost reduction is a key to achieving such an objective. In any case, the use of IT in banking in general is no longer a ‘nice-to-have luxury’, but a necessary means of gaining competitive advantage in customer perception. In this. Islamic banking is no exception.
Effective investment in IT-based business solutions will certainly enhance the efficiency of Islamic banking and improve customer sei-vice in general. However, it is important to maintain a balance between the use of IT and the true business requirements to avoid being on the ‘bleeding edge’ of technology.
To this end, one ought to develop customer-friendly business processes whilst ensuring the integrity and security of customers’ deposits.
Islamic banking institutions should take advantage of state-of-the-art use of IT in their banking operations. Customers are now more demanding, their expectations have been raised, and there is no excuse, in their eyes, for Islamic banks not being as versatile as conventional banking systems.
Islamic Banking Systems Market Survey
During autumn 1996, the author, together with a fellow professional, conducted an extensive market survey on Islamic banking systems. Th e objective of the survey was to assess the Islamic banking systems’ market place and to shortlist software houses (packages) as part of a wider project scope.
More than 35 organisations involved in Islamic banking were surveyed, including:
• Islamic retail banks,
• Islamic international wholesale banks,
• Islamic investment companies.
• Islamic finance companies and
• Software houses.
The organisations surveyed, including the software houses, were based in the following countries: Bahrain, Egypt, Ireland, Jordan, Kuwait, Lebanon, Saudi Arabia, UAE and UK.
Results of the market survey revealed the following:
• Fifteen software houses claim to support Islamic banking.
• Eight software houses have actually developed Islamic banking systems.
• Six packages are modifications of conventional banking systems.
• Two packages claim to be purpose designed for Islamic banking.
However, no package was found to provide the ‘complete’ set of functionalities to support Islamic banking.
Furthermore, it was established that in terms of Islamic banking application systems software, there is very little in the market place today that is well enough designed, fit for the unique purposes intended, or cost effective.
The market survey also revealed that:
• The Islamic banking systems market place is still not mature.
• Islamic banks and financial institutions contacted did not know what they wanted.
• Software houses contacted did not really know what to design.
• A number of software houses are still waiting to be commissioned to develop Islamic banking software.
• There are many interpretations as to how Islamic banking financial instruments are, or should be, implemented from a business viewpoint.
Business Requirements
Requirement specification is the foundation for any system development. This is very true of an Islamic banking system.
Islamic banking institutions provide various types of products and services even though they are in general based on the same Islamic concepts. From a systems viewpoint, the business requirements are different and should be treated as such.
Given that the business rules differ from one Islamic banking institution to another, and from one product to another, the systems requirements are bound to be different. For this reason alone, it is important that the individual Islamic institution’s business and system requirements be uniquely specified.
Most Islamic banks offer deposit-taking accounts not too dissimilar to those offered by conventional banks. Where Islamic banking institutions differ, however, is in the provision of Islamic financial instruments, such as:
• Murabaha (Cost-plus-based financing)
• Mudaraba (Trust management)
• Musharaka (Partnership)
• Ijara (Leasing)
• Bai Salam (Sale of goods with deferred delivery)
• Bai Istisna (Sale of goods/articles to be produced)
Generally speaking. Islamic financial instruments fall into trading, management, partnership and leasing contract types. It is possible to combine two instruments in one contract, e.g., trust funding for residential property, which is a combination of Musharaka (partnership) and Ijara (leasing).
The variety of business processes involved in dealing with so many types and combinations of contracts reinforces the need to take the subject of requirements specification seriously. Short cuts can be both risky and costly.
There are numerous business issues relating to Islamic banking which have yet to be fully addressed by Sharia scholars before they are fully incorporated in the analysis, e.g., use of collateral.
Therefore, in the absence of a clear directive, one should include appropriate reference to such issues as require resolution just in case there may be system design implications later. In other words, it is better at the requirements-specification phase to include potential areas for closer scrutiny, and label them as such than to exclude them.
Use of IT can only enhance a business operation. It is no substitute for what lies behind good business ideas, routine administrative procedures and the creative methods for conducting business. It follows that irrespective of IT, the business processes developed to support Islamic banking have to be conducive to conducting the business. Therefore, it is important to ensure that the business processes are smartly designed.
Apart from the Haram aspect of interest, or Riba, the differences between interest and Profit/Loss-Sharing (PLS)-based financing are, inter alia, as follows:
• Unpredictability of profit/loss
• Profit/loss distribution
• Computation of interest
• Interest is pre-determined
• Interest can be taxed at source
Systems Design Strategies
Having made the case for the need to specify the business requirements for an Islamic banking system at the outset, it is now necessary to address the system design strategy options.
Although this is usually technically driven, it is important to examine the possible options from an investment viewpoint. Besides the technical considerations, selection of the appropriate system design strategy is dependent on the business requirements and budget. There are three system design strategies: modification of existing systems, customisation of packaged systems, and bespoke development.
The simplest route for developing IT solutions to support Islamic banking is to modify existing systems. Invariably this entails a compromise of reduced functionality. Like any other investment decision-making situation, the more refined the desired objective is, the more costly it is likely to be.
In systems terms, the more functionalities, the more complex the design and system interfaces, the more cost elements there are to be considered, e.g., lines of code, technology platform, capacity and, most importantly, on-going system support. The solution usually ends up being a ‘best fit’ compromise.
Given the evolving state of the Islamic banking systems’ market place, and in the absence of suitable cost-effective software packages, the majority of the Islamic banking institutions use modified versions of existing conventional banking systems. From a systems perspective, there is nothing wrong with modifying existing systems to support new products and services. This is certainly a viable option, and must be considered as such.
The other factor which needs to be taken into account when considering system design options, in addition to the technical and business constraints, is the Islamic banking system users’ and customers’ perceptions. Sometimes modification of existing or packaged systems is not satisfactory to the user because of the compromise in functionality, not least for customer-facing staff Moreover, customers’ expectations of banking services nowadays far exceed what computerised banking systems can presently offer.
In general, modification of any application system is dependent on the design parameters and assumptions, e.g., database design, data structure and key records. Hence this option is usually less costly with shorter time scales for delivery. However, modifying any system to provide extra Islamic banking functionalities has a threshold beyond which the system efficiency will deteriorate and costs escalate, e.g., support, performance.
It is common for conventional banking systems that the interest-based computational processes are hard coded with the ability to manipulate the variables, e.g., value, period and rate. The rationale for this is that interest is a common denominator for practically all conventional banking operations. Conversely, in Islamic banking, the basis for computation is PLS and not interest, thus requiring a more flexible and versatile design approach.
Because of the extensive variations of deals within an Islamic banking environment, the formulae for PLS computation should therefore not be hard-coded. The system design ought to be unique to PLS. This is desirable from a technical design viewpoint as the algorithm, logical decision tables and data flow inherent in any application system will be specifically set-up
Banking systems that have been modified to provide limited functionalities to support Islamic banking cannot be as efficient as bespoke systems. On the face of it, it appears that there is a strong case for developing a bespoke system to meet the business requirements. However, because of development costs and risks, this option becomes less attractive.
The ideal option is to customise a purpose-designed Islamic banking packaged system with the design specifications discussed earlier and provide maximum flexibility. Unfortunately, there are no packaged systems today with such features. In any case, the basis for selecting an appropriate system design strategy usually ends up being a trade-off between functionality and cost.
The Model Islamic Banking System
It follows that there is a strong argument for developing an Islamic banking model system that meets the business requirements and is strictly conformant to the Sharia. Developing a model Islamic banking system supports the business-and Sharia-driven call for the setting up of a model Islamic bank.
The most challenging task is to define common practices and standards, which so far has dissuaded major software houses from investing in the development of generic Islamic banking systems. A model Islamic banking system will go a long way towards the enhancement of Islamic banking standards and can certainly provide a platform for adopting common business processes and procedures.
The model system should have the maximum variations to reflect the varying business processes and should be scalable to suit any one Islamic banking institution’s specific requirements for today and tomorrow. Modularity enables Islamic banking institutions to select modules to suit their requirements to meet business needs and growth.
The model Islamic banking system can be made up of a number of integrated modules, including an optional General Ledger, and should be capable of interfacing with other banking systems to capitalise on existing investment in IT.
Such a model Islamic banking system must be developed in an open-systems environment to enable portability and interconnectivity and should be mostly configurable to minimise the set-up and on-going support costs.
Developing a model Islamic banking system entails two significant phases, that is, requirements specification and system development, including design, building and testing of the system. The requirements specification phase involves the following steps:
• Develop business processes for the model Islamic banking functions, products and services.
• Identify system requirements to support the model business processes.
• Validate the business processes and system requirements using a prototype.
• Prepare detailed functional specifications.
Conclusions
To conclude, the following points need to be stressed:
• Islamic banking institutions who are seriously wishing to gain a competitive advantage must develop efficient operations by investing in the effective exploitation of IT.
• Investment in IT is precious, but too risky to leave to chance. Throwing money at IT will not do.
• Developing suitably engineered (or re-engineered) business processes, as well as identifying and validating the business and system functional requirements, together form the sound foundations for such an investment.
• If the business processes are smartly designed, then introducing IT can add value – otherwise it will not.
• Procuring a software package, or carrying out any in-house systems development prior to validating the business and system requirements can be disastrous.
• The basis for selecting an appropriate system design strategy, i.e., bespoke versus modification, usually ends up being a trade-off between functionality and cost.
• There is a need for a model Islamic banking system that meets the business requirements and is strictly conformant to Sharia and which can be modified to suit each Islamic banking institution’s specific requirements.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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