QUANTIFYING THE ISLAMIC FINANCIAL MARKET SIZE
RODNEY WILSON
Islamic finance is often regarded as being a specialised or niche market. The ‘niche’ certainly seems to have grown, as the funds which are managed in accordance with the Sharia law are now valued at over $70 billion.
Such growth from less than $300 million over the twenty-year period since the mid-70s cannot simply be explained by the fact that those clients that were originally involved have simply become wealthier. Rather it suggests that a wider spectrum of clients is becoming involved, including those who had little understanding of what Islamic finance involved, and even those who were initially sceptical.
Despite this success, only part of the potential market for Islamic finance has been tapped and there remains much scope for further growth. Arguably, however, the easiest part of the market has already been tapped. To penetrate further, a more professional approach to the marketing of Islamic financial services will be required.
New clients will nee d persuasion, and may be mor e demanding in the type of information that they expect the banks and investment companies offering Islamic financial services to give. For the providers of Islamic financial services, there is the issue of how much to allocate to marketing budgets.
Islamic Investment Capability
Although there are significant Muslim populations in Europe, including over one million Muslims in the United Kingdom, much of the demand for Islamic financial services originates from within the Islamic world. From a marketing perspective, the challenge of attracting business from British Muslims is very different from that of dealing with clients from the Middle East, South Asia or the Far East, as the financial environment is much more competitive in the United Kingdom.
Here Islamic investment or unit trust products have more chance of being successful as add-ons to existing financial assets rather than Islamic bank deposits, given the range of commercial banking services available, with which the smaller Islamic institutions cannot hope to compete. There is an inter-bank for Islamic banking services in London, and to a lesser extent a personal banking market for clients of high net worth, but not really a retail market in the normally accepted sense.
Most of the Islamic money and investment funds that are “booked” in international financial centres such as London originates in the Islamic world. Given this situation, the potential market for Islamic financial services is largely a sub-set of the total market for banking and investment services in the Islamic world.
Therefor e an examination of the macroeconomic and banking indicators for Muslim countries can be instructive in gauging the potential for future expansion, although an allowance must be made for factors which inhibit or prevent capital movement out of some of the countries, notably foreign exchange controls.
Table 1 illustrates how the per capita income level of the countries of the Islamic
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world, when measured in common purchasing power parity United States dollar terms, is related to bank savings ratios in fourteen Muslim countries. These countries have internationally comparable economic statistics that are reported annually by the World Bank, and in the case of bank savings, monthly by the IMF.
The bank savings to GDP ratios refer to commercial bank deposits, which include deposits in Islamic banks in all those countries listed, apart from Algeria, where no such facilities are available. All bank savings in Iran can be regarded as Islamic, but in most of the other countries the proportion varies from four to twenty per cent of the total, the proportion being highest in some of the Gulf states.
It is difficult to estimate the proportion of savings which is held as assets acceptable under the Sharia law, as conventional banks offering Islamic deposit facilities do not distinguish between Islamic and non-Islamic accounts in their financial reporting.
Needs and Concerns of the Islamic Investor
The distinction between bank deposits for transaction purposes and accounts which are regarded as savings assets is important in Islamic banking, and it is arguably in the provision of savings (or investment) deposits that specifically designated Islamic accounts have much appeal to the depositor.
There can, of course, be religious objections to placing even transactions deposits which earn no interest with a conventional commercial bank, as the bank will be involved in Riba-based lending, which could be thought of as tainting the client’s deposit, even if he or she does not obtain an interest return themselves.
Nevertheless, it is interest-rate savings accounts that present a greater moral problem
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for the Muslim depositor, which is why participatory profit-sharing deposits based on the Mudaraba principle are a much more acceptable proposition.
The ratio of demand (transactions) to savings (investment) deposits is illustrated for a number of Muslim countries in Table 2.
A high ratio, as in Algeria, Bangladesh, Pakistan and Saudi Arabia, may indicate that bank clients are willing to hold transactions balances out of necessity, but do not see the banks as vehicles for savings. This may reflect apprehension on religious grounds of banks in general, although in some of the countries other factors may also be important.
These may include perceived inefficiencies in the financial services provided, especially where banks are state owned. Furthermore, low-income earners may simply not use banks, and the underdevelopment of banking generally may reflect the low level of a country’s economic development.
Institutional loyalty and client inertia are features of the market for banking services. Personal clients often bank with the same institutions as their parents, and the amount of switching between different banks during an adult lifetime is very limited. It is this inertia which has made it so difficult for the new Islamic banks to enter the established market and attract retail customers.
Clients are often wary of novelty, and most of those who have decided to open investment accounts with Islamic banks have usually continued to maintain their current account with their previous bank, rather than “putting all their eggs in one basket.”
In developing countries with monetarisation, the banking habit spreads to new segments of the population. The spread of branch banking has facilitated this process historically, as the population in smaller towns and villages have increasingly found it convenient to deal through neighbourhood branches.
The new banking clients tend to be the wealthier social groups, and young people. Older people accustomed to dealing largely with cash transactions may be reluctant to use financial intermediaries.
The spread of the banking habit usually occurs through the young and is a matter of generation change. In much of the Islamic world, the major spread of banking was in the 1950s and 1960s. As Islamic banks really only started operating on a significant scale in the 1970s, they unfortunately missed this opportunity to capture a new market.
Latecomers can, of course, learn from the mistakes of others, but in banking it is usually a disadvantage to be the last entrant. The Saudi Arabian market illustrates this. The National Commercial Bank enjoyed a virtual monopoly from its establishment in 1938 until 1957, when the Riyadh Bank was founded.
The latter never caught up in terms of market share, and although the new Saudised banks established in the late 1970s and early 1980s chipped away at the National Commercial Bank’s market share, it retains its dominant position until today.
Western and Arab banks often try to target university students, as although these young people often have little money, they are the most likely group to be the important clients of the future. In the marketing of banking services, it is crucial to take a long-term perspective.
A number of Islamic banks have also grasped the potential importance of this student market, especially given the Islamic fervour on many university campuses. Establishing a branch on the campus of state-run universities in the Islamic world is often a problem, but a number of Islamic banks have succeeded in acquiring premises close to the main entrance gates to universities.
Building a profile of the Islamic investor
Islamic finance is often approached from the perspective of the service provider rather than the needs of the client. To some extent this reflects a view of Islamic economics as a set of rules and procedures for ordinary Muslims to follow in their everyday lives. The financial instruments have largely been developed from what is deemed practicable and convenient for the bank, provided they can be seen to be consistent with Sharia law.
Often it has been a case of adapting and modifying conventional instruments so that they can be seen to be Islamically legitimate. Once the Sharia advisor is satisfied that religious laws are observed, then the instrument or service can be offered.
Marketing is a completely neglected issue in the literature on Islamic finance, and a topic which is rarely if ever discussed in conferences on the subject. This may reflect the top-down approach, seeking to provide a financial service which is thought by those in authority to be suitable for the Muslim bank client, rather than finding out what the customer actually wants and sees as acceptable, given his or her religious faith.
Customer preferences can be ascertained through casual empiricism, and simply listening to what particular Muslim clients are requesting may well be appropriate for those providing highly personalised banking services to clients of high net worth. In these cases, the costs of tailoring financial instruments to individual preferences may be both feasible and financially viable, as the transaction costs can be built into the margins charged for the personalised facility.
Outside the world of private banking for the very rich, however, it is necessary to provide more standardised services. What type of instruments should be provided, and how should they be structured with respect to the time to maturity and the costings?
There are, of course, basic Islamic financing facilities that are well-established and defined, such as Mudaraba, Musharaka, Murabaha and Ijara. What should be the terms on which each of these is offered, if they are to appeal to the customer and widen the market for Islamic financial instruments?
Rather than the bank simply providing the service on a “take it or leave it” basis, it may be more successful if it first undertakes market research to identify what potential clients find appealing and acceptable.
Some may view client discretion as a luxury, and marketing as a way of appealing to customer whims, almost a frivolity, which is ill-suited and unnecessary for the religious and the devout. Marketing and its sub-disciplines have become an important part of management science, however, and its tools and techniques have a serious purpose.
customer whims, almost a frivolity, which is ill-suited and unnecessary for the religious and the devout. Marketing and its sub-disciplines have become an important part of management science, however, and its tools and techniques have a serious purpose.
Market research can be useful for finding out if existing clients are satisfied with the Islamic financial services on offer, as well as ascertaining the expectations of potential customers. It can also be used to test reactions to new financial products, which may determine whether the bank considers it is worth proceeding with their launch. Often customers do not really know if products are actually suitable until they have been tried.
One method of proceeding is to run a trial for a new financial service with a particular market segment, and conduct a small pilot survey of the initial users to obtain feedback. The only problem with this approach is if the trial group was selected in anticipation of a favourable response, their characteristics may deviate from that of the possible wider market. Positive feedback from the trial group may be no guarantee of wider market acceptability. Modification in the light of negative feedback from the trial group may actually bias the service provision in a way that makes it less acceptable generally.
Market research is the major means of scanning the environment to determine whether particular products are likely to be acceptable. The standard literature on environmental scanning includes religion as one feature defining market segmentation, but there are many others. Islamic banks serving domestic retail markets find that the services used depend on the clients’ income, occupation, level of education, age and family position.
Institutions serving a number of Muslim countries may find that each market has its particular characteristics reflecting ethnic and social differences, in spite of the common religious values and beliefs of its client base. Political, fiscal, economic and legal factors are determined nationally, not for the Islamic world as a whole, which implies considerable diversity in financial product provision.
International marketing intelligence involves the systematic gathering, recording and analysis of data on particular markets, so that the bank can decide which market to focus its efforts on, the entry strategy, and how to build up a client base.
International marketing can be reactive, where questionnaires or in-depth interviews are used to collect primary data, or alternatively it may be non-reactive, where existing secondary data is used, which will not usually have been collected by the bank itself.
The Albaraka group, when deciding in which of the republics of the former Soviet Union to establish a presence, had to take account of the relative sizes of the Muslim populations, per capita income levels, economic development prospects, the stability of the potential host countries and the attitude of the authorities to the entry of an Islamic bank to their market for banking services. Khazakistan was chosen in view of its large size, political stability, the positive attitude of its government and its rich natural resource base.
Creating an effective marketing strategy
Although most Muslims are aware of Islamic financing possibilities, and some use the services provided by Islamic banks, and the Islamic facilities offered by conventional banks, there is a lack of knowledge concerning the terms of the financial products on offer, and how the instruments actually work.
Islamic banks have undertaken relatively little advertising, and most of what there is consists of simple press notices and a few billboard hoardings. The aim has been to foster awareness of the existence of Islamic banks in the market for banking services, and to a lesser extent create a brand image.
Conventional banks which offer Islamic financing facilities have been often somewhat discreet about what they provide, some of the effort being to “cross sell” Islamic financial products to existing customers of the bank, rather than tap new markets. They do not, of course, turn away business that comes their way, often through connections in the inter-bank market, but there has been no high-profile marketing strategy aimed at the general public.
Banks in countries where the entire financial system has been Islamised, such as Iran, have no need to promote Islamic financial products, as these are simply what is on offer, and there is no question of competing with conventional Riba-based banks.
In Iran, the banks, most of which are state-owned, advertise in the press to create name awareness, and to some extent to reassure their existing clients of their presence and solidity, but they do not attempt to promote particular services through advertising, or aim to entice clients away from other banks, whether state or privately owned.
Often press advertisements take the form of simple announcements of assets and liabilities, contrasting the situation of the last financial year with that of the previous year. These are to reassure, and merely reproduce information contained in their annual general reports.
Press announcements of this type are often a reporting requirement, either by the auditors, or government or both. Such official announcements are mainly of interest to other bankers, or shareholders in the banks, but most clients, and the newspaper readership at large, give them little more than a passing glance.
Because of the innovative nature and complexity of Islamic financial products, informative advertising is needed which goes beyond mere financial reporting, or the promotion of awareness of a particular bank. It is more a matter of explaining and educating, pointing out the advantages and implications of using particular Islamic financial products.
In doing this, decisions have to be made concerning what media to use to get across the message, what potential client group to target, and what the level and content of the information should be. Clearly these are not independent. Media such as television and radio are good for promoting brand awareness, but not for imparting information of any complexity.
Placing advertisements in financial publications may reach a specialist readership in the banking and business community, but will have little impact at the retail level amongst the general public. To reach the latter the mainstream press may be preferable, but there is then the issue of whether to advertise in quasi-governmental or more independent newspapers.
Placing advertisements in financial publications may reach a specialist readership in the banking and business community, but will have little impact at the retail level amongst the general public. To reach the latter the mainstream press may be preferable, but there is then the issue of whether to advertise in quasi-governmental or more independent newspapers.
One of the most effective means of providing educative promotion at the retail level is through the production of leaflets on the particular Islamic financial services being offered.
These can be made available in display racks in bank branches free of charge, and can also be obtained on request in response to newspaper advertisements, where the potential client is asked to tick the appropriate box and post the advertisement after cutting it out.
A telephone number can also be quoted for callers to leave their addresses so that the leaflets can be posted to their homes or offices. The bank is able to build up a database from the responses of potential clients for Islamic banking services, who can then be targeted from time to time with promotional literature. This should not be too frequent, in case it is regarded as junk mail, but phased-timing can build up potential client awareness.
The content of the leaflets should be carefully planned. Very glossy material may be expensive to produce, and may not portray the appropriate image. Conventional black print on a white background could be appropriate, and where colour is introduced, a single colour may suffice.
Bullet points and sub-headings may be appropriate, but the structure should be kept clear and simple. When considering how much information is to be included in the leaflets it is important to bear in mind the attention span of the potential reader, especially if they are aimed at the personal rather than the business client.
Most bank clients are not as interested in financial matters as bankers themselves, who after all have chosen careers in finance. Leaflets should not take an excessive amount of time to read, and banks may regard it as preferable to produce several leaflets on their Islamic financial services rather than one leaflet giving details of the entire range.
Smaller well-focused leaflets are cheaper to produce, and it is wasteful to include information which a particular client does not want. Readers may resent searching for what is relevant to their requirements. On the other hand, a larger leaflet which enables the reader to browse through a wider range of services introduces the possibility of cross-selling.
A client interested in an investment account only may be attracted by the services provided with a current account. Th e merchant interested in Murabaha trade credit may be attracted by the leasing contracts provided through Ijara.
Rather than having separate leaflets on different Islamic financing facilities such as Mudaraba, Musharaka, Ijara and Murabaha, banks may find it better to categorise leaflets for each type of service.
A leaflet covering current account facilities would contain enough information on its own, for example, with separate leaflets on savings and investment accounts, although it may be thought appropriate to draw the reader’s attention to the breadth of services provided by the bank. For those seeking funds, separate leaflets could be produced for personal and family financing facilities, small businesses
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and facilities such as trade and equity finance.
How extensive infrastructure spending may impact on investment decisions
Islamic banks, like conventional banks, are interested in investment expenditure and government spending more generally, as this aggregate macroeconomic data provides some indication of the possible future demand for Islamic funding. In most Muslim countries, government spending tends to compliment commercial bank finance rather than crowd it out.
Hence a high level of government spending may be associated with good financing opportunities, although there is the issue, especially in the Gulf states, of the extent to which this can be sustained with continuing depressed oil prices.
There is considerable variation in the level of investment in relation to GDP in the Islamic world, as Table 3 shows. The investment ratio data can be compared with the per capita GNP data in table 1.
Such a comparison reveals, not surprisingly, a positive relationship between the ratio of investment to GDP and the level of per capita GNP, although economies such as Kuwait are obvious exceptions. Much investment is still financed by governments rather than privately in the Islamic world, but the figure does give some indication of the relative demands for funding.
Most of this funding is raised through conventional rather than Islamic financial instruments, but both private seekers of finance and governments in the Islamic world are increasingly aware of the advantages of being seen to use Islamic instruments, not because they are cheaper, but because of the favourable public reaction.
Major deals which have involved Islamic financing include the purchase of power generation equipment in Pakistan and the acquisition of Airbus aircraft for airlines in the Gulf.
Other airline deals may include the purchasing of aircraft for Malaysian Airlines worth $1.5 billion and the arrangement of Islamic finance for fleet modernisation by the Biman Airline of Bangladesh in a deal worth $150 million.
As Table 3 shows, it is Malaysia and Indonesia, which have the highest investment rates in the Islamic world. It is therefore not surprising that it is in these South East Asian countries that some of the largest Islamic financing deals have recently been arranged.
These include: a deferred payment deal (Al-Bai-Bithaman Ajil) for work worth $782 million on Kuala Lumpur’s new international airport at Sepang; financing valued at $354 million for a new transport terminal in Jakarta; and housing finance worth |30 0 million for a complex of 8,000 apartments, also in Indonesia. The Faisal Islamic Bank of Bahrain has been involved with the latter.
Predicting the long-term needs of the market as a whole and preparing to meet the demand
Islamic banks have to make decisions about how to provide their services, which involves determining the location of their head offices and planning the number and distribution of branches. For banks serving a domestic market, the national capital or the leading commercial centre is usually the favoured headquarters site, even though premises may be more expensive to acquire and maintain in such locations. Where direct personal contact with clients is essential, this implies the necessity of a physical presence. Building up a branch network is the obvious way of achieving this, but this can be costly in terms of staffing and premises.
Decisions have to be made about the level and range of service to be provided by each branch. Acceptance of all forms of deposits is usually devolved to each branch, as well as the provision of withdrawal facilities.
Personal financing for small amounts may also be arranged locally, including modest Murabahas to facilitate wholesale or retail trade. Standard Ijara leasing contracts may also be authorised. Most equity participation arrangements on a Mudaraba or Musharaka basis have to be approved by the head office. This is because they involve the Islamic bank taking on risks with respect to its returns, and not merely the risks associated with repayments default.
For Islamic banks primarily involved with personal clients of high net worth and large international trade financing deals, most matters will usually be dealt with through the head office. Personal contact is maintained either by the clients visiting the bank from time to time, or by the bankers visiting the client, where the business is on a significant scale.
Day-to-day communication is maintained by telephone and fax rather than E-mail, as Islamic banks, like other banks, have been reluctant to use the Internet, because of worries over the security of open access UNIX systems. Extending computerised banking systems to provide direct screen and keyboard access to business clients with appropriate modem links may well become more of an issue for Islamic banks in the future. Many Western banks already provide such facilities to enable clients to check their account balances, make deposits and withdrawals and send messages.
There can be little doubt that the telecommunications revolution will have profound implications for the logistics of providing Islamic banking services, just as it has for the conventional banks. Islamic banks with only limited or no branch networks may find this becomes less of a handicap when competing with conventional banks with networks.
Those dealing primarily with clients of high net worth or major business customers are likely to find that the advances in telecommunications work to their advantage, as such clients are likely to have both the facilities and skills to maintain on-line links.
There are, of course, trade-offs between the price at which a particular Islamic banking service is offered and the quality of the service provided. For large deals the bank will be able to offer a more highly personalised service, but this will be instead of at least part of the discount associated with business on a substantial scale. Different banks of course are able to make different levels of profit on their business, but this reflects their own cost structures as well as their ability to convince the client that the service is worth paying for, even when the quotation exceeds that of their rivals.
Profitable Islamic banks are not simply those that attract business by pricing their services at low levels, or those that promise the highest returns; it is the quality of provision which may matter, and some institutions may prefer to provide a quality service to a low-volume market, rather than offer a lower quality product at a cheaper price on a higher volume basis.
The latter may not be an especially profitable way of proceeding. Developing new financing facilities and providing an extended range of services can also be costly.
Islamic banks have to decide if they are to be niche players in terms of the types of products provided, or whether they can provide a fuller range of services on a fee basis in line with conventional banks. They, of course, have to avoid all interest payments and receipts as this would constitute Riba, but many conventional banks are increasingly charging customers for many of their services on a fee basis rather than applying interest.
Islamic banks function to some extent like investment companies, as their savings and investment deposits are received on a profit-sharing basis and funds are often advanced through Mudaraba or Musharaka equity participation. This means depositors and those receiving funding have a direct interest in how profitable the bank is; depositors through the profit-sharing, and recipients of funds because the bank is more likely to withdraw from its equity stake if it needs to restore liquidity because of a shortfall in deposits.
This identity of interests is not complete, however, even for the profit-sharers. There is still the issue of what proportion of the profits to pay to the holders of investment accounts. This normally depends on the amount of notice they are required to give prior to making withdrawals. There is also the issue of how profits should be shared between the bank and those being funded. In other words, with much Islamic financing the issue becomes one of relative share determination, rather than a matter of absolute pricing.
By the year 2000 it would seem reasonable to anticipate that up to one quarter of bank deposits in the Gulf could be on an Islamic basis, with Mudaraba investment increasingly replacing conventional savings and investment deposits. Such a proportion seems a realistic proposition, even with a modest marketing effort.
Elsewhere, the proportion may be lower, five percent being a more realistic target in Turkey, Egypt and Malaysia. Nevertheless, the challenge for the banks may not be so much to attract Islamic deposits, but rather to identity how these funds can be used profitably through Murabaha, Musharaka and Ijara operations. There is certainly likely to be increasing competition among suppliers of such funding, with pressures on margins which affects the conventional as well as Islamic banks.
Nevertheless, much will depend on overall economic developments in the region, and in particular on whether oil prices firm up or remain depressed. Despite such concerns, the long-term future for Islamic finance seems assured. What is at issue is the speed of development, not the progress towards more ethical finance.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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