Islamic Banking Core Systems: The West European Opportunity (Strategic Focus)

Islamic banking has gained significant traction in many parts of the Islamic world. However, outside the UK, West Europe has remained a nascent market. New government policy changes may drive new entrants into this market over next 5 years. Given Sharia compliance has the significant implications on IT systems and processes this will create new opportunities for core system vendors.

Report Highlights
France is set to become the next growth market for Islamic banking in Western Europe, with the French government in process of adjusted policy to facilitate development of Islamic banking and a number of Islamic banks are expected to be authorized by mid 2009

Given the nascent nature of Islamic banking in Europe, technology spend to support and develop retail Islamic banking is currently a small fraction of overall technology spend. IT spending is expected to double over next five years (albeit from a small base) increasing from just under $30m in 2009 to over $60m in 2013.

Conventional banks are likely try to enhance / develop existing core systems initially in order to minimize capital expenditure outlay. Depending on uptake success, banks may then adopt new systems 3-5 years down the line. In contrast, standalone banks are more likely to deploy new Islamic specific core systems as part of market entry strategies.
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Overview 1
Catalyst 1
Summary 1
Key Messages 2
Uptake of Islamic banking remains nascent in Western Europe despite recognized potential 2
France is following the UK in leveling the policy environment, with other Western countries likely to follow in medium-term 2
Sharia compliance drives core systems requirements beyond most conventional systems 2
Islamic banking has process implications across sales, origination and servicing 3
West European entrants will focus on core systems, plus online for standalone banks 3
Retail Islamic banking technology spend in Western Europe will reach $60m by 2013 4
Vendors need to demonstrate long-term commitment to Islamic banking 4
The competitive battlefield will be at country level rather than for overall Islamic offering 4
Table of Contents 5
Table of figures 6
Market Opportunity 7
Islamic banking has become a viable alternative to conventional banking 7
Islamic banking concepts revolve around community banking, ethical investment and affinity marketing 8
The practical application of Sharia law to Islamic banking is subject to interpretation by Sharia scholars 9
Islamic banking can be provided by conventional banks through an Islamic window or Islamic subsidiary 9
Uptake of Islamic banking remains nascent in Western Europe despite recognized potential 11
The West European potential customer base from domestic and temporary Muslim population is significant 11
The Muslim population does not necessarily represent the potential Islamic banking market population 12
Public policy and regulation are the initial barriers, with understanding the long-term issue 13
The UK market has led retail Islamic banking provision in Europe, with basic Islamic products so far 14
Greater provision of UK Islamic banking coincided with removal of tax and regulatory disadvantages 15
Ownership of underlying assets creates additional tax liabilities for Islamic products 16
The structure of Islamic products often places them outside conventional banking regulatory frameworks 16
Shortage of contractual and legal expertise in Western European markets is a significant challenge 17
Take-up by the Muslim community has been good, but Islamic banking remains niche 18
UK Muslim understanding of Islamic products is long-term challenge, but financial crisis will assist take-up 19
The financial crisis has reduced the relative strength of conventional banking model 19
France is following the UK in leveling the playing field, with other Western countries likely to follow suit in the medium-term 20
The French government has adjusted policy to facilitate the development of Islamic banking 21
The German banking sector was an early mover in Islamic banking, but has not sustained momentum 22
Italian Islamic banking suffers from tax disadvantages and nascent political interest 22
The Netherlands has shown interest in developing Islamic banking, but limited movement so far 22
EU banking passport principles will drive less active governments to deal with Islamic banking 23
Customer Impact: Technology implications 24
Sharia requirements drive different accounting and calculation approaches in core 24
The need to distribute pooled profit means that calculating deposit returns is more akin to fund administration 24
Parameterization of conventional core systems will rarely be optimal for Islamic products 25
Haram requirements mean Islamic windows should co-mingle funds and treat accounting separate entities 26
A separate Islamic core system is not necessarily ideal for Islamic window structure 27
Islamic banking has process implications across sales, origination and collections 27
Bank ownership of asset drives different origination process and an asset management requirement 28
Achieving Sharia compliance requires attention to sequence of origination as well as contract content 29
West European entrants will focus on core systems, plus online for standalone banks 29
Initial IT priority in Western Europe will be on core, with standalone banks the main users of new systems 30
Technology development around origination is likely to be limited in the short-term 30
Strong direct channel and third party integration capabilities will be important for standalone banks 30
Retail Islamic banking technology spend in Western Europe will reach $60m by 2013 31
Retail Islamic banking technology market will be led by UK and France in the short-term 31
Achieving Sharia compliance is essential, but main core system investment business drivers still apply 32
Competitive Landscape 33
The Islamic banking core systems market remains fragmented with a strong regional aspect 33
Niche/regional Islamic banking core vendors remain important players in the Islamic core banking market 34
A number of the leading conventional core vendors have entered the Islamic core banking market 35
The leading conventional core vendors are catching up in the Islamic banking space 36
Niche vendors retain some advantage in Islamic markets due to cultural and process understanding 36
Growing reference lists mean that leading vendors are now likely to dominate larger and regional implementations 37
Go to Market 38
Vendors need to demonstrate long-term commitment to Islamic banking 38
The ongoing development roadmap is important with a view of Islamic banking beyond the Middle East 39
Vendors should develop Islamic services capability for both implementation and support 39
The competitive battlefield will be at country level rather than for overall Islamic offerings 40
Developing country specific out-of-the-box capability will be a valuable differentiator 40
Vendors targeting Western Europe should highlight conventional presence and Islamic expertise 40
Vendors should recognize that success metrics may differ from the non-Islamic market 40
Profitability metrics and business case drivers may differ, with greater focus on customer base growth 40
However, underlying IT drivers for core system investment around flexibility and time-to-market are similar 41
Recommendations 42
APPENDIX 44
Definitions 44
General terms 44
Glossary of key Islamic banking terms 44
Ask the analyst 44
Datamonitor consulting 45
Disclaimer 45
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Figure 1: Customer sweet spots for Islamic banking models 10
Figure 2: Distribution and population density of Muslim population across Western Europe 12
Figure 3: Main Islamic deposit products provided in UK market 14
Figure 4: Main Islamic financing products provided in UK market 15
Figure 5: Islamic Bank of Britain customer deposit and operating income growth H2 2004-H1 2008 18
Figure 6: France is likely to be most significant Islamic banking market in the short-term 21
Figure 7: Banking activities affected by co-mingling requirements for Islamic windows 26
Figure 8: Technology spend on retail Islamic banking in Western Europe, 2009-13, $m 31
Figure 9: Business drivers for core systems investment in Western Europe 32
Figure 10: Islamic world-based Islamic banking core systems vendors 34
Figure 11: Pan-regional conventional core system vendors with Islamic banking offerings 35
Figure 12: Top functionality requirements for core system replacement in Western Europe retail banks 41
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