17 March 2012
I was recently interviewed in writing by Islamic Finance News magazine of Malaysia about the state of the retail Islamic banking market in the UK. They used some of my comments, along with comments from other respondents, to write an article “Islamic retail banking: Are we ready for the big league?” which was published in the 14 March 2012 issue of the magazine.
Space constraints meant that it was not feasible for the magazine to use all of my comments. Accordingly for readers of this website I have set out my full comments below. The questions are my paraphrase of the questions Islamic Finance News sent me, since the magazine has the copyright in the wording of the original questions.
The Islamic window operations of HSBC and the other UK conventional banks do not publish separate figures. Accordingly the only figures available for UK Islamic retail banking are those published by Islamic Bank of Britain (IBB). IBB has reported significant losses in every set of its published accounts. The most recent published accounts are those for the year ended 31 December 2010; they show accumulated losses from commencement of just over £54 million.
The recent global financial crisis appears to have had no significant impact on UK Islamic retail banking. The losses made by IBB are, in my view, unconnected with the global financial crisis since it was loss-making before the crisis occurred.
The key thing which needs to be understood about the UK Islamic retail banking market is that the addressable market is very small. The total UK Muslim population was estimated in 2009 at about 2.4 million. However the addressable market is much smaller since from the 2.4 million one needs to exclude the following categories of person.
This is explained in more detail in my website article Why has retail Islamic banking not taken off in the UK?
In comparison the conventional banking sector in the UK is well established with a very large addressable market. Accordingly it has significant economies of scale and manages to be very profitable.
There are two distinct reasons why UK Islamic retail banking is not cost competitive with UK conventional retail banking.
Compared to the large UK conventional banks, IBB is a very small bank. There are many costs associated with running a bank such as having a compliance function, having an internal audit function, IT systems etc. which do vary with the size of the bank but not in a linear way. At its simplest, if the bank's balance sheet increases in size tenfold, these costs do not increase by a factor of 10. The consequence is that these overhead costs are much more onerous for a small bank than they are for a large bank.
This issue is much less significant for the Islamic window operations of conventional banks since they are able to make use of the same internal functions and systems that are used by the conventional part of the bank.
There are some costs in Islamic finance that do not arise in the conventional finance. For example a conventional bank does not need a Shariah supervisory board and does not need an internal Shariah compliance department.
More fundamentally many financial transactions are more complicated to implement in Islamic finance than they are in conventional finance. For example a conventional household mortgage simply requires the bank to send money to the solicitor effecting the purchase of the property for the individual customer, and that solicitor to register the bank as the legal owner of the property at the UK land registry. There will of course be a loan agreement signed between the customer and the bank.
In comparison, a household mortgage under diminishing musharaka requires the bank to purchase the property from the seller, requires a rental agreement between the bank and the customer and requires subsequent sales of parts of the property from the bank to the customer. Even with maximum efficiency, the diminishing musharaka transaction is likely to take more professional time and involve greater costs than the conventional mortgage.
The Islamic retail banking proposition in the UK is unable to compete with conventional banking in terms of cost. Accordingly the only customer base it can attract are those Muslims who prefer Islamic retail banking to conventional retail banking on religious grounds and are willing to pay extra for a product that they regard as more religiously appropriate.
The only marketing strategy that I have seen from IBB or indeed the Islamic windows of conventional banks is a strategy based upon religious preference.
When IBB first started operating, a small number of non-Muslims were attracted to it as IBB was seen as offering a new and more ethical product than conventional UK banks. However as IBB cannot compete on price its ability to attract non-Muslim customers is very limited.
The Islamic window operations of conventional UK banks are unlikely to be seen as significantly more ethical than the rest of the conventional bank that they are part of. Accordingly I would expect few if any non-Muslim customers to be attracted by the Islamic windows of the conventional banks.
As a stand-alone bank IBB publishes its accounts. I am not aware of HSBC or the other conventional banks that have UK retail Islamic windows publishing any information about their UK Islamic operations. However I understand from hearsay that in monetary terms HSBC Amanah in the UK is bigger than IBB.
Some Muslim customers are deterred from doing business with the Islamic windows of conventional banks for religious reasons since they are concerned that their Islamic activities may be contaminated by association with the larger conventional bank within which they are contained. However others will be attracted by the familiar brand name and the perceived greater level of security offered by dealing with names such as HSBC or LloydsTSB.
The great advantage that an Islamic window operation has is that it is able to take advantage of the economies of scale of the conventional bank that it is part of. This allows the Islamic window operations to be more cost-effective than the stand-alone operations of IBB.
I do not have any data on where the customers of the Islamic window operations originate from. It is a reasonable assumption that many customers of HSBC Amanah may previously have been customers of HSBC conventional bank. However in the absence of an Islamic offering from HSBC those customers might well have been lost to IBB or to the Islamic window operations conducted other banks such as LloydsTSB.
Accordingly from a strategic viewpoint the management of the UK conventional banks are unlikely to be concerned that their Islamic window operations might be cannibalising their conventional banks. In any event the number of Muslim customers involved is relatively small.
The small size of the UK retail Islamic banking market is likely to deter new stand-alone entrants. Conversely I would expect IBB under its new ownership by QIIB to remain in the market. Reducing its losses will require a combination of cost-cutting and increasing the total level of its revenues.
I would expect the conventional banks to continue with their retail Islamic window operations since those operations require a few incremental costs. While no figures are published, I would not be surprised if those retail Islamic windows operations were operating at a profit.