A New Avenue to Business

Islamic banking seems a promising opening for domestic tech players looking to offset the impact of the US slowdown.

A clutch of IT companies are bullish on an ‘under-penetrated financial services domain’, which they claim will not be negatively impacted by the US credit crunch. What’s more, even global banks that have burnt their fingers in the U S sub-prime crisis are keen on action in this space, making the demand environment even more vibrant for Indian IT companies, they say.

There are projections of this market reaching the $1-trillion mark in the near future.

Welcome to the world of Islamic banking.

What is this all about?

As Wikipedia says, Islamic banking refers to a system of banking activity that is consistent with Islamic law (Sharia) and guided by Islamic economics. One of the main differences between conventional and Islamic banking is the absence of interest-based transactions (riba). For instance, instead of lending funds to a buyer for purchasing property, an Islamic bank would itself buy the property and sell it to the buyer at a profit. The buyer will pay back the amount in instalments.

Other features of Islamic banking include the avoidance of economic activities involving speculation (ghirar), introduction of an Islamic tax (zakat), staying away from goods and services that are contrary to Islamic values (alcohol, pork, etc.) Moreover, investments in gambling, prostitution, pornography and weaponry are prohibited. Acceptable investments include those made in education, food production and biotechnology.

According to estimates, the total assets under management in the Islamic banking world is expected to increase to $1 trillion by 2013, from the current levels of $300 billion.

Globally, new Islamic banking licences are being issued and existing banks are keen to add an Islamic banking window to their operations, according to Manek Fitter, partner, financial services, Ernst & Young

Islamic FIs are in the first wave of automation and less than 10 per cent of the existing ones have deployed an enterprise-wide automation solution. Indian vendors see a great opportunity in selling software that enables core banking, risk management and customer relationship management, says Vishnu Dusad, CEO of Nucleus Software, which has three clients in this space.

No sub-prime impact

Things look rosy from the demand side. Clearly, the Islamic banking space is bucking the trend of slowdown in demand currently seen for IT projects in the BFSI (banking, financial services and insurance) space elsewhere, says Haragopal M, Vice-President and Business Head, Finacle, Infosys Technologies.

The slowdown in IT spending in the financial services space is fuelled by the US sub-prime mortgage crisis and is affecting countries and economies that are downstream targets for investment.

By definition, Islamic financial institutions are prohibited from investing in the sub-prime business of the US, says Dusad of Nucleus. “Islamic banking products do not support fancy derivatives or invest in sub-prime bonds. Hence, they have been able to stay away from the mess in the US,” he explains.

West Asia and the Far Eastern regions, which account for 55-60 per cent of the total Islamic financial services market, have remained largely insulated from the credit trouble in the US, says Haragopal of Infosys.

Demand from West Asia (countries such as Saudi Arabia, the UAE, Bahrain, Egypt and others) alone accounts for roughly 33 per cent of the overall market. This demand is fuelled by the surge in oil prices and the need to finance infrastructure development in those regions, which is one of the most important growth areas for Islamic banking products, reckons Hanuman Tripathi, Managing Director of Mumbai-based financial solutions company, Infrasoft Technologies.

Interest among MNC banks

Of late, Islamic financial institutions are expanding in the US and other parts of Europe to meet the needs of a growing Muslim population. Tripathi believes that financial institutions stung by impairment of their asset portfolios in the western world, will seek to de-risk themselves from further losses by using the Islamic banking model, especially in West Asia.

Banks such as Citibank and Standard Chartered Bank have already formed full-fledged Islamic banking arms. Recently, HSBC announced that it will set up a standalone Islamic banking unit in Malaysia. Since several Indian IT companies already work with global multinational banks, they can leverage those relationships to get IT deals on the Islamic banking front, a senior industry analyst says. In doing so, they can make up for revenue losses incurred from the same client (due to project postponements).

N.G. Subramaniam, President, TCS Financial Solutions, believes that an increasing number of highly complex products tailored to the needs of Muslim investors are being offered today, thereby expanding the playing field for IT firms. A recent innovation is the Sharia-compliant hedge fund, which does not engage in short-selling. That’s because Islamic law states you cannot sell shares if you do not own them in the first place. “Shariah risk management is a must- have in coming years and will be a differentiator for technology vendors in the market place,” says Subramaniam. Providing technology solutions for conventional banking is no longer a high-margin game, owing to the plethora of domestic and overseas competitors. No wonder Indian IT companies are chasing and winning contracts in this space.

In the last quarter alone, Nucleus Software signed three deals that have a significant Islamic banking component. Infrasoft Technologies signed up four new customers for its Islamic investment banking and wealth management products.

“In the current quarter too, we are in advanced negotiations with over six new customers and hope to close at least four of them,” says Tripathi of Infrasoft.

Though Infosys has not signed an Islamic banking client for the past two quarters, the company sees the demand environment panning out to its advantage, says Haragopal

Apart from the usual players (such as TCS, i-flex Solutions, Infosys, Misys, Systems Access, and Temenos) that operate in this space, there is a second group of regional vendors that specifically target the predominantly Muslim-populated countries. Some of these vendors, such as Path Systems, have built core banking systems specifically for use by Islamic banks, while others have developed systems that support both conventional and Islamic products, says Subramaniam of TCS. The local experience and presence of the regional vendors serves them well in winning new implementations. Analsyts see niche players in Muslim-populated countries as potential targets for acquisition by Indian companies, who want to strengthen their Islamic banking portfolio.

Some companies are able to achieve higher margins on their Islamic finance business as they tweak existing core banking or risk-advisory products into Shariah-compliant ones, instead of investing in altogether new suites of offerings.

“Indian IT companies are not re-sellers but owners of their respective software solutions. Since they have access to the source code, 65 per cent of the product remains the same while only the remaining needs to be tweaked for specific requirements,” says Fitter of Ernst & Young. In doing so, several IT firms need have only a single integrated team that will have domain experts in both conventional and Islamic banking. One hurdle is getting functional specialists for developing and managing solutions as the requirements are region, bank or country-specific, according to Subramaniam of TCS.

Lack of standardised principles in the Islamic banking space is a major deterrent for IT companies, as Deepak Ghaisas, vice-chairman of i-flex solutions, had pointed out some time ago. Another challenge is that Islamic banking products have to support different languages and standards prescribed by the Shariah board of that region. Every Islamic bank in the world has on its payroll at least one Muslim scholar, who determines what is acceptable under Islamic law. Infosys tries to work around this by partnering with local companies in West Asia which will also assist in actual product development. “These firms help us to translate and regionalise our products. Moreover, they put us on to the right consultants or authorities who are experts in Islamic banking,” says Haragopal.

The bottom-line is that, this being a new market, it holds out much promise for IT vendors, says Subramaniam of TCS.

However, going forward, Islamic finance automation will require continuously evolving domain knowledge and companies to come up with out-of-the-box software products in order to have a distinct competitive edge. When this happens, the IT market for Islamic finance too will soon decide its market leaders, followers and laggards.