Sharia law encourages collaborative banking including in treasury services
The trend for Islamic banking is extremely compatible with another banking trend – for cash management and trade finance convergence, says Shaheryar Sadiq Ali, vice president, relationship and sales manager, Gulf and Pakistan Treasury Services at BNY Mellon.
Demand for Islamic banking products has increased dramatically in the past 10 years. This has come at the same time as a trend for the convergence of two traditionally separate banking functions – trade finance and cash management. Advancements in technology partly initiated this trend, allowing trade finance to be viewed as a cash optimisation tool rather than purely for risk management purposes.
However, many in finance are now discussing a further convergence – between the combined cash and trade offering and with the burgeoning Islamic treasury services offerings. This is an exciting prospect – especially for the Middle East – with the two streams surprisingly compatible. Yet there are hurdles to overcome before the two trends can merge not least – again – with respect to technology.
Islamic cash and trade
There is no difference between an Islamic transaction banking function and a conventional one in terms of functionalities, except that an Islamic one must operate within the confines of Sharia compliant principles. There are three crucial rules that must not be broken. Any banking transaction governed by Sharia law must, therefore, be free from speculation and contain no interest or unspecified contingent liability.
Yet as the function of an Islamic treasury service (transaction banking division) is the same as that of a non-Islamic one – to generate and utilise liquidity – then combining the two concepts to create a fully-integrated Islamic treasury service is surely a viable option. As neither traditional cash nor trade is based on speculation, with both involving the exchange of goods, an integrated treasury service and Islamic banking offering must be possible.
Certainly, many Islamic bankers think so – for instance, Ali Akbar Khan, vice president of Financial Institutions at Dubai Islamic Bank (DIB), says: “The structure has to be modified to Sharia principles largely with the financing aspect.”
“When you undertake any trade under Islamic banking there have to be underlying goods or services that have to be clearly defined and the financing structure has to be Shariah compliant. This is the key difference between Islamic and conventional finance.”
Far from seeing converged treasury and Islamic banking as conflicting, bankers agree that Islamic banking could in fact assist with a marriage between cash management and trade finance.
Increased demand for Islamic finance
Since the recent global crisis, the advantages of the non-speculative nature of Islamic finance have become increasingly apparent to the world beyond the Middle East. According to practitioners, this has led to a boost in demand for Islamic banking products, driven by the fact that Islamic banks generally fared better than their conventional counterparts during the crisis.
As Lakshmanan Sankaran, Head of Trade Finance at the Commercial Bank of Dubai (CBD), observed: “One of the reasons for this is Islamic banking is goods-based not just paper-based, so it was more visible, transparent and safe,” he says. “It is therefore in a stronger position to cope. We are very optimistic of the demand and potential for Islamic banking products, including on the trade side.”
Islamic banks' ability to deal with liquidity concerns during the crisis has indeed bolstered demand for Sharia compliant banking services. Liquidity concerns also increase the need for supply-chain efficiency. Therefore, if Islamic banking principles were combined with integrated treasury services, an ideal solution could be found for the clogged supply chains of many Middle Eastern corporates.
Middle Eastern banks are developing advanced technology. But providing an integrated Sharia compliant cash and trade offering might prove to be a problem for some banks. The technology required for such a platform is complex and expensive, as well as time-consuming to install.
This is not helped by technologically- advanced corporates who could often be way ahead of local banks in terms of IT. As technology is seen to drive convergence, the advanced corporates could force banks to develop their own fully converged cash and trade platform, as – if banks are unable to keep up with corporates – they stand to lose out to bigger global players that have already developed such a platform.
Indeed, as some of the Middle East's leading corporates have become aware of the possibilities of technology in this area they have busily developed their own infrastructure. One large corporate in the Middle East has implemented its own customised centralised treasury system that the banks log on to. Given its lead, it is the corporate’s system that the banks will have to link to when undertaking business with the company – a classic sign of the power of some corporates in the region.
But if local banks can be ahead of corporates in terms of technology, the technological awareness of the region's corporates will make it much easier for them to utilise an integrated treasury services/transaction banking platform – meaning that a great leap forward is possible for the region if the banks seek to make it.
Outsourcing's danger for local banks
Local banks are faced with several options. If they want to match the larger technologically advanced corporates in terms of technology, one answer is to partner their treasury services with a global provider having an integrated Islamic treasury services platform. Although this might ease the move to Islamic integrated treasury services for local banks, this may not be the best solution for banks or their customers – not least because corporates wanting Islamic banking services are generally keen to avoid provisions from global banks for fear their finances and transactions will be polluted by mixing with non-Islamic ones.
Partnering seems like an easy option in terms of functionality and service, however, although the problem for local banks and corporates is that global banks' integrated treasury platforms have been built for the needs of their own global cross section of local and regional clients. Therefore, the service provided is unlikely to be suited to the specific needs of the Islamic market, which will also need to be tailored to the needs of specific banks (especially as Sharia law differs from country to country).
Also, partnering places the local bank in a vulnerable position. By outsourcing its client-facing functions the smaller bank gives the insourcing global player insight into its local businesses. The local bank is exposed to the risk of the larger bank poaching its customers – unless the larger global bank has a stated model that does not compete in the same market as the local/regional banks. BNY Mellon, for example, has such a commitment of not competing with its local banking customers.
Indeed, it would be better for local banks to partner with a specialist non-competing provider, such as BNY Mellon. This way local banks can combine their knowledge of their corporate clients' specific needs dictated by their region, with global expertise – creating a solution that is tailored to the demands of the local banks' client base. Such a service would also truly understand how Islamic finance and integrated treasury services can be made compatible, a win win for both.
* The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute treasury services advice, or any other business or legal advice, and it should not be relied upon as such.