Development of Islamic Windows of Conventional Banks: Global Trends

1. Development of Islamic Windows of Conventional Banks: Global Trends Dr Sofiza Azmi Senior Research Fellow Asian Institute of Finance Kuala Lumpur, Malaysia

2. Introduction • The number of Islamic windows of conventional banks has risen to 350, almost equal to total number of Islamic banks world-wide • There are countries that allow only Islamic Windows and not full-fledged Islamic banks (Ethiopia through a Directive effective from October 1, 2011) • There are also countries that do not allow Islamic Windows, like Malaysia (for retail banking), Lebanon and Qatar

3. What is an Islamic Window? • “An Islamic Window is a separate department within a conventional bank, which operates under strict guidance by an independent Shari’a Advisory Board (comprising Muslims scholars of repute, credibility and due social recognition) to develop and offer Islamic financial products to the clients that demand such products.” • An Islamic Window may offer its products and services through conventional branches or dedicated Islamic branches of the conventional bank

4. Historical Developments • Conventional investment banks in the West have since the 1960s been offering tailor-made solutions to their High Net Worth (HNW) clients from the Middle East • This was in essence start of the Islamic Window model • The most important development in the Islamic Window was however, the decision by NCB of Saudi Arabia to gradually Islamise its retail banking operations by converting some selected branches • This eventually led to the Islamisation of the whole retail banking operations of NCB

5. Historical Developments • Malaysia provides another example of a successful Islamic Window model that led to the creation of fully licensed Islamic banking subsidiaries of the parent conventional banks • Qatar has recently adopted a similar approach by disallowing Islamic Windows and conventional banks are not allowed to offer Islamic financial services • Lebanon is another country that does not allow Islamic Windows • All other countries where Islamic banking exists, conventional banks are allowed to set up Islamic Windows

6. Issues with Islamic Windows • Islamic Windows are seen to have led the development of Shari’a light financial products • Tawarruq-based products • Credit cards • Weak Shari’a supervision • Lack of commitment to the development of Islamic banking • Cannibalisation is a fear • Many conservative Muslims believe that segregation of Islamic funds within a conventional bank is merely an accounting trick

7. Issues with Islamic Windows • Leakages are bound to happen • Given the availability of conventional banks to use more advanced liquidity management and treasury operations, with the help of derivatives and other such products, conventional banks with Islamic Windows can potentially drive the Islamic banks out of the market, if financial performance is the main criteria of bank selection by customers • Not conducive for development of an Islamic banking industry

8. Global Trends • It is quite natural to conclude that Window model serves only as a transitory mechanism • With the increase in the size of the Islamic financial services industry, the full-fledged Islamic banks make more sense than setting up Islamic Windows. • Islamic banks like Al Rajhi, ADIB, KFH, and DIB have become big players in the market, and hence have acquired technology and sophistication in structuring and operations, which match that of the conventional banks • This certainly limits the scope and further growth in the business of Islamic Windows

9. Global Trends • Malaysian model and that of NCB are only exceptions • The real driving force behind conversion is the government directive role and not the “test and convert” kind of market phenomenon • There are only seven significant cases of conversion • Middle East Bank into Emirates Islamic Bank (UAE) • Sharjah National Bank into Sharjah Islamic Bank (UAE) • Dubai Bank into Dubai Islamic Bank (UAE) • NCB (Saudi Arabia) – only retail banking • Khyber Bank (on going) (Pakistan) • Industrial Development Bank into Jordan Dubai Islamic Bank (Jordan) • National Bank of Development into an Islamic bank by ADIB (Egypt)

10. Global Trends • Apart from these seven cases of conversion, we do not observe any big banks (operating Islamic Windows) converting into full-fledged Islamic banks • Even some rather successful Islamic Window operations (like HSBC Amanah and Standard Chartered Saadiq) had to set up full-fledged Islamic banks in Malaysia, following the government’s decision not to allow conventional banks to have Islamic (Retail) Windows

11. Global Trends • All the major investment banks (like Deutsche, Citi, UBS and others) have significantly downsized their Islamic Windows • “Islamic Windows are like prayer mats, which can be rolled back at any time; full-fledged Islamic banks are like mosques that cannot be wound up at the will of people” (a contemporary advocate of Islamic banking)

12. Policy Implications • The governments and financial regulators in the OIC-bloc must ensure that only full-fledged Islamic banks are allowed to set up • Conventional banks must only be allowed to offer Islamic financial services, once they have demonstrated their serious commitment to Islamic banking and have a clear roadmap to full conversion of their operations into Islamic • In the newly-liberated Arab Spring countries, there is a huge popular demand for Islamic banking, the above policy implications are more relevant to such countries

13. Conclusions • Islamic Windows have certainly played an important role in the development of Islamic banking & finance but their future role is rather limited • Islamic Windows are by and large less rigorous in implementing strict requirements of Shari’a and hence are viewed with suspicion by conservative Muslims • Nevertheless, the Islamic Windows model should be adopted with caution and with clear roadmap to full conversion