EY: Islamic banking growth on the increase across globe

19 January 2016 Consultancy.uk

Islamic banking, termed participant banking, is outgrowing conventional banking in many of the world’s predominantly Islamic countries. Today the total participant banking market is worth around $920 billion, which is projected to grow to more than $1.6 trillion by 2020, research by EY shows. Particularly the Gulf States are seeing rapid participant banking growth. RoE within the sector remains relatively robust at 12.6%.

In a recent EY study, titled ‘World Islamic Banking Competitiveness Report 2016’, the professional services firm explores the Islamic Banking landscape. The report is built up from an analysis of 69 participation banks (Islamic Banks) and 45 conventional banks, covering the markets of Bahrain, Qatar, Indonesia, Saudi Arabia, Malaysia, United Arab Emirates, Turkey, Kuwait and Pakistan.

International Participation banking assets

Market growth
The report finds that the markets covered contain 93% of international participant banking industry assets, valued in excess of $920 billion in 2015. The largest part of that value stood in GCC (Gulf Cooperation Council) countries, at $606 billion, followed by ASEAN countries at around $159 billion. In terms of the total share of banking assets, in the GCC region participant banks held 34% of total assets, while ASEAN area participant banks accounted for around 13% of the total market value.

The increase in asset value has been impressive between 2010 and 2014, growing with a CAGR of 16%. This is despite the political upheaval that has plagued the various regions in recent years.

Regional participant banking size

Regional size
Internally participant banking makes up more than half (51.2%) of the total banking space in Saudi Arabia. The country has the largest international participant banking share, at 33%. Malaysia comes in second at 15.5% of the global share, with participant banking taking a 21.3% share of its domestic banking market. The UAE comes in third in terms of international share, with 15.4%, followed by Kuwait at 10.1%. The smallest contenders are Pakistan at 1.4%, even while it represents 10.4% of the internal markets, and Bahrain at 1.6%, while internally it represents 29.3% of the total banking sector in the gulf state.

Asset growth

The participant banking sector shows considerably stronger growth than the conventional banking system in almost all of the banks in the countries surveyed in 2014. Saudi Arabia stands at the forefront with participant banking growing at 18%, while conventional banking grew at 7%. Malaysia saw its participant banking grow by 4% and its conventional system by 1%. The UAE booked considerable growth in both types of banking institutions; participant banking was up 18% and conventional banking 19%. The largest growth has been booked in Qatar, where participant banking was up 20% in 2014. The only country to see negative growth in its participant banking system has been Turkey, where it fell -1%.

Top 20 participant banks

Growth and profit
According to the analysis, the combined profitability of the top 20 participation banks has increased by $1 billion to more than $7 billion in 2014, growing with a CAGR of 14% (2010-2014). This resulted in a healthy growth of return on equity (RoE), which has positively contributed towards increasing shareholders’ equity (22 banks have crossed the equity landmark of $1 billion).

The report finds that participant banking assets grew slightly faster than conventional assets, at 14% relative to 11%, between 2010 and 2014. The RoE for 2014 fell slightly in favour of conventional banking asset investments, at 14.5% compared to participant banking investments at 12.6%.

Increase of participant banking assets by 2020

Future projections
The projected asset pool is set to increase considerably over the coming five years. For 2015 the estimated Saudi Arabia pool stands at $343 billion, which will more than double to $766 billion by 2020. The UAE pool will increase by more than $100 billion, while Malaysia will see an additional $70 billion. The total market will be worth more than $1.6 trillion in the regions considered. In contrast, a recent BearingPoint analysis places the total market value at around $3 trillion by 2018, up from an estimated $1.8 trillion today.

According to Muzammil Kasbati, Director at EY’s Global Islamic Banking Centre: “The external operating environment is certainly getting tougher, given the prevailing oil price and the resulting impact on banking system liquidity and infrastructure spend. Islamic banks are in a better position to weather this storm due to the simpler nature of their balance sheets, basic products and localised operations. However, they do not appear to be ready for the digital changes that are impacting the way customers engage with banks. A fundamental review of their operating models at this stage will be critical to the success of Islamic banking across the Organisation of Islamic Cooperation markets.”

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The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.