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the sector’s development by funding Is- lamic financial services institutions and by creating the enabling legal and regulatory frameworks. Over time, Islamic banking has expanded, as economic and demographic growth in predominantly Muslim countries has spurred the demand for Shariah com- pliant solutions.


But the supply side has also had a role to play: The increase in financial services in- stitutions offering Islamic banking products has raised the level of awareness among customers. However, it also has raised the competitive intensity of the market.


At the same time, Islamic capital markets have witnessed a wave of innovation. Today, the products and solutions of most conven- tional capital markets can be replicated in a Shariah-compliant manner. The most notable instrument (by volume) that has emerged is the Sukuk, an Islamic financial vehicle similar to a bond.


From 2003 to 2007, nearly $85 billion was raised through Sukuk. On the supply side, the main driver of growth in Islamic banking is the increasing number of financial serv- ices institutions offering Shariah compliant solutions.


In addition to the new Islamic banks that are being formed, there is an emerging trend among existing conventional banks to convert their operations to become Shariah compliant. For example, Dubai Bank in the UAE and Kuwait Real Estate Bank (now Ku- wait International Bank) in Kuwait recently converted their entire operations to be Sha- riah compliant.


in the marketplace than ever before. Incum- bent banks and new market entrants are facing vastly different market conditions and need to develop new sources of differ- entiation beyond compliance with Shariah (Islamic law) to compete or remain success- ful in the future.


Islamic Finance: A Growing Market Historically, the growth in Islamic banking has been driven by the needs of retail bank- ing customers seeking to borrow and invest in accordance with their personal beliefs.


However, Islamic banking products were initially not as competitive as their conven- tional equivalents, in terms of both pricing and service offerings. In certain countries, governments have fostered the develop- ment of the Islamic banking sector. For ex- ample, in Malaysia, the government drove


With increasing competition in their home markets, a number of Islamic banks in the Middle East have started to expand globally, with an initial focus on Asia and Africa. Re- cent examples include Dubai Bank, Qatar Is- lamic Bank, and Al Rajhi Bank (P Vayonas)


The increase in supply has two effects. First, with a greater number of players in the mar- ketplace, public awareness of Shariah-com- pliant products and services is heightened.


This is important, since in many countries, including Muslim ones, the level of aware- ness and understanding of Shariah-compli- ant products is remarkably low. Secondly, the increased competition in the market- place resulting from a larger number of pro- viders will lead to improved product innova- tion and pricing.


This in turn will boost the attractiveness of Shariah-compliant solutions to both Mus- lims and non-Muslims alike. (P Vayonas


Booz. Co). Originally, Islamic banks derived their competitive advantage not only from being Shariah compliant but also from be- ing the only pure-play Islamic bank in town. For example, Al Rajhi Bank in Saudi Arabia, Kuwait Finance House in Kuwait, and Dubai Islamic Bank in the UAE long benefited from monopoly-like status in their respective markets. This situation has changed con- siderably over the past few years.


For example, in the UAE, there are now eight full-fledged Islamic banks and many conven- tional banks with Islamic offerings, known as windows, in addition to Islamic finance companies. Saudi Arabia has three fully- fledged Islamic banks, and all the remain- ing banks offer Shariah-compliant solutions through various distribution channels.


The increasing number of key players in the marketplace is putting pressure on pricing and eroding margins. At the same time, con- sumers are increasingly demanding a return on their funds—either through direct income from deposits in mudharabah-based profit and- loss-sharing investment accounts or by switching to investment products such as mutual funds.


The effect is to negate the traditional fund- ing advantage of Islamic banks. Additional- ly, with Islamic banking integrating into the mainstream, and with more and more con- ventional banks offering Shariah-compliant products, the clear distinction between Is- lamic and conventional banking is vanish- ing.


As competition intensifies, the providers of Islamic financial services need to develop new sources of differentiation beyond Sha- riah compliance. It is quite possible that these sources will need to be different for full-fledged Islamic banks and for those banks with Islamic windows (P Vayonas).


Identifying 3 Key Areas for differentiat- ing between Islamic and Conventional Fi- nance In order to be a cut above the rest it is im- perative that you identify as a business the 3 key areas of difference between Islamic and conventional financial business mod- els. These 3 key areas include the follow- ing:


If you look at product development in Is- lamic finance it can be noted that there has been significant advances in recent years. Today, most conventional products—wheth- er in banking, asset management, or capi- tal markets—can be replicated in a Shariah compliant manner. The main reason why Is- lamic financial institutions have developed product innovation is subsequently due to


2011 February Global Islamic Finance 61


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