The past decade has seen two extraordinary banking trends, especially in the Middle East. The first has been the growth of Islamic banking, brought about by a pent-up demand for Shariah compliant banking services. The second is the convergence of two core banking functions – trade finance and cash management. This convergence came about through the increased efficiencies of the cash management function by IT developments, allowing it to enrol trade finance as a cash optimisation discipline rather than purely a risk mitigation instrument. Many bankers in the Middle East are now predicting the merger of these two trends to produce a merged cash and trade services offering that is Shariah compliant. Yet barriers, not least with some of the players involved, remain.
Islamic Cash Management and Trade Finance
An Islamic treasury function, like a conventional one, must generate and utilise liquidity in an optimal manner. However, it must also function in accordance with Shariah principles. All practices must fit with the principles of Islamic finance. There can be no interest, no speculation, and no contingent speculative liability in any transaction. Yet as long as these principles are complied with, it is possible for a treasury services function to be Shariah-compliant and for there to be no difference between Islamic and conventional cash and trade. In fact, Islamic principles may help convergence because, in most examples when applied to the true methodology, neither cash nor trade are based on speculation.
Even specialist Islamic bankers agree with this sentiment, especially with trade. For instance, Ali Akbar Khan, who is vice president of financial institutions at the Dubai Islamic Bank (DIB), states that the principles for Islamic banking fit very well with trade finance.
“The structure has to be modified according to Shariah principles only with the financing aspect,” he said at BNY Mellon’s roundtable recently held in Dubai. “When you undertake any trade under Islamic banking there has to be an underlying commodity or service that has to be clearly defined. This is the key difference between Islamic finance and conventional finance, but one that supports the role of Islamic finance within treasury services.”
This means that Islamic finance can encourage convergence, which also means there is no reason for Islamic banks not to offer integrated treasury services if they are able to.
Islamic Financing in High Demand
The global financial crisis has highlighted some of the advantages of Shariah compliant finance and has – according to practitioners – led to a boost for Islamic offerings, especially in treasury services. Specialist treasury practitioners have also noted the performance of Islamic banks during the global recession. Lakshmanan Sankaran is head of trade finance at the Commercial Bank of Dubai (CBD). He observed that Islamic banking coped better in the recent crisis.
“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 said. “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.” Indeed, the demand for Shariah complicity has recently increased as a result of the ability of Islamic banks to deal with liquidity concerns during the global crisis.
Technology and Convergence
Yet further growth in a converged Islamic cash and trade offering will bring with it a greatly heightened technology need. This is likely to prove a challenge for banks in the Middle East that, in some cases, face challenges in updating their technological capabilities.
The banks’ apparent resistance to technology is in contrast to the corporates in the Middle East, which are generally technologically-savvy. Technology is a driver of cash and trade convergence, and so the advanced state of corporates should encourage local Islamic banks towards convergence.
It is natural that, as technology develops, corporations and banks will become more aware of it. ETA ASCON is a good example of this trend. The company has implemented its own centralised treasury system that the banks log on to – @GlobalTrade. Given their lead, it is ETA ASCON’s system that the banks have to use when undertaking business with them – a classic sign of the power of some corporates in the region.
However, one advantage of some local companies being technologically more advanced with respect to treasury services is that they will more easily accept the next step of adopting Shariah-compliant treasury services via an integrated IT platform – if only the banks could catch up with them in terms of an IT offering.
Yet, the advanced state of the Middle Eastern companies requires the banks act quickly to provide Shariah compliant integrated treasury services, before their corporates look further afield – perhaps to international banks that have the requisite IT function and could quickly develop Shariah-compliant services of their own as a direct reaction to market requirement.
Outsourcing a Potential Option
Local banks are thus faced with several options. One of these is to outsource their non-customer contact treasury services offerings to a global bank that offers Shariah-compliant integrated cash and trade functions. This solution, however, is not ideal. Corporates who desire Shariah complicity fear utilising the services of global banks in case their finances are ‘tainted’ by non-Islamic finances that have been exposed to interest.
Also, although outsourcing helps local banks get most of the way in terms of functionality and service, these platforms have been built for the needs of a wider cross-section of local and regional banks by global banks. They are, therefore, proprietary systems – meaning the local bank will have to adopt a partnership approach. As a result, the service gained is unlikely to be suited to the general needs of the Islamic market, which will need to be tailored to the specific needs of specific banks (especially as the interpretation of Shariah law may differ from country to country and bank to bank). For the local bank, another key concern is the competitor risk. By outsourcing its client-facing functions, the smaller bank is, in effect, giving its larger peer privileged access to its local business, thus running the risk of the larger bank poaching its valued customers unless the larger global bank has a stated model that does not compete in the same market as the local/regional banks.
Following from the premise above, a better solution for local banks may be to partner with specialist non-competing providers to provide Shariah-compliant integrated treasury solutions. This way, corporates in the Middle East are provided with global technology, combined with local expertise that understands how Islamic finance is compatible with an integrated treasury services offering, without the local banks running the risk of poaching.
It is heartening to note that banks such as BNY Mellon have a policy of not competing with clients, but rather of working alongside the local banks. Local banks need to form close collaborations with non-competing partners in this manner and approach corporations having used their local knowledge to consider their specific needs.
Therefore, despite the specifically local nature of Islamic financing, the needs of local banks – when it comes to offering converged cash and trade finance services along Shariah compliant lines – may best be met via a partnership arrangement with a global bank. Either that or the local corporates may develop their own integrated and Shariah-compliant solutions, and cut out the local banks altogether. Worse still, the corporates may decide to partner directly with the global banks to meet their business needs.
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.
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