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Asian digital banks cannot ignore Islamic opportunity

Radar Payments - in collaboration with Fincog - recently published a report on the state of digital banking in Asia. In the latest in a series of blogs we look at the evolution of payment services within the region’s Islamic banking sector.

Islamic banking continues to grow in importance. In May, S&P Global Ratings reported that the $2.2 trillion global Islamic finance industry was expected to expand by between 10% and 12% over the next 12 months.

Ratings agency Moody’s has observed that Islamic banking is poised to grow particularly strongly across South and Southeast Asia post-pandemic with growth outstripping that of conventional banking.

Key to this growth are efforts by governments of major Islamic banking markets in South and Southeast Asia to develop the sector, given its role in increasing financial inclusion by extending access to payment services.

A 2020 report from the Islamic Financial Services Board (‘Digital transformation in Islamic banking’) found that Islamic banks are at different stages of development and implementation of activities relating to the digital transformation of their operations. Some are already deploying technology via the use of software applications for payments and transaction services.

The report observes that many Islamic banks have introduced mobile banking apps and digital wallets. Their usefulness as a vehicle for reducing financial exclusion through the provision of payment services has become apparent in jurisdictions with a low penetration of bank account ownership but a high rate of access to mobile smartphones, especially among millennials.

The Islamic Financial Services Board notes that while digital transformation presents opportunities to Islamic banks to boost their revenues, new entrants are expected to continue to have an increasing influence on customers’ experience and expectations which may exert pressure on incumbents’ profitability, especially in profitable service lines such as payments.

The 2020 Islamic Finance Development Report states that Islamic financial institutions responded to the coronavirus crisis by stepping up access to innovative payment services. The report authors also observe that digital-based financial institutions have become much more popular during the pandemic with Islamic challenger or digital-only banks emerging in non-core markets such as Malaysia and Australia.

At the launch of the 2020 World Bank Islamic finance report, Abdul Rasheed Ghaffour, deputy governor of the Central Bank of Malaysia (Bank Negara Malaysia) observed that Islamic finance could accelerate digital innovation through value adding partnerships with the fintech community. Malaysia has seen a considerable take up of mobile banking technology, with a penetration rate equivalent to nearly 60% of the total adult population.

With increasing awareness of e-commerce amongst Malaysians, businesses have shifted their platforms or increased their presence on online marketplaces and their utilisation of e-payments.

The Islamic Finance Outlook 2021 edition suggested that greater digitisation and fintech collaboration could help strengthen the resilience of the industry in a more volatile environment and open new avenues for growth.

Financial technology has the capacity to increase standardisation, streamline processes, reduce costs and boost transparency, making Islamic financial instruments more competitive relative to conventional forms of banking.

As economic development continues to flourish and regulations across the region become more established, it is clear that the APAC payment fintech industry is ripe with opportunity. Southeast Asia is a particularly interesting market given that it is currently less established in the digital banking space.

As religious beliefs and their respective approaches to finances differ across the region it is evident that a blanket approach to digital banking would not be successful, but rather that tailored solutions are more likely to bring success.

Unlike the blanket approach neobanks in Europe have adopted to enter multiple markets simultaneously, it is important that new players in this region develop targeted, localised products and propositions, embrace partnership opportunities within an open tech ecosystem, and utilise customer insights with a data-driven approach to successfully attract consumers.

Creating a targeted proposition which addresses gaps in payment service availability in countries such as Indonesia (which is home to the largest Islamic population in the world) is a potentially valuable approach.

Furthermore, a plethora of opportunities still exist to focus on the vast unbanked and underserved population in the region, who seek low cost payment services accessible in rural societies. There is an increased need for non-financial services to drive added value through embedded finance, which can be defined as the use of banking-as-a-service and API driven banking and payments services to integrate financial services within other environments and ecosystems.

Players who want to develop a less targeted proposition may still find success. However, as joint ventures and consortia continue to be the dominant receiver of digital banking licenses, it is highly advisable that new entrants follow a similar business model.

Specifically, in less established markets, partnerships with established tech groups will likely prove vital in quickly scaling to take market dominance over other new competitors.

To discover the state of digital banking in Asia Pacific, download the report.

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