Importance of Retail Financial Services

Article By: David Vicary

Islamic Finance and the Public Good – The Importance of Retail Financial Services

The old adage that cheap funding really assists in the development of Financial Services, rings as true today as when I first heard it mentioned over 40 years ago!  It is also particularly true in the world of Islamic Finance.

There is no doubt that in some markets, Malaysia for example, that the Capital market has achieved deeper penetration levels than the retail market (65% versus 20%).  This reflects a couple of things.

1. Cost of funds  — Savvy Company Finance Officers know that they can get Islamic funds 15 to 20 basis points cheaper and this is as a result of volume.

2. The savvy corporate guys have figured out that Islamic Finance is good for business and have, therefore, warmed to the value proposition of Islamic Finance.

However, if more funds were mobilized from the retail market at low or no costs, could further growth in the industry be achieved?
The answer is a resounding yes in my view!

Here are a few thoughts on the matter.

Many of you will doubtless recall my comments on EPL.  Education, Perception and Liquidity.  All three of these essential elements are required when developing the Retail side of the business.

Firstly, Education of the consumer, with regard to the choices available and the ethical values of Islamic Finance.  In order to get the scale of the opportunity into some sort of persective, let’s take a look at a couple of numbers.  The total of Islamic Finance assets out there are said to be approximately USD 1 trillion.

In the United States alone, over USD 3 trillion is placed by consumers in “Ethical Investments”.  It does not take too much imagination to see the opportunity here for branding and promoting the values of Shariah as consistent with ethical investing and healthy living.  All it takes is some education to change the Perception! Already some of the North American Pension funds are investing in Shariah compliant instruments because of the ethical values and also the strong returns.

Secondly, Perception. Until you are able to understand the building blocks and mechanisms of Islamic Finance yourself, it is difficult for the individual to explain and convince the general public of the Value Proposition.  If you take a simple comparison between a 12 month Conventional Fixed Term Deposit and a Mudarabah General Investment Account (MGIA is the IF equivalent of a FTD), on the face of it they may look similar.  However, under closer scrutiny two major differences emerge. One, the MGIA is based on a concept of risk sharing and two, you can break the investment before a maturity date and not be penalized for it.  That means that if you can demonstrate that the historical performance of MGIA is as good as or better than the projected Interest Rate, you can easily persuade investors that the flexibility of withdrawing an investment prior to maturity, without being penalized, is a much better
Value Proposition.

Thirdly, there is Liquidity.  This is the engine that fuels the growth.  I have often thought of Islamic Finance as “The effective and efficient mobilization of capital for the benefit of the community by investing in the real economy” All that means is that if you can create more liquidity at a reasonable price and deploy it to where it can be used effectively, you will have a winning combination.  If we as practitioners can persuade the Public through Education and addressing mis-Perceptions, then we will attract much more money into the system, which can then be deployed to where it is needed the most.  The recently created International Islamic Liquidity Management Corporation IILM Co will play a vital role in supporting the cross-border flow of short-term liquidity.

While the area of Capital Markets is both challenging and absorbing; it is the development of the Retail market that brings IF it’s greatest challenges.  The developments of the coming months, as we move to the next level of transformation in the Industry‘s “Globalisation” could prove vital to the long term future and sustainability of IF.

As ever, there is much to do and not a moment to lose.