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A Critical Assessment On Product Development & Innovation Within The Islamic Financial Services Industry
A Critical Assessment On Product Development & Innovation Within The Islamic Financial Services Industry
By
Date of Submission
18 November 2012
A C ritic a l As se ss me nt on Produc t
De ve lopme nt & Innova tion within the
Is la mic Fina nc ia l Se rvic e s Indus try
The Issues in Product Innovation
1.0 Introduction
for Islamic Financial Institution (IFI) to offer innovative products addressing consumer
demands. It is not sufficient to take conventional products and just change a few terms and
conditions. The ultimate aim should be to come up with truly Shariah based products. In
addition, the different demands of the various customer segments have to be considered.
Product innovation is a buzzword now in the industry as IFIs clamour to introduce new
products that can entice people to participate in it. This paper will mainly be on the issues and
Literature Review
There are many papers on the topic of product innovation in Islamic Finance because
business world now points to the fact that development of ‘successful new products is
probably the single most important issue facing managers today’ Poolton, J. and Ismail, H.
(2000). Innovation allows the IFIs product differentiation to ensure comparative advantage
among IFIs.
services as ‘an opportunity to gain competitive advantage’ which would give, say, a retail
Similarly, Prajogo and Sohal (2001) find that innovation has a ‘crucial role in securing
(NSD), John and Storey (1998) have included a wide range of research articles and books on
this subject. In addition to that, most conventional banks and other financial institutions are
having their own innovation and service development departments. Bowers (1985) finds in a
survey that practitioners across the financial industry believe that service development is vital
Islamic finance literature. There is a need for a consolidated body of relevant literature
The first Islamic bank was established in Egypt in 1963 by Ahmad El Najjar. The key
principle used was profit sharing (non-interest based philosophy of Shariah). By the end of
1976 there were 9 such banks in the country. These banks neither charged nor paid interest
but their activities were mostly limited to trade and industries where these banks invested
directly or as partners of depositors. They were more like financial institutions rather
commercial banks.
A Critical Assessment on Product Development
& Innovation within the Islamic Financial Services Industry
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Kulsanofer Syed Thajudeen
The first bank to be explicitly based on Shariah principles was established by the
Organization of Islamic countries (OIC) in 1974, called Islamic Development Bank (IDB).
This bank primarily provided funds for development projects between member governments.
The bank charges fees for financial services and provides profit sharing financial assistance
for projects.
The vast development in Islamic finance occurred in 1980s. Although, non payment of
interest in the main principle applied but Islamic Financial Institutions have evolved to
include other Islamic principles such as property rights, sanctity of contracts and the rules of
sharing risk. 1
Classical writings on Shari’ah, some of which date back to twelve centuries ago mentioned
equity sharing with a sleeping partner (Mudarabah) and crop-sharing (Muzara’ah). They also
mentioned three salebased financing contracts: deferred payment sale (al bay’ al ‘ajil),
forward sale with cash advance (Salam) and manufacturing financing sale (‘Istisna’). Lastly
classical writings also mentioned leasing (Ijarah) as a form of financial contracting. (Kahf,
2006)
1
Excerpts from The History and Growth of Islamic Banking and Finance, 37
A Critical Assessment on Product Development
& Innovation within the Islamic Financial Services Industry
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Kulsanofer Syed Thajudeen
Current Product Innovation
Several financial instruments have been developed and are considered innovations in Islamic
finance.
1) Profit-Rate Swap
Commerce International Merchant Bankers Berhad Islamic’s Islamic profit rate swap, a
finance. It is not derived from the trading of exchange of interest rates but rather, from the
2) Sukuk
Sukuk is an Islamic investment certificate, where each holder owns an undivided beneficial
ownership interest in the underlying assets. Consequently, Sukuk holders are entitled to share
in the revenues generated by these assets, as well as being entitled to share in the proceeds of
their realization. (Box, 2005;). The sukuk was styled based on the bond.
There is a lot of room to diversify the types of sukuk available in the market. The market is
increasingly moving from the “lease and lease back” Sukuk structures of first generation to-
There is a need for a global Sukuk market where securities are listed on international ex-
changes such as London, Dubai, Singapore, Hong Kong, New York or Paris. Structuring of
Sukuk in the future is expected to incrementally move towards more complex Sharia compli-
ant securitizations. A more liquid market, enabling transparent and efficient secondary pric-
An Islamic mutual fund or unit trust is simply an investment scheme that pools funds from
money market instruments. An investor wishing to participate with a mutual fund would do
so by purchasing units offered by the mutual fund. The price or value of these units varies
daily according to the value of the assets held by the fund. This is styled based on the conven-
It is similar to the Islamic mutual fund, except in this case the investments are made in com-
panies that are not listed on the public stock exchange. Venture Capital and Private Equity are
ideal Islamic compliant investment structures as is applies the concept of profit and loss shar-
5) Takaful
The recent boom in real estate and infrastructure projects in the GCC has created
substantial demand for mortgage protection products and home owner’s Takaful plans.
The rising awareness among Muslims for halal financial products has increased the
demand for Takaful. Global Takaful contributions grew by 19% in 2010, to US$8.3b.
Global Takaful contributions are expected to reach US$12b by 2012. Saudi Arabia
remained the largest market in GCC. It is based on the conventional insurance.2
2
Ernst and Young, “ The World Takaful Report 2012, pg14
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& Innovation within the Islamic Financial Services Industry
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Kulsanofer Syed Thajudeen
6) Infrastructure and Project Finance
Islamic finance is expected to play a significant role in the project finance market in the GCC
region. With the growth of the Islamic finance market in recent years, experience has shown
that major projects can be commercially financed either fully from Islamic finance or by
The key reason for the growth is due to the Shari’ah-compliant structures that are now being
more widely recognised and secondly, Islamic banking across the region can now operate at
highly competitive rates for these key infrastructure projects. This growth in demand for Is-
lamic finance has led to further development of Shari’ah-compliant structures for infrastruc-
7) Islamic REITS
According to the Malaysian Securities Commission’s Guidelines, “Islamic Real Estate In-
vestment Trust (REITS) is a trust investment vehicle that invests or proposes to invest at least
50% of its total assets in real estate. An investment in real estate may be by way of direct
real estate”. The objective of the Islamic REITS is to provide unit holders with a stable distri-
bution per unit with the potential for sustainable long-term growth of such distributions. It is
9) Hedging
Some of the Shariah compliant hedging tools currently being introduced include, Profit Rate
Hedging and Foreign Exchange Hedging. For example, Bank Islam Malaysia offers the
Wiqa’ Profit Rate Swap, which is an agreement to exchange profit rates between two coun-
terparties, normally fixed rate party and a floating rate party. The Wiqa Cross Currency
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& Innovation within the Islamic Financial Services Industry
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Kulsanofer Syed Thajudeen
Swap, is an arrangement between two parties to exchange a series of profit and principal
payments denominated in one currency, for another series of profit or principal payments de-
nominated in another currency, based on a notional principal amount over agreed period.
Another financial service innovation was introduced by HSBC, which became the first UK
bank to offer a pension fund that is in compliance with the requirements of Shariah. The
HSBC Life Amanah Pension Fund is the latest addition to a portfolio of products offered by
HSBC Amanah Finance, the Group’s global Islamic financial services division, which was
The main issue in product innovation in Islamic Finance is the fact that all the products are
based on the conventional financial products available in the market. Although Shariah
compliant contracts are used, the outcome of the products are the same. There is a need for
product differentiation. Islamic Finance Institutions need not follow the trend of the
conventional banks.
Another important issue is Islamic Finance requires its financial products to be Shariah
compliant. The financial products need to be approved by Shariah scholars before it can be
marketed. Unanimity among the Shariah scholars on the Shariah compliance of the products
is a valid problem. The absence of universal standards to govern the Islamic products
compounds the problem. Due to these problems the product development process becomes
protracted. There is a need for standardization of Shariah rulings and hence Islamic financial
products across the globe. The lack of uniformity among Islamic institutions as to the
interpretation of Sharia on certain issues can hamper the structure of a project finance
transaction (De Belder and Ruder, 1999; Martin, 1997; Yasseen, 2005).
3) Mature Management
Wise governance of the Islamic financial institution is of utmost importance. Without it the
performance of the industry will be affected in a negative manner. Good governance occupies
the most important place in the Islamic finance industry (Rifaat, 2006).
Developing products according to the Shariah is not an easy feat. The need for highly skilled
and experienced shariah committee members therefore increases with the development of
innovative Islamic financial products and services. To meet this human capital requirement,
large financial institutions can act as knowledge centres to attract foreign talent from the
existing international financial hubs, as well as retain local talent.( Grewal, 2011)
Another often-mentioned challenge in the Islamic finance industry is the issue of liquidity. It
is no secret that Islamic financial markets currently lack the liquidity, breadth and depth of
conventional financial markets. Islamic financial institutions’ (IFI) product range has
developed rapidly over the last ten years to meet the demand from both retail and corporate
entities. However, IFIs still face the challenge of a lack of instruments to manage liquidity.
For one thing, Islamic banks cannot manage liquidity at hand in ways similar to traditional
banks investing in notes or government treasury securities. Also, it has no Sharia alternative
in the market and at the right size. The above factors deprive Islamic banks of the financial
instruments which the banks can use to manage the maturity gap at the lowest risk possible.
Also, Islamic financial services are of a different nature and differ from those provided by
conventional banks, either in transactions or activities that require approval of the Shariah
committee. This is the main difference between the operations of conventional bank and
Islamic institutions (Rifaat,2006).As a result, products are short-ended given the current
The risk of rate of return is a prevalent problem facing Islamic financial institutions. In order
to counter the problem, there is a need to find Islamic solution suitable for these instruments.
The refusal to sell debt and investment guarantees is one of the major principles of Islamic
banking activities. However, selling debt can be considered acceptable on condition that the
sale does not result in dealing in interest. The risk of the rate of return can be managed by a
variety of instruments in conformance with Shariah, despite the fact that some of these
instruments are under study to raise them up to a standard acceptable internationally in the
5) International banks
The growing demands for halal financial products has forced International banks to offer
Islamic finance but they treat Islamic financial products from entirely a marketing
perspective. They are able to compete with the IFIs because of their sheer size. The
differentiating point for Islamic banks, if they comply fully with Sharia, is in combining both
the religious intentions and compliance with Shariah, a condition which cannot be met by
The entry of the international effect has a two pronged effect. One, the entry of international
banks in the Islamic finance industry will lead to upgrading the service level and quality of
local banks. The entry of foreign banks in the Islamic finance industry has two contrasting
aspects. The positive aspect is the diffusion of knowledge on Islamic financing. However, the
negative aspect is that these banks, because of their educational background, might not
improve the functioning of Islamic finance in an appreciable manner. This will have a
negative impact on the development of Islamic products in terms of compliance with Sharia
(Hafeth, 2006).
A Critical Assessment on Product Development
& Innovation within the Islamic Financial Services Industry
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Kulsanofer Syed Thajudeen
6) Bank interest
The issue of accepting dealing in bank interest (riba) is a controversial one. The Sheikh Al
Azhar in Egypt made a ruling (fatwa) that charging bank interest is not a violation of Sharia.
However, such an issue must be decided by a consensus of Islamic scholars, and the
consensus is that bank interest is a violation of Sharia. Some scholars at Al Azhar oppose the
Fatwa from Iran that say that charging bank interest is not a violation of Sharia (Al Alaywi,
2006). The differences between the Islamic scholars on that issue have not been resolved.
Possible Innovations
One of the issues of product innovation in Islamic Financial Institutions is the products are
based on the conventional banking products. This process can be termed as conversion of
conventional products into Islamic products. Professor Volker Neinhaus argued that this can
conversion of products brings the economic profiles of conventional products into Islamic
banking.
Dr. Humayon Dar, believes that Islamic finance must have distinct social objectives in order
to survive in a highly competitive market. Islamic banks must find a niche area and
differentiate from the conventional banks. One example is the is Fauji Foundation in
Pakistan, which was set up in 1954 as a charitable organisation, and now is one of the largest
industrial conglomerates in the country with total assets of over 250 billion Pakistani rupees
investments in industrial production (e.g., cement, fertilizers, and oil & gas etc.), education,
members to save together in order to do business for the benefit of all the programme
members. This could be a deposit taking institution in itself or may have a deposit taking
The Islamic Foundation will conduct real businesses where the members will be the direct
benefactors of the goods and services provided. The rest are sold in the market and the profits
Members of the Islamic Foundation should be able to enjoy benefits in terms of free or highly
subsidised goods and services. For example, if the Islamic Foundation runs a hospital, the
Similarly, they must have easy and affordable access to education and other social services.
On the other hand, if the Islamic Foundation runs a finance programme, it must give
preferential treatment to its members; such as, providing interest-free loans for home
The foundation model may based on the waqf (a form of Islamic trust) so that the assets are
locked into a structure that creates socially responsible assets. The Islamic foundation is an
institution that organises and runs real businesses for the benefits of its members. As
examples of such social projects are abound in the West as well as in the Muslim world, there
is a need to study these different models in order to develop a new model of Islamic financial
Conclusions
The number of Islamic financial products has increased in leaps and bounds to cater to the
to partake in previously untapped areas and trends for more sophisticated financial products
The product innovation in the Islamic financial industry thus far has been more towards
imitating the conventional financial products. However, there is a need for Islamic Finance to
differentiate itself from conventional banking through its products. It is not enough to base it
on Shariah compliance alone but it must be to improve society. The financial products must
be able to integrate Shariah, Islamic economics and modern day finance to truly represent
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