Role of ICT in driving growth of Islamic Finance

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By Jaafar S. Abdulkadir

Islamic financial services operate on well-defined principles that seek to combine the goals of economic efficiency and social justices at all times. These principles include the prohibition of interest in transactions, the sanctity of contracts, investments in permissible ventures only and the restrictions of excessive risk-taking behaviour and speculative conduct that is driven by greed and blatant disregard for ethics.

The application of these principles in the Islamic Finance industry is hinged on many factors that include the quality of governance and the robustness of the information technology infrastructure and systems.

Information and communication technology has in particular brought a complete paradigm shift on the performance and on the customer service delivery in the banking industry. In a bid to catch up with global development, improve the quality of customer service delivery and reduce transaction cost, banks have invested heavily in ICT, and have adopted ICT networks to deliver a wide range of value-added products and services. ICT development has a significant effect on development of more flexible and user friendly banking services.

Information Technology systems in Islamic finance industry represents a crucial area of the Shariah compliance process and should thus reflect all the Shariah requirements in its feature, information management and process flow as well as the execution of contracts.

The IT system should be robust and resilient enough to thwart any effort to process any non-Shariah-compliant transactions. The IT system determines how the transactions are structured, executed and implemented.

In the procurement of IT systems, there are bound to be risks that affect both conventional and Islamic banking systems. One of the risks could be that of operational and delivery risks like cost and time overrun in the implementation phase of the systems. There could also be a mismatch between the bank’s requirements and an over-engineered and poor quality IT system that is inefficient and difficult to operate and maintain.

There are some unique challenges that affect the deployment of IT infrastructure and systems in the Islamic banking environment. The determination of Shariah compliance being the preserve of a bank’s Shariah supervisory committee, the lack of standardisation in the interpretation of Shariah law is bound to be a huge challenge for the development of a Shariah-compliant IT system that is universally acceptable.

There have been efforts by the standard setting bodies such as Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB) to improve standardisation of practices and harmonise Shariah interpretations. However, such standards are not mandatory nor are they universally accepted and enforced.

The other challenge may arise out of the complex nature of the Islamic financial products that operate on the basis of various contracts like sale, lease, agency and profit and loss sharing structures which are  totally a paradigm shift from the straight forward interest-bearing products that is the norm of the conventional banking practices. IT system vendors have to exercise due diligence in the development of their system capability to support the right intentions and products that conforms to the Shariah principles.

The other area where the IT infrastructure is very crucial is in the area of segregation of funds mobilised under the Islamic banking window operating within a conventional bank.

The separation of these funds must be as logical as practically possible with verifiable firewalls in place. The motivation to engage in cost-cutting measures so as to obviate the need to operate a parallel banking infrastructure and processes meant to create firewalls between the Islamic banking window and the parent conventional bank often undermines Shariah compliance and exposes the bank to reputational risk.

The IT systems in the conventional banking environment have adequate provisions to regulate clients’ behaviour especially in charging interests for delayed payments in respect of loans. The IT systems for Islamic banking should have the capability and the appropriate levers to drive the clients’ behaviour that conforms to Shariah principles governing transactions.

The information technology and infrastructure has a huge bearing on the governance of any financial institution since it is relied upon for information processing, decision making, reporting, disclosures and risk management. In an Islamic bank, the IT system should be strong and flexible enough to address the changing customer needs in a cost efficient manner without compromising the compliance to the Shariah standards.

Finally, there should be a deliberate and strategic focus on continuously testing and improving the quality of the IT infrastructure in an Islamic bank in a bid to address gaps that may undermine Shariah compliance and efforts geared towards effective risk management.

Writer is the KCB Head of Islamic Banking, and Chair, Islamic Finance Advisory Sub-Committee of the Kenya Bankers Association

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