The last decade has seen significant growth in Islamic banking globally, with the Asia-Pacific (APAC) region emerging as a pivotal hub for Islamic finance, driven by rising customer demand and the adoption of modern technologies.
A new paper produced by Systems Limited, a publicly listed Pakistani technology company, in collaboration with Temenos, explores the rapid developments in Islamic banking, particularly in Indonesia and Malaysia, and the increasing role of technology such as open banking, digital banking, and artificial intelligence (AI) in shaping the sector.
Islamic banking, also referred to as Islamic finance, refers to a system of banking that complies with Islamic law also known as Shariah law. The underlying principles that govern Islamic banking are mutual risk and profit sharing between parties, the assurance of fairness for all, and that transactions are based on an underlying business activity or asset.
These principles are supported by Islamic banking’s core values whereby activities that cultivate entrepreneurship, trade and commerce and bring societal development or benefit is encouraged, while activities that involve interest, gambling and speculative trading are prohibited.
According to the Islamic Corporation for the Development of the Private Sector (ICD), Islamic banking has shown remarkable growth since its inception in the 1970s, reaching US$2.88 trillion in assets under management (AUM) in 2019 and recording an annual growth of 14%.
Malaysia and Indonesia as top Islamic banking hubs in Southeast Asia
In Southeast Asia, Malaysia and Indonesia have emerged as key Islamic banking hubs. Malaysia, in particular, is recognized as one of the most advanced and diversified Islamic banking sectors in the world, offering a wide range of financial products across deposits, financing, treasury and trade finance.
In the deposits sector, the Systems Limited report says that Malaysia predominantly offers Wadiah accounts (safekeeping) alongside Mudarabah options (profit-sharing). The financing sector is marked by a strong preference for Tawarruq for monetization, alongside Murabahah and diminishing Musharakah for vehicle and house financing.
The treasury sector is vibrant, featuring a wide range of innovative money market products and an advanced derivatives market, while in trade finance, Malaysia adheres to the Uniform Customs and Practice (UCP) guidelines, ensuring robust letter of credit processing and guarantee management.
As of 2019, Malaysia held US$570 billion in Islamic AUM, accounting for 20% of the global total and standing as the second largest Islamic banking market in the world, according to the ICD.
In contrast, Indonesia’s Islamic banking sector, though growing rapidly, has a more conservative and emerging profile across various product categories.
The Systems Limited report notes that in the deposits sector, Mudarabah is the predominant offering, with a growing acceptance of Wadiah.
Financing products are aligned with traditional structures, with a preference for Ijarah (leasing) and diminishing Musharakah in vehicle and house financing. The treasury sector is functional but less advanced compared to Malaysia, offering basic Mudarabah instruments and limited securities trading. Finally, trade finance operations in Indonesia follow UCP standards, ensuring consistency with international practices.
According to Fitch Ratings and data from the Islamic Financial Services Board, Indonesia is the ninth largest Islamic banking market by total assets, ranking ahead of countries like Pakistan, Egypt, and Oman. However, conducive regulations introduced over the past year are poised to fuel the growth of the sector.
In November 2023, Indonesia’s Financial Services Authority (OJK) launched the Roadmap for the Development and Strengthening of Indonesia Islamic Banking 2023-2027. The roadmap aims to create a resilient and competitive Islamic banking sector, focusing on accelerating digitalization in the sector and increasing the contribution of Islamic banking to the national economy.
Technology: a driver of Islamic banking growth
The Systems Limited report highlights technology as a key force behind the growth of Islamic banking in Southeast Asia. This trend has been driven by increasing expectations of millennials and Gen Z, coupled with the rise of digital channels, it says.
One of the most significant trends in Islamic banking is open banking and the growing integration of Islamic banks with fintech application programming interfaces (APIs). This integration allows banks to directly offer customers enhanced services such as Sukuk investment platforms, Jamiyaa (a rotating “savings pot”), and Takaful (Islamic insurance) products, the report says.
Another key trend is the rise of digital banking amid regulatory changes. Malaysia’s Bank Negara granted in April 2022 digital banking licenses to five consortia. Three licenses were given out to a consortium of Boost Holdings and RHB Bank; a consortium led by Grab’s GXS Bank and Kuok Brothers; a consortium led by Sea-YTL Digital; a consortium of AEON Financial Service, Aeon Credit Service (M) and MoneyLion; and a consortium led by KAF.
In Indonesia, digital banking has experienced explosive growth. According to Bank Indonesia and Universitas Muhammadiyah Surakarta, the value of digital banking transactions in 2023 reached IDR 58,478 trillion (US$3.9 trillion), up 13.48% from the previous year. As of 2023, Jenius Bank had 5.2 million users, Blu BCA had around 1.7 million customers, and Bank Jago recorded 10.2 million users, according to Kontan.
AI is another tech trend outlined by Systems Limited. This technology is being utilized by Islamic banks and other financial services providers to enhance operational efficiency, streamline processes and deliver personalized customer experience.
For example, Mashreq Al Islami Bank has partnered with Kore.ai to develop the Bank Assist virtual assistant. This AI-powered assistant provides personalized self-service and faster resolution of customer queries in both Arabic and English.
AI is also being utilized in robo-advisory services, which provide customers with Shariah-compliant investment advice tailored to their needs. Wahed Invest, for example, is a Shariah-compliant robo-advisor which uses AI to offer diversified investment portfolios. Other notable AI-powered robo-advisory platforms include Sarwa and FinaMaze both from the United Arab Emirates (UAE).
Featured image credit: edited from freepik
