Session 3: Product Development and Innovation Presenter and Moderator: Ahmed Ali Siddiqui EVP Product development & Shariah Compliance, Meezan Bank Limited Panelists: Muhammad Faisal Shaikh Head of Product & Business Development, BankIslami Pakistan Limited, Sadaqat Ullah Khan- Shariah Supervision & Audit Dept, Dubai Islamic Bank, Neil Beckley FSS Solutions Leader GMU, IBM, Mohammad Mujeeb Beig Head of Research & Product Development, MCB Bank Limited and Salman Rashid - Head of Product Development & Shariah Compliance, Islamic Banking Group, Bank Alfalah Limited. The session commenced with a presentation by Ahmed Ali Siddiqui on Strategic Road map for Islamic Financial Product Development & Innovation. Ahmed Ali Siddiqui to Muhammad Faisal Shaikh: Give us an idea of the direction of product development in the country. Muhammad Faisal Shaikh: Bismillah hir Rehman hir Raheem. As far as the question that Ahmed has put to me, I think there are 2 sides of this question. One is a very bright picture as Ahmed rightly said that right now after almost 10 years of Islamic commercial banking we are now able to provide almost all kinds of services to our corporate and consumer clients. We have got products for majority of the needs of corporate customers if the need and the business is Halal, and if the need is genuine, we have got a product. There is no way that some one can say that Islamic banking is not providing a particular product for a particular company. I think right now they are providing complete solutions to all kinds of corporate customers. I mean, there was a time when people used to get some services from Islamic banks and other services from conventional banks but right now we are able to provide complete services to our customers. But the other side of the picture is not very bright. I think when I see the bright side, I feel very satisfied but when I see the other side I become upset because sometimes I feel that as a product developer, and I and myself included in that list, we focus more on providing alternate to the conventional banking products and I think that is the need right now because customers want an alternate to conventional banking products but as a product developer sometimes I feel I will be more satisfied if I can provide something innovative to my customer and use the Islamic banking product to really mobilize the customer more for the benefit of the business and this side sometimes makes me upset. Till today only Meezan Bank is the most strongest bank in the industry and others are new comers in fact but I feel that as the industry grows, as other banks become more fluent players in the market, these products will flow in and if the customer demand is there, I think we will be able to provide services in this regard. Ahmed Ali Siddiqui to Mohammad Mujeeb Beig: There is a discussion in the industry that our products need to be more Shariah based. Can you elaborate what is going on? Mohammad Mujeeb Beig: Bismillah hir Rehman hir Raheem. Basically this is generally accepted opinion of the general people that only Shirkat ul Aqd based Musharaka and Modaraba are more Shariah based products which should be developed by the Islamic banking institutions. No doubt that it is a correct Publicitas Conferences 1
statement and Mr. Ahmed has already said that Islamic banking institutions have developed Shirkat ul Aqd based Musharaka but the time suited to launch, market and practice these products is awaited because if you see the ATAR of overall banking sector in Pakistan today, it is not more than 50%. It means not only the Islamic banking institution but the conventional ones as well. They have been conservative while executing financing to all sectors of the industry and as you have seen that there is a depressed economy in Pakistan nowadays, so the risky products like Shirkat ul Aqd based Musharaka and Modaraba cannot be across the board launched by any single banking institution in Pakistan. The reason being there must be proper risk mitigation, there must be proper legal coverage to avoid the risk of loss of the capital of the Islamic banking institutions. As Mr. Irfan Siddiqui rightly said in the morning session that banking is a highly leveraged business and we have up to 92% of our total finance generated through deposits so they have to make sure that all of our products launched and practiced should be well risk mitigated and depositors interest should be safeguarded by the Islamic banking institutions. So they have to wait for a suitable time to launch across the board Shirkat ul Aqd based Musharaka and Modaraba but as Mr. Ahmed has already said that there are certain customers which have been chosen to market these products and some of the Islamic banking institutions have already practiced if and I can share with you all good news that you will see in the foreseeable future, Shirkat ul Aqd based Musharaka products for the trade finance business in Pakistan. On the other hand if we see that other modes of finance like debt based Murabaha and semi equity based Ijara, we can see that has been taken place and effective from 1 st July 2010 - since SBP has already implemented as a law of the land four of the AAOIFI Shariah standards in letter and a spirit as they have been issued by the AAOIFI Shariah Supervisory Board. So less preferred modes like Murabaha are now practiced by all the Islamic banking institutions according to the same standards as have been issued by the Shariah Supervisory Board of AAOIFI. Ahmed Ali Siddiqui to Salman Rashid: Just adding to your thing, I would like to ask Mr. Salman Rashid that Mujeeb Sahib mentioned that Musharaka yet has to come and with respect to Murabaha and debt based instrument, it is perceived that they should be in lower percentage but you see that the short term need of the business is not that they want you to become the partner. If a company needs raw material for just six months, so is it not fair to continue with these instruments and then also do research for Musharaka? Salman Rashid: I think I would agree with what you are saying. Clearly with a history of just ten years and the capital base that we have built up in ten years, it may not be prudent to take a leap of faith and go with a stock business initiative where the risks are potentially very high. There has to be a combination and I think there is a middle path and you have brought me to the point which I exactly wanted to talk about. Without going into the negative aspects of certain element, we can learn from that element. In the West, the capital markets are developed to a great extent. Of course there is abuse in certain ways but there are two products there. One is private equity and one is venture capital and those two products are very close to the Islamic precepts and I would say Islamic spirit of financing and rather than converting and convincing customers to join us in a venture, we should go out to enterprises which are short of funds, which are looking for a partner and who would be willing to take us on board on Islamic term and there are many businesses who would like to do that. It is possible that they may Publicitas Conferences 2
not have a history of businesses but then that is left to our expertise to see whether that model will work or not. So the entrepreneurial skills of Islamic banks would also come out in that. The other advantage of that would be that once you are into that area then obviously and naturally your rate of return would increase or it would be a very small portion of your portfolio and against that portfolio you can then market a product to the general public. So again you would be reducing your exposure, you would be getting a higher publicity exposure by turning up a return of 20%, 25% on a project and while the incidence of risk may be high and there may be incidence of losses also but with prudent investment you can do that and that is a path which I think that Islamic banks need to take and I think it will be a great publicity thing also and advancement for Islamic banks. Ahmed Ali Siddiqui to Muhammad Faisal Sheikh: Can I agree that maybe at this point in time we need to be careful and not just jump to one mode and another and then gradually see what happens. Mr. Faisal has to leave so I will just take the advantage of his presence, I would just ask a short question from him and then we can come to the other panelists. Mr. Faisal could you tell us what areas we must explore to achieve that growth and what are the potential areas for us as Islamic banks? Muhammad Faisal Sheikh: I think being the products developers and the corporate sector which has been using Islamic banking products since last ten years, I think it is now time to unleash the real power behind the Islamic modes of finance. I mean I can quote an example, it's a hypothetical example obviously but I see many mobile companies have got advertising budget which is running into millions, if they can somehow tap the Islamic banking product of Musharaka, I am not saying we can have a pure PLS model but we can have some innovation in that and we can involve mobile companies into a Musharaka product, a Musharaka Sukook whereby we can involve general public in their sales. I mean the more profit the company earns, the more Sukook subscribers will get and this can revolutionize their sales. If they want to hire, for example, 100 sales men, they will have to pay them but if they sell Sukooks to 100 people, they will get free sales men of 100 persons who can market their products in the sense that as the sales of that mobile company increases, their profitability increases. Similarly food companies, for example Nestle, Engro Foods can have these kinds of Sukook where they can involve general public in their sales and say them that look if we earn more, we will get more and this was actually done when Musharaka TFC was launched by Meezan Bank in 2002. But the problem with Sitara was that it was an industrial product and their sales probably broke all the records but obviously it was not in general public because you know that as an Islamic banker we believe in faith, so there is a power of dua. Where a customer subscribes to a Sukook and he knows that if the profit of the company increases, his share of profit also increases and for that matter, the profit, at that time Sitara was paying 3% on Murabaha & 2% on Sukook. Ahmed Ali Siddiqui to Muhammad Faisal Sheikh: So you are talking about involving customer & again doing Musharaka sort of thing with customer? Muhammad Faisal Sheikh: Probably, I am not saying that this could be a pure PLS but I am saying that probably this is some sort of a niche market or part of a business which can be securitized in a way that make people involved in the business. Probably there are many other issues as well but the people of Pakistan are not involved in the development of the country. e.g. if there is a project, a new drain is Publicitas Conferences 3
being built or a new road or a new highway, people of that area can be involved through issuance of Sukook I mean, you give them ownership of that highway & I guarantee that there will not be not a single person who can dig a hole in that highway or lay pipeline in that. Ahmed Ali Siddiqui to Neil Beckley: Thank you Faisal. Taking your views & suggestions on mobile companies I come to Neil now we are taking about technology to take Islamic finance to new level. So what is your say about it? There are areas like branchless banking or mobile banking; they all require technology support. So are we ready? Neil Beckley: I am not quite convinced to the rush to innovate. You know, if we think about what happened to conventional banking in the last 10 years. You had a very crowded market, very competitive market & there has been this pressure to seek new sources of revenue and there is a consequence which probably embarks into some risky areas and with retrospect we probably wouldn t have done if we would have known the consequences. And I think as a prudent banker as I started my career with the Bank of England as Central Banker so it s very risk averse. So obviously nobody embarks on a product innovation journey and expect it to be zero risk otherwise there wouldn t be anything in it. On the other hand, to be much aware of what we are embarking on and of all of the consequences is the most important thing. I think my view is that you have got a market undoubtedly that is expanding rapidly by natural forces, the attractiveness of Islamic banking is growing worldwide, not only in Pakistan. There will be more players coming into the market and certainly the international players etc but my focus would be while you got the market coming to you there is a natural move towards Islamic banking, first be more efficient with, what you are doing now. Optimize everything you are doing now before you start embarking on potentially riskier or take more risk in less understood activities and products. Ahmed Ali Siddiqui to Neil Beckley: I think that s a good point. We need to be efficient and effective on what we are currently doing and I am sure that technology has a lot to support Islamic banks. Neil Beckley: Yeah we have been fortunate as IBM to work with a couple of newly started Islamic banks in the Middle East and you are coming into say that UAE market which is pretty well served by the Islamic banks, so you have got to be different. What is new to Islamic banks coming to a competitive market you got to have a value proposition and you have to have a USP and generally speaking people are focusing on optimizing what they are doing already. Ahmed Ali Siddiqui to Sadaqat Ullah Khan: Thank you Neil. Now coming to DIB, Mr. Sadaqat Ullah is here. He has an experience in the Shariah audit & supervision. So I would like to ask that we talked about that in Islamic banking, say, the product has to be Shariah compliant. So why is it necessary to have that very high level of Shariah compliance for the industry? Sadaqat Ullah Khan: Assalam O Alaikum, before responding to the question, I would like to add something to the product issue. I observed in Pakistan that there is no product which is providing upfront cash to the customer and most of the people who need cash immediately in order to meet their internal requirements, their domestic needs, they have to go towards conventional banks, so in the UAE, Publicitas Conferences 4
almost all banks have introduced cash financing products against future delivery of goods. So I think this is a good area. Ahmed Ali Siddiqui to Sadaqat Ullah Khan: I think this is a good area and to the product development here and the team here, we need to think that if the customer is going to the conventional sector only because if we don t have such products then we should work out some solution ensuring the Shariah compliance as well. Sadaqat Ullah Khan: You see the product is important in order to save people from going towards conventional banking so one side we will be saving the people from going towards conventional banking, taking the loan on interest and secondly we will be increasing product level and financing level. You can note this for further discussion. Regarding Shariah compliance level as you explained in your slide that no compromise on Shariah compliance. So this slogan is from all Shariah Advisors, all Islamic Banks and even from the management also. Mostly what is the importance? There are certain areas which indicate the importance level. First of all, we all are somehow responsible before Allah; therefore it is imperative and an obligation on us to ensure Shariah compliance level in all the transaction being executed by the IFIs. So those transactions should be carried out as per the Fatwa issued by the respective Shariah boards and compliance level is of course needed for another reason to comply with the Article of Association of the bank and the directive of the Central Bank, SBP. Ahmed Ali Siddiqui to Mohammad Mujeeb Beig: Sir, yes we agree that as a professional, it s our ethical responsibility and because of that entity you have to be Shariah compliant. Thank you Sadaqat Sahib we will come to you in a short while. Mujeeb Sahib I would like to ask to, what hurdles we face as a product developer? Are there regulatory hurdles or hurdles from the mindset to change to new products, what are the hurdles that we face when we develop products for Islamic Banking? Mohammad Mujeeb Beig: Basically when we try to develop certain unique products, like Running Finance Musharaka (RFM). So you ll have to first satisfy your management that the risk will be properly mitigated in this product. You ll have to satisfy the lawyers, the internal and external as well that what you have suggested on a product development of the provision of the legal documentation will be suitable to mitigate the risk of loss of capital of IBIs. These are the initial stages where you have to satisfy in management that whatever innovative product you have developed is enough capable to be launched in a market and the IBIs will not be hurt, the profitability will not be hurt and that if there are certain losses, then suitable provisions in the product launch period have been provided and that future profits from the products will be suitably enough to compensate the future losses from that product. Once you satisfy your management, the legal advisors, then you have to convince the people, the general public and if you are launching a product on the liability side, then corporate and commercial banking customers will have to be satisfied with this product. E.g. if its RFM then you ll have to satisfy them that whatever the RFM or cash finance you are taking from the conventional banks, that this product will satisfy your needs. Let me just conclude the first question that you have asked that we have to make a very good combination of Musharaka, Modaraba, Murabaha, Salam, Istisna & Ijara, that the suitable combination of these products will Insha Allah suffice the purpose. We ll have to satisfy the Publicitas Conferences 5
needs of the customers then we have to visit the customers, analyze the need of the customers and then to give the product to them. Ahmed Ali Siddiqui to Sadaqat Ullah Khan: Thank you Mujeeb. Sadaqat Sahib, could you highlight that when you develop any product, very briefly, what controls of Shariah compliance we need to have? Sadaqat Ullah Khan: Basically whenever you are launching a new product, Fatwa is issued by Shariah board and normally there are no issues in issuing Fatwa because board of scholars is sitting and after due deliberation, they are allowing to introduce a new product. But when this Fatwa is issued and provided to the business unit and operation and all other stakeholders, the execution issue comes. Many times I discussed with many prominent Shariah scholars, they are of the view that always there are issues in the execution of a Fatwa, which means how transactions are being executed by the operations and the business head, the business unit and RM, sometimes front office and they are not able to properly communicate with the customer. What I suggest is while using a new Fatwa and before production implementation, there should be a document which should contain all execution required to make a transaction fully Shariah compliant. So there should be no confusion among people who are working. Ahmed Ali Siddiqui to Neil Beckley: So basically you are building controls from day 1. Taking lead from your questions, I would come to Neil. You see the difference in Islamic financial transactions, it is process intensive and you monitor each step of the process. As a student of technology, I also know and we have discussed that yes this technology had that enabling or efficiency of monitoring processes and workflows. So I have two questions for you, 1) very briefly, do you think this process in base financing of Islamic banks can very effectively be captured in the current level of banking softwares. Because philosophically banking softwares first talk about lending money. Here we say you lend money, you buy material, you store material, you sell material, so do you think is technology ready to help us to monitor those processes and secondly the current softwares do they have the capability? Neil Beckley: I think if you just hang on to my presentation, about 10 minutes time, I will address that with an example, but more seriously from a technology perspective, conventional banking systems supplies or applications have been around for 20-30 years or more. There hasn t been to date a real market demand to encourage application providers to write from scratch an Islamic banking product and to my knowledge, that s still the case now. There isn t a core banking vendor out there. It does create challenges. My colleague was talking about one of the product before which is really a combination of problem 4 or 5 individual products. We link them together and in one form or another it becomes the end product to the customer. In investment banking we have trouble linking customer transactions with hedging. So, now you don t have common applications to support core banking business and you are now trying to link 4 or 5 different transactions together to get an overall exposure. This is getting pretty complicated. So, back to your first question and now certainly what we see is a trend towards moving the finance origination process, the finance products out of the core banking system. So, the whole credit review process, the work flow and the business process management associated with it is 100% tied to the documentation. Islamic banking can be in document centric and Publicitas Conferences 6
we now have the ability to link those two. And finally when it comes to the general ledger, then the underlying transaction can be booked but I believe in short we are now there. Ahmed Ali Siddiqui to Salman Rashid: Just to end up the session I would like to ask Mr. Salman Rashid to just briefly sum up and then we can move on to the IT session. Salman Rashid: Basically what we have heard here is that we have multiple choices. The focus is essentially on being Shariah compliant, which is the most essential thing and in addition to that we are looking at product diversification. We have already developed products which mirror or meet the needs of customers as they used to when they were banking with conventional banks. There are a few gaps and hopefully they will be covered with time and with time we ll also be getting system support and I m sure as the market grows bigger, then institutions like IBM, FSS they would be interested in coming to Pakistan and developing softwares for Islamic products. So, all in all it looks like we are on our way to a more comfortable environment, both product wise and process wise. Shariah compliant wise, I think the real challenge is perhaps not so tangible because the real challenge is the battle of the minds and that is where we have to prove ourselves and convince the customers that A) we are Islamic, B) if we are Islamic then perhaps there should be an added premium to that because the basis of Islamic financing is such that there should be a greater reward. I think that is the next wall we ll have to surmount. Ahmed Ali Siddiqui to Sadaqat Ullah Khan: Thank you very much Salman Sahib. May be you would like to add a few words? Sadaqat Ullah Khan: Proper and regular Shariah training of all the staff who are involved in the day to day transaction is very important. Be it operations or RM or front line staff because normally people meet with the front line staff and they ask questions about Islamic banking and transactions and they talk of finance and putting deposits. If they are unaware about the whole Shariah process how they will explain? So it is very important that regulator training should be carried out for staff involved in the transaction processing. Ahmed Ali Siddiqui: Thank you and with these words, we come to the end of the panel discussion and we hope that we had an interactive and fruitful discussion. Just a last word that there is a continuous process of learning and improving and in Islamic banking industry what we see, is keenness to open new solutions, keenness to diversify, keenness to innovate. With these words, I would like to thank all the panelists here for being with us for this session and I would like to conclude here. Publicitas Conferences 7
Question from the audience 1. It s regarding the development product. What is the first Islamic product that was developed in terms of profit participation, term certificates, way back in bankers equity whereas loss was being shared with the bank? When they were put into practice, the banks realized that we are ending in a loss and those were taken away and they were replaced by TFCs. Were these PTCs Shariah compliant and why they were withdrawn and do the Islamic banking products share in losses or do they assure that the capital is safe? Ahmed Ali Siddiqui: I would like to quickly answer this one that what we have seen with the TFCs and PTFCs is that they were in there for quite some time but fortunately or unfortunately, there was no mechanism for ensuring Shariah compliance at that time. There was no supervision system but now the Islamic banking industry is at a stage where when we develop any new TFC or Musharaka certificate and Musharaka Sukook this is a mandatory requirement to get clearance from the Shariah Advisors and if it is a Musharaka based certificate then it goes without saying that it has to be a PLS mechanism and you cannot guarantee the principal because then it defeats the whole concept of and purpose of that certificate. 2. I am Shahzad from Pak Qatar General Takaful Limited. I have been a student of Islamic finance for last 4 months, not much experience but I just like to know that you as a product developer and Shariah compliant, do you recommend any marketing tactics to your teams because at the front end before many people came to me but were just unable to convince me and that is the case with many people outside. Are there post launch surveys or is there anything you recommend in the post launch scenario to your marketing team? Mohammad Mujeeb Beig: There are 3 processes that are done to ensure that the product is to the satisfaction of the Shariah Advisors. 1) The Shariah Advisor visits or he delegates the power to certain persons to whom he trusts that whatever Shariah pronouncement or Fatwas he has issued, the branch operations staff is acting upon the Shariah pronouncement in letter and spirit. 2) There are Shariah compliant officers who make sure that AAOIFI Shariah standards, which have been taught by the Shariah Advisors to the Shariah compliant officers provision by provision have been implemented by the branch staff. Ahmed Ali Siddiqui: I would like to add that there is a practice of doing mystery shopping or mystery surveys. So that is always there to judge whether the staff is properly trained or not and our Shariah audit also sometimes do and take interviews from the staff that what is their understanding and we also go to the customers and have their feedback. This is a continuous process and the key benefit as an Islamic bank is that a Shariah Advisor is always there and customer can always go to the Shariah Advisor in case he has any complain or any issues about the Shariah compliance. With these words I would like to thank you all. Publicitas Conferences 8