Analysis: A temporary end to the Islamic banking dream in Europe
Source: Ovum , Author: Daniel Mayo
Posted: Mon August 2, 2010 11:28 pm

INTERNATIONAL. The Islamic Bank of Britain (IBB) was bailed out this week by a group of Qatari investors, which are injecting £20 million worth of capital.

With the bank struggling to grow its income, the outlook for retail Islamic finance in the UK, and indeed Europe, looks bleak.

However, the financial difficulties of the bank are largely a result of the current economic conditions and regulatory environment, rather than underlying demand.

The longer-term prospects remain attractive as a niche growth market, although the demand for supporting core systems in Europe will remain in a hiatus for the next couple of years.

Islamic banking has not proved immune to the market environment

IBB announced this week that it was unable to operate as a going concern unless a £20 million injection of capital from Qatar International Islamic Bank went ahead. The bank has managed to increase its deposits and customer base in the post financial crisis landscape, but has been unable to achieve profitability.

While this is perhaps understandable given its growth ambitions, the worrying aspect has been the direction of profitability, with losses rising from £5.9 million in 2008 to £9.5 million in 2009, and the inability to generate top-line income growth from customer deposits through its Islamic financing approach.

This position contrasts with a more optimistic outlook back in 2008, when the advantages of conventional interest-based banking appeared to have dissipated with the crisis. The expectation was that the shared risk/return and ethical approach of Islamic finance were well aligned to the sentiment of the times and that uptake would expand accordingly.

Being a weathervane for the sector (as the UK’s only pure-play retail Islamic bank), the situation at IBB indicates that, in fact, Islamic banking is not immune to market conditions.

While the bank has seen increased demand for its Home Purchase Plans (HPPs being an Islamic version of home mortgages in the UK, without the use of interest), capital constraints have restricted its ability to fund growth.

This has been exacerbated by the general requirement of the Financial Services Authority for banks to increase their capital ratios. On the liabilities side, the bank has been relying on the Islamic interbank market to generate revenues, which has remained uncompetitive compared to the conventional banking sector.

This meant that the bank was unable to generate sufficient growth to support its cost base, and despite cost adjustments in 2009 it was at a crossroads to either obtain a fresh capital injection or effectively become an unsustainable business.

This is a significant blow to the development of Islamic banking across Europe, and is likely to slow down further take-up for the next couple of years at least. This has certainly been reflected by some of the other players, with HSBC Amanah focusing outside the UK and Lloyds TSB pulling back from its Sharia-based mortgages.
Development of Islamic banking will remain challenging in Western markets, but niche markets will emerge

The UK has been a first-mover for the development of Islamic banking in Europe, despite its relatively small Muslim population compared to France or Germany (there are approximately 1.8 million Muslims in the UK, compared to 3.3 million in Germany and 6.0 million in France).

This was due to more conducive regulatory and legislative policies that removed many of the disadvantages Islamic banking can suffer against conventional banking products – for example, HPPs can attract double stamp duty in many countries. However, other European countries have started to remove these barriers, with France in particular expected to see its Islamic banking market develop.

Difficulties in the UK market will dampen the rollout of Islamic banking in other European countries, given that backers are largely coming from the same Middle East investor pool. However, the current difficulties in the UK are more a reflection of the general state of the economy and banking sector than underlying demand for Islamic banking products.

The market is likely to see a deferment, rather than cessation, of development in Europe, and this means that the opportunity for core systems vendors is likely to be postponed for a couple of years at least.

Note. Daniel Mayo, is Research Director for Ovum. Ovum is part of the Datamonitor group.

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