An IT solution that supports seamless and rapid establishment of a startup Islamic bank from the ground up, or allows the conversion of a conventional bank without operational hindrance, or...

1. Featuring research from
Issue 2
Islamic Banking &
Technology Challenges
How ETHIX financial solutions ensures “Sharia Compliance”

2. 2
Contemporary Islamic banking has gained significant traction in recent
years with an estimated annual growth rate in excess of 15%. Islamic
banking continues to make its mark far beyond its traditional majority
Muslim nation base, making considerable strides into the well-rooted
conventional financing sectors.
Having weathered the challenges of the recent financial turmoil due
to their prudent investment strategies and driven by strong investor
demand on both the individual and corporate sides, the total Islamic
industry continues to be the beacon for socially responsible banking.
With this increased interest in Islamic finance comes an increased
demand for Islamic banks. Due to the huge logistical, regulatory
and economic challenges of establishing a new bank, many well-
established players across the Middle East and North Africa have
opted to convert undercapitalized, non-performing banks in a bid
to tap the rising demand for Shariah compliant products and, most
importantly, avoid the heavy investment and logistical requirements to
launch a completely new bank. As in the case of the National Bank for
Development in Egypt (acquired by Abu Dhabi Islamic Bank).
• Meanwhile, other banks such as the Kuwait International Bank (for-
merly Kuwait Real Estate Bank) and Ahli United Bank (formerly The
Bank of Kuwait and the Middle East) have sought to gain a competi-
tive advantage by relaunching themselves as fully fledged Islamic
banks.
Overcoming hurdles
One of the greatest challenges in launching an Islamic bank is having
access to a well-established independent and active Shariah board.
While this process can be rapidly increased by utilizing already
existing Shariah boards, it is the implementation of the Shariah board’s
rulings into the day-to-day running of banking operations, product
development and product rollout that serves as the greatest hurdle to
Shariah compliant operations and transformation.
Islamic Banking & Technology Challenges
2
Islamic Banking & Technology Challenges
4
Gartner Research:
Islamic Banking: Opportunity or Money Pit
for Conventional Banks?
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3. 3
Islamic banking may have its idiosyncrasies but its technological
requirements are no different. Therefore, an IT solution that can enable
business conversion from conventional to Islamic, at the same time
allowing the existing business model to continue without hindrance, is
a serious proposition.
As a result, technology and, more specifically, Islamic IT solutions are
major factors in leading the transformation process. This is where
technology experts like International Turnkey Systems (ITS) take front
stage in easing the transformation. As a complete broad-spectrum
Islamic information technology and banking solutions provider,
their mandate is to provide banks with technological solutions and
technical services required for the conversion of conventional banks,
allowing banks to increase product development and rollout across
the entire enterprise while offering reduced cost of total ownership and
implementation.
When a chief technology officer speaks to a service provider, one of the
main issues tackled first is the core banking system. More often than
not, a bank would prefer to choose a service provider that offers a one-
stop solution like ITS’s ETHIX.
Tailor-made solutions
ETHIX is an Islamic banking solution that enables the restructure and
launching of new Islamic products in a timely and efficient manner.
ETHIX solution is a web services based solution that offers services and
functions for Islamic finance, Islamic investment, core banking, delivery
channels, trade finance and other banking services, which in turn
enhances the bank’s competitive edge.
Haitham Abdou, group director of marketing & Banking Business
Solutions at ITS, states that the ETHIX solution was developed from
scratch, specifically for the Islamic banking industry rather than a
conventional solution that has been fine-tuned to meet specific Shariah
requirements. He goes on to state that the principal behind the ETHIX
solution is that it is a fully customizable, tailor-made product allowing
for complete flexibility.
Existing solutions have parameters that allow each individual Shariah
board to specify differing products in accordance with their Shariah
interpretation; these rigid predefined parameters can, however, have
a tremendous impact on dictating bank workflow and operating
procedures, limiting productivity and hindering scalability.
ETHIX Financial solutions was Designed to ensure the basic principles
of Sharia Compliance, However, the product does not “Dictate” sharia
compliance. Due to the diversity of compliance between sharia boards,
ETHIX was designed to allow the definition of Shariaa compliance
from the ground up, thus ensuring 100% sharia compliance as per
the decisions of each bank’s Shariaa board. Such a concept has
allowed for the quick deployment of the product for banks converting
to Islamic, startup Islamic banks, or Islamic windows coexisting
with a conventional environment while maintaining all the rules and
guidelines of a sharia compliant process.
Shariah compliance
Haitham further elaborated: “ITS realized that it would be impossible
to ensure that our product could accommodate every single Shariah
board; for vendors like ourselves, a rigid platform would require
considerable customization on behalf of the customer.” Thus, ETHIX
was created from the ground up to offer complete flexibility in defining
Shariah compliance, so that the product would not be limited by rigid
constraints.
The ETHIX solutions main advantage lies with its certification by the
Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI). This was achieved by creating an Islamic piece of clay on
which the main principals cannot be broken, allowing the customer to
start building Shariah compliance from the ground up. It is this “novel
approach that has allowed ITS to have the same system running
in over 30 financial institutions in different countries and regions, all
adhering to different Shariah rulings, while running on one line of
code”, Haitham elucidates.
As a completely customized product created with the considerations
required for Shariah compliance, the customer is therefore not
required to wait for product updates and development from the
solutions provider. By dispensing with box-ticking measures, the
customer is able to update and create products on the fly, allowing the
customer to launch products and services very quickly and bringing
them to market without hindrance.
ETHIX is a culmination of ITS’s business knowledge and know-how,
synthesizing their technological expertise and product flexibility. Ease
of integration with conventional systems has also been a central
feature. Taking conventional product structures and mapping them
into their Islamic counterparts has allowed ITS to implement the first
Islamic window for a conventional bank in the Middle East, such as
the Commercial Bank of Dubai. ITS looks set to continue this trend by
signing up to assist Libya’s largest bank, Gumhouria Bank, in creating
its first Islamic window.
Source: ITS

4. 4
Islamic Banking: Opportunity or
Money Pit for Conventional Banks?
As many conventional banks search for ways to boost revenue,
some may turn to Islamic product offerings that have the potential to
contribute significantly to their business growth strategy. CIOs need to
be ready to deliver an informed technology assessment of this new
market opportunity.
Key Findings
• Islamic banking is experiencing higher market growth rates in
African and Western countries than in other regions of the world.
• Standardization of Islamic banking processes is at an early stage of
maturation; this will increase the risk associated with the selection
of core banking systems.
• For most Western countries, the real potential of Islamic financial
services is located in the securities and wealth management space.
Recommendations
• Include distinct branding – similar to direct banks spawned from
conventional banks – and stand-alone core banking technology
support within the business case for Islamic banking.
• Create a vendor shortlist with a heavy criteria weighting on local
bank references; current Islamic banking market requirements can
differ significantly by region.
STRATEGIC PLANNING ASSUMPTION
Through 2014, core banking systems will be unable to simultaneously
support conventional retail and Islamic banking businesses without
significant customization.
ANALYSIS
Introduction
Gartner defines Islamic banking as a system of banking or banking
activity that is consistent with the principles of Islamic law (Sharia) and
its practical application through the development of Islamic economics.
Sharia prohibits the payment or acceptance of interest fees for the
lending and accepting of money.
Also, recognizing that the prevailing model for banking worldwide is
non-Islamic, this research will use the term “conventional” to describe
this predominant banking approach.
Market Information
Islamic financial services are nearing $1 trillion in reported managed
assets, with about 700 Islamic financial institutions (IFIs) spread
throughout every region of the world. The Islamic banking system
(IBS) market – that is, the market of the technologies that enable these
financial products to be bought, sold and distributed – is predicted
to be a $1.2 billion market in 2011 and to grow at a 10.9% compound
annual growth rate (CAGR) between 2009 and 2014, while the external
IT spending component will have a higher CAGR, at 18.1%. The IBS
market is expected to reach $1.6 billion in 2014 . As consumer trust in
conventional banking waned during the recent economic downturn,
Islamic banking enjoyed marked market expansion. Islamic banking
is perceived by its customers as a mutually beneficial partnership,
and is regarded by some banks as an opportunity to re-establish a
connection with consumers. Whwth?
Growing demand is evident for Islamic products from new markets
such as African and Western countries. An increasing number of
conventional banks will open Islamic banking windows (see Note 1)
in a conventional branch environment, mixing both conventional and
Islamic banking capabilities.
The Islamic banking market will continue to grow at a double-
digit pace. This is based on (1) the increasing Muslim population
in particular regions, (2) newly available assets from unbanked
populations, and (3) the relatively low effect of the financial downturn
in the high economic growth regions such as the Middle East and
Asia/Pacific.
Moreover, Western countries – as a consequence of new legislation
already introduced or about to be – will encourage higher adoption
levels of Islamic financial services although these changes will
primarily impact the Islamic bond (Sukuk) market. For example, in
France, fiscal instructions for Sukuks, Murabaha, Ijara and Istisna were
published in August 2010 (see Note 2).
What’s the Technology Impact?
Similar to retail banking technology trends, the replacement process
of in-house Islamic banking software with commercial off-the-shelf
(COTS) systems is accelerating, especially in mature Islamic banking
markets such as the Middle East. Drivers for Islamic banking core
replacement align closely to those of conventional banks. However,
the Islamic banking market lacks consensus industry product
definitions, such that the core banking offerings of this market differ
considerably. For example, if a vendor develops product support for
a Middle Eastern bank, an Indonesian bank may find these product
supports inadequate for their local market. This situation increases
the risk associated with the selection of core banking systems, as
banks may purchase systems that have to be highly modified to gain
approval (a fatwa) from certified Islamic scholars.
However, there are signs that the Islamic banking market is on a
path of progressive maturation, with an undercurrent of activity to
establish standard policies and corresponding products beyond the
proprietary and localized approach currently in practice. For example,
an emphasis on standardization of processes that comply with Islamic
law (Sharia) is gathering momentum among more than 150 Islamic
financial institutions that are members of the Accounting and Auditing
Organisation for Islamic Financial Institutions (AAOIFI; www.aaoifi.
com/aaoifi/). This group of financial institutions and other member
stakeholders, such as vendors and consulting firms, are expected to
consolidate business requirements for Sharia compliance, but this is
not expected to become effective for the next few years, and regional
differences may persist beyond this time frame.
Gartner Research:

5. 5
In addition to the lack of a single set of Islamic banking standards and
correspondingly low adoption rates, banks that enter this market are
faced with the choice of distributors offering Sharia-compliant products
or two vendor technology model choices (see Figure 1):
• Conventional core banking systems with an Islamic banking module
• Pure-play, Islamic core banking systems
Gartner believes that leveraging a single core system for simultaneous
conventional and Islamic banking support for multiple regions is
not feasible at this time without increasing operational risk and
raising higher levels of deployment and operational complexity. The
underlying architecture of these core systems is not yet sufficiently
advanced to accommodate the component granularity required to
easily leverage multiple go-to-market models.
The full and true integration between the Islamic and conventional
core banking systems within banks supporting an Islamic window is
a major pain point. Achieving such full integration between products
from the same provider is the minimum expected requirement;
however, many banks are requesting full integration of coexisting
products from different providers.
FIGURE 3
Representative Vendors for Islamic Module and Pure-Play Core Systems
Source: Gartner (June 2011)
TCS = Tata Consultancy Services
Gartner predicts the evolutionary track for core system design,
especially those supporting retail banks, won’t be available to support
this “dual deployment” model through 2014. In the interim, increased
levels of customization will be required to bridge the integration gaps.
Bottom Line
The Islamic financial services market is steadily maturing and is
experiencing increased growth. Based on Gartner’s 2010 Islamic
Banking Survey (see Evidence), Islamic banking windows seem to be
enjoying less success than the pure-play business model. Given that
consumer trust remains low, it shouldn’t be surprising that prospective
Islamic banking consumers have a perception that an intermingling
of conventional and Islamic banking may occur – this model will stunt
market penetration. Not unlike the opportunity for direct banks that
spawned from conventional banks with separate branding, Gartner
predicts that the need to maintain a separate identity and brand for
Islamic banking centers – and IT systems, too – will be most effective.
Ensuring that proper assumptions are established and expectations
set for technology, deployment into the Islamic banking market is
crucial. Getting this right will determine whether this market proves to
be a genuine revenue opportunity or an investment money pit.

6. 6
Evidence
The information in this research was supplemented by several sources,
such as previous Gartner research studies, anecdotal evidence
from client inquiries with vendors and end users, the results of two
dedicated surveys, and the analysis of more than 300 Islamic banking
deals signed in the past five years. It was also tested through Gartner’s
usual rigorous peer review process.
In particular, results from two surveys have been used in this research:
• The 2010 Islamic Banking Survey was a global study of 13 leading
IBS providers that accounted for 82% of the market share in IBS
spending. This survey was conducted in early 2010.
• The 2010 Islamic Banking Update Survey was the annual update
of the previous global study to reinforce the view of the market and
the positioning of the IBS providers. Fourteen leading IBS providers
that accounted for 85% of the total market share in IBS spending
were included in this update. This survey update was conducted in
January 2011.
• More than 300 Islamic banking deals have been monitored and
tracked by Gartner during the past five years. Key contract metrics
have been analyzed for more than one-third of these deals and
have enabled Gartner to better define the market and its behaviors.
Source: Gartner Industry Research, G00213298, Don Free, Vittorio D’Orazio, 20 June 2011
Note 2
Islamic Product Definitions
Murabaha is the sale of goods with an agreed-to profit markup on the cost. Murabaha sale is of two types. In the first
type, the Islamic bank purchases the goods and makes it available for sale without any prior promise from a customer to
purchase it. In the second type, the Islamic bank purchases the goods ordered by a customer from a third party and then
sells these goods to the same customer. In the latter case, the Islamic bank purchases the goods only after a customer
has made a promise to purchase them from the bank (source: Accounting and Auditing Organisation for Islamic Financial
Institutions; AAOIFI).
Ijara means letting on a lease. It refers to the sale of a definite usufruct of any asset in exchange for a definite reward. It
refers to a contract of land leased at a fixed rent payable in cash and also to a mode of financing adopted by Islamic banks.
It is an arrangement under which the Islamic banks lease equipment, buildings or other facilities to a client, against an
agreed rental. (source: Association of Islamic Banking Institutions Malaysia)
Istisna is a contract whereby the purchaser asks the seller to manufacture a specifically defined product using the seller’s
raw materials at a given price. The contractual agreement of Istisna has characteristics similar to that of Salam in that it
provides for the sale of a product not available at the time of sale. It also has a characteristic similar to the ordinary sale
in that the price may be paid on credit; however, unlike Salam, the price in the Istisna contract is not paid when the deal
is concluded. A third characteristic of the contractual agreement of Istisna is similar to Ijarah (employment) in that labor is
required in both (source: AAOIFI).
Note 1
Islamic Window
The Islamic window is the practice set up by a conventional
financial institution that provides Islamic financial services in
compliance with the Sharia law.

7. 7
About ITS
Market leader
ITS is a full service company, with 25 offices worldwide, covering all
geographical locations including a centralized state-of-the-art managed
data centre. This network of on-the-ground resources allows ITS to offer
24/7 local support. Haitham continues by saying: “ITS is not just an Islamic
banking solutions provider, we are the IT partner of an organization.�
Through their suppliers they are able to provide everything from hardware
and security through to storage and document management solutions.
�This gives us an extra unique value proposition over any other provider,”
Haitham summarizes.
ITS has received numerous awards over the last year or so for its Islamic
solutions from its instrument definition engine, Islamic product definition
engine, and its workflow and accounting solutions. The solutions
company looks set to continue this trend with ETHIX, which has been
widely tested throughout its existing partnerships. ITS’s global launch
should see expansion across the far east into Asia Pacific, as well as
moving into new areas in Europe and the United States.
ITS’s objective is to become the global leader in Islamic banking solutions.
If initial success is anything to go by, the proven status of ITS’s Islamic
solutions will guarantee that the future is indeed technologically driven.