Disruptive innovation

Institutions offering Islamic Financial Services (IIFS) need to revamp their Governance, Risk and Compliance (GRC) practices in order to drive sustainable growth and ultimately reinvent the value proposition of Islamic finance.

The Islamic financial services industry continues to experience profound regulatory and practical challenges and there is continued pressure on industry stakeholders to revisit their governance and business models. Key to these issues is the regulatory inconsistency that exists due to different regulatory regimes, and in some markets where the industry has operated and evolved, different products structure offerings. Several IIFSs maintain multi-country operations and face the challenge of dealing with the different regulatory and financial reporting standards, such as IFRS (International Financial Reporting Standards) versus AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) as well as modes of financing and capital requirements, to name a few. 

That said, regulatory inconsistency and other practical differences have all created an unnecessarily uneven playing field upon which the industry grows and also potentially acts as delivering a competitive disadvantage to the Islamic financial service industry.

This article discusses the broad industry stakeholders’ considerations and attempts to provide practical insights on three focus practices: Regulation, market practices and business support. It argues that industry strategists and thought leaders should adopt a culture of change and should drive innovation in business and human capabilities that will ensure efficient business processes and good governance practices.

Change in this case is defined as a strategy implemented by the board, executive management, and designed to provide an overhaul plan to implement leading industry practices in the following strategic priority areas in Islamic finance:

• Strengthening the governance, risk and compliance environment.
• Improving risk management and internal controls.
• Enhancing financial reporting and disclosure practice.
• Ameliorating Sharia’ compliance process and assurance.
• Upgrading business models to respond to market changes and regulatory requirements.
• Leadership and talent development.
• Industry collaborative initiatives.

Each of these practices involves major decisions and significant change. One new approach that we advocate is to think about engaging the industry in collaborative dialogue platforms to address the catalysts for change in regulation, governance, risk and reporting transparency. This approach is driven partly by the current need to stand up to competition and challenges, and partly by the increasingly strategic role that change is expected to play in business today. For many IIFS, a change may be the right plan for the industry’s boards and executive management to revitalize and energize policies and plans, and boldly develop the services and capabilities needed to support future growth objectives.

Industry stakeholders should lead sustainable growth in developing a change strategy to drive innovation that would, in turn, benefit the industry and society as a whole. Some of the critical steps include internal and external challenges in the areas of regulation, risk, governance, leadership and operational considerations. These cross-organizational issues rank high on the agendas of boards, CEOs, and executive management of IIFS.

While not intended as a roadmap, the whitepaper serves as a blueprint for IIFS wishing to understand, and ultimately act on, the business model challenges.

Key insights

1. Risk-based approach to regulation

Given the differentiating factor of Sharia’ compliance, IIFS are encouraged to adopt the risk-based approach guidelines set by industry standards such as the revised risk-based approach guiding notes developed by the Islamic Financial Services Board (IFSB)–13,14,15 and 16. 

2. Need for better cross-border cooperation

Discussions with industry thought leaders reveal that there is a need for better cross-border cooperation and coordination between different regulatory authorities in key markets. This is an absolute priority to improve regulatory consistency toward market synergies.

3. Culture of regulatory compliance

Industry personnel should observe ongoing efforts to respond to regulatory changes and requests for information.

4. Implementation of industry best practices

Standard-setting bodies (SSBs) such as the IFSB (Islamic Financial Services Board), AAOIFI and IIFM (International Islamic Financial Market) often look to the leading IIFS in the industry, and based on which they develop standards and guidance for new regulations in risk, capital and solvency. In these instances, they develop industry best practices and assist IIFS in implementing them. However, the industry should be given more incentives to implement these standards. National regulatory authorities equally need to help create the required awareness among market players and other stakeholders to adapt a culture of good practices.

Navigating the route to change

A change strategy to reinvent the value proposition of the Islamic financial service industry is high on the agenda of many industry leaders. This necessity was fueled lately by the global economic downturn coupled with geopolitical risks, that created more pressure on industry strategists and policy-makers.

Evidently, they need to make significant investments in planning and executing a change strategy. Embracing the issues and challenges discussed in this whitepaper will arguably help IIFS sustain business continuity. However, too often the same rigor and commitment are not dedicated to preparing the functional leadership team to navigate this change.

As an industry executive, your leadership team will need to invest in building a committed and aligned team to address your organization’s needs and address gaps in practices and expertise.

At the same time there are undoubtedly business benefits from enhanced change analytics, particularly in view of the much more sophisticated governance, regulation and compliance that are key to the strategy. The chart at right sheds light on the process of change requirements and assessment. By analyzing governance frameworks using sophisticated change analytics, Islamic finance professionals can develop the pressing strategy solutions that enable their institutions to improve governance practices and accelerate performance.

In parallel, industry executives can bring more value to their IIFS using this approach by addressing questions such as:

• Are the business and financial goals of the IIFS viable?
• What products and markets deliver the greatest promise for revenue or growth in a particular jurisdiction and set of regulations?
• How should the IIFS revamp its business and financial model to generate a competitive advantage?
• How often should governance frameworks be updated to reflect on the business environment and the institution’s business objectives? 
• What resources and capabilities enable management to effectively execute and deliver the change strategy without impacting on the fundamentals of Sharia’ compliance?

The answers to the above questions and acting upon them should help deliver the strategic change aspired to by industry leaders, and create value to shareholders and stakeholders. Leadership and management executives can tailor this approach and choose effective ways to implement a change strategy that is able to enhance the governance, risk-management and compliance (GRC) practice that in turn is able to drive innovation in building business capabilities and Islamic financial solutions that drive sustainable growth.