Declining growth rates are occurring in key geographies including KSA, Bahrain and the UAE, where growth rates have dropped to between three and eight percent from double-digit figures. In parallel cost income ratios are increasing in most markets, putting pressure on profitability.
Up until now, Islamic banks  have typically emulated the conventional bank offer, but the eroding profitability trend suggests it is now time for a new approach. A.T. Kearney says to sustain profitable growth a more sophisticated leveraging of the Islamic banking potential is required.
"Strategically Islamic banks need to revisit their positioning and decide whether they want to fully exploit the Islamic banking niche or compete head on with conventional banks," said Cyril Garbois, Partner, A.T. Kearney Middle East. "Operationally Islamic banks need to seek greater efficiency across the value chain."
Fully exploiting the Islamic banking niche means targeting customer segments that care most deeply about Shari’ah compliance in their financial dealings, as well as offering products and services that meet not only general financing but also Muslim-specific customer needs. While Islamic banking products abound in auto finance and credit cards, there are limited products available in more sophisticated segments, such as asset management and wealth management. In addition, products tailored to Muslim-specific needs provide a platform for true differentiation.
"Market gaps to better meet Muslim-specific client needs with dedicated banking products, fully aligned with Islamic core values, are many and varied. These market opportunities are under-developed and present attractive platforms for profitable growth, for players willing to exploit the niche," added Dr. Alexander von Pock, Principal, A.T. Kearney, Middle East.
Competing head-on requires Islamic banks to meet a broader set of customer needs, in terms of offer and efficiency of service. Islamic banks are typically at a scale disadvantage as they are often smaller in size and this is testing their ability to remain on par with their conventional counterparts, and compete profitably. Islamic banks willing to explore alternative branch models, as well as alternative channels such as online banking and phone banking, will be better placed to tackle this challenge.
Whatever strategic position an Islamic bank chooses, they will typically need to improve profitability through greater efficiency across their business. A.T. Kearney identifies sales effectiveness, operational efficiency and performance management as key target improvement areas for banks to maximise impact on the bottom line.
Given the early signals of slowing growth and eroding profitability, Islamic financial institutions have plenty of work to do to address strategic positioning and operational efficiency. "Taking the time now to consider strategic choices and address operational fundamentals will better place Islamic banks to capture and master the changing dynamics of their industry," said Garbois.