Islamic retail banking has emerged as a powerful engine of inclusive financial services for the world especially targeting the Muslim population. Rooted in the principles of Shariah law, Islamic retail banking offers a credible alternative to conventional banking for millions of consumers globally. MAHMUD HOSSAIN writes.
With the global Islamic finance industry valued at approximately US$4.5 trillion in 2023, as per the Islamic Finance Development Report 2023 by DinarStandard and the London Stock Exchange Group, of which retail Islamic banking forms a significant portion, the opportunities are vast – but not without challenges.
Opportunities
Financial inclusion and ethical finance
Islamic retail banking is uniquely positioned to deepen financial inclusion, especially in Muslim-majority countries where segments of the population are either underbanked or completely unbanked. For example, the World Bank estimates that over 1.7 billion adults remain unbanked, according to ‘Unbanked adults worldwide’ by the World Bank Global Findex Database 2021, with a significant share residing in OIC member states.
By focusing on profit-and-loss sharing models, like Mudarabah and Musharakah, risk-sharing instruments and asset-based financing like Murabahah and Ijarah, Islamic retail banks are well-suited to serve low-income households, microentrepreneurs and rural communities. These instruments inherently promote responsible lending in the areas to meet the necessities permissible under Shariah and discourage speculative activity.
Resilience and high recovery rates
Islamic microfinance institutions (MFIs) have demonstrated exceptional repayment performance – often achieving recovery rates above 98%, according to ‘Islamic microfinance institutions recovery rate’ by Consultative Group to Assist the Poor (CGAP) in the Islamic Microfinance Report, 2019, even in volatile markets. This stems from the emphasis on direct linkage with real assets, social accountability through group-based lending models and community-based monitoring systems. These practices reduce moral hazard and enhance social cohesion, motivate the investment clients to adjust the liabilities timely which, in turn, improves the recovery rate.
Demographic and digital trends
The global Muslim population is projected to reach 2.2 billion by 2030, according to ‘The future of the global Muslim population’ by Pew Research Center, 2017, with a large youth cohort demanding digital-first banking solutions. Islamic retail banks have an opportunity to leapfrog traditional models by embracing mobile banking, digital onboarding and AI-based customer service. Countries like Malaysia, the UAE, Indonesia and even the UK are now seeing growth in Islamic neobanks and digital Shariah compliant financial apps.
Untapped markets in Africa and Southeast Asia
Despite high Muslim populations, countries like Nigeria, Bangladesh, Indonesia and Pakistan still have low penetration of Islamic retail banking. In Nigeria, for instance, Islamic finance accounts for less than 2% of the banking sector, according to ‘Nigeria Islamic finance penetration’ by the IMF, despite Muslims comprising over 50% of the population. This signals significant room for growth, especially through rural outreach, agent banking and microfinance Software as a Service platforms.
Policy and regulatory support
Many governments and central banks are now recognizing the social and financial stability offered by Islamic retail finance. Regulatory frameworks are evolving in markets such as Indonesia (OJK roadmap), Pakistan (State Bank of Pakistan’s Vision 2025) and the GCC countries, enabling Islamic banks to offer digital products, participate in open banking ecosystems and expand their reach under favorable legal structures.
Challenges
High profit rates and cost structure
A major concern in Islamic retail finance is the high effective profit rate – often exceeding 20% driven by high administrative and operational costs, according to ‘High effective profit rates in Islamic MFIs’ in the IMF Working Paper 2022. Unlike conventional banks, Islamic banks may face added expenses in structuring Shariah compliant products, maintaining Shariah boards and conducting due diligence.
Digitalization offers a pathway to reduce costs, but the upfront investment remains a hurdle for small and mid-sized Islamic banks and MFIs. The challenge is to scale operations through shared services, automation and digital channels without compromising Shariah integrity. But onsite supervision of micro investment clients remains a big challenge in reducing operational costs.
Regulatory fragmentation and supervision gaps
While the Islamic finance industry is growing, regulatory oversight – especially for MFIs and rural Islamic banks – remains weak in many jurisdictions. Institutions like Bangladesh’s Microcredit Regulatory Authority often lack the manpower and infrastructure to ensure end-use verification, client protection or data transparency.
Harmonizing Islamic finance regulations and providing tailored supervision tools for Islamic MFIs are essential to protect consumers and ensure sector stability.
Human capital deficit
There is a significant shortage of skilled personnel trained in both conventional banking and Islamic jurisprudence. This limits the ability of institutions to design innovative products, comply with evolving regulations and provide high-quality customer service.
Although countries like Malaysia and Bahrain have developed world-class training centers, the capacity gap remains wide across South Asia, Africa and the CIS region.
Competition from informal credit
In many rural markets, informal moneylenders still dominate due to ease of access, familiarity and lack of documentation. Low education level and lack of awareness are causing rural people to be subject to exploitation. Islamic retail banks must work harder to offer fast, low-cost, trust-based products that match the speed and simplicity of these informal providers.
This requires tailored agent banking, low-tech mobile platforms and strong community engagement to build trust and transition among customers into the formal financial ecosystem.
Monitoring and governance complexity
The principles of Islamic finance demand rigorous monitoring to ensure Shariah compliance, especially in investment-based or profit and loss sharing models. End-use monitoring, client education and post-financing supervision are often resource-intensive and challenging to implement at scale.
Innovations like digital contracts, AI-based risk scoring and remote monitoring tools could help but need to be adapted to local cultural and regulatory environments.
Conclusion
Islamic retail banking stands at a pivotal juncture. The convergence of demographic trends, digital innovation and regulatory openness provides an unprecedented opportunity to reshape financial inclusion across the Islamic world and beyond. However, systemic reforms – cost rationalization, talent development, stronger regulation and digital scale – are imperative for it to succeed.
If rightly done, Islamic retail banking could not only become a sustainable business model but also a driver of social justice, equity and economic resilience for the smart generations to come.
This article is by Mahmud Hossain, CEO and co-founder of Millennium Information Solution.
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