June 29, 2013


Insight: Strategic pitfalls to avoid in establishing Islamic financial institutions

In recent years, we have seen resurgence in enthusiasm to create new Islamic financial institutions.
This enthusiasm is for good reason – as prosperity increases in key Muslim markets, the awareness of Islamic financial services grows, and regulators express increased openness to the sector.
The eagerness to establish new Islamic financial institutions is found not only amongst entrepreneurs, but also “intra-preneurs”: executives at financial services institutions keen to establish Islamic financial services lines or subsidiaries.

As founders embark on the journey to establish new institutions, they would be well-served to avoid strategic pitfalls that have been faced by institutions before them. A few such pitfalls include the following:
Launching a business in the absence of an enabling regulatory environment
It is tempting, in the drive to be “first to market”, to take a shotgun approach to launching an Islamic financial institution. While founders typically recognize the importance of having the necessary regulatory reform (such as avoidance of double-taxation on Islamic financing products), they often push ahead to launch the institution before the reform is implemented.

Opening for business without a level regulatory playing field puts new institutions at a disadvantage. This disadvantage can lead to disappointed customers, suboptimal results, and unhappy shareholders.
Rather than launch the business too early, founders should invest effort in developing their business plans, capabilities, relationships, and governance models in the time it takes to have the regulation in place. This positions them for early success once the conditions are favorable.

Under-investing in internal management capabilities
The path of establishing an institution typically begins with the engagement of advisory firms. Expert advisors play a necessary and efficient role in supporting founders as they formulate strategies and business plans, raise capital, apply for licenses, and draw up their constitutional documents.
The advisors who formulate the business model are often retained to support its implementation. There is merit in this approach, as it accelerates the pace of organizational development and fosters greater consistency between strategy and implementation.
Founders need, however, to invest substantially in developing internal management capabilities. Identifying and recruiting top talent – especially in senior executive roles – requires early attention and sustained focus.
Too often, in the rush to launch quickly, founders rely on external consultants to operate the business without a core team of in-house leaders appointed. This approach can lead to serious issues such as (a) an insufficient sense of ownership, (b) a short-term mindset, and (c) a lack of strategic alignment between the people in charge at launch and the full-time executives hired thereafter.
Finding and securing in-house management expertise – particularly in the specialized Islamic finance industry – is often more difficult than drawing on external advisors. The recruitment process for a world-class CEO, for example, can require a full year of effort. It is thus crucial that founders begin the recruitment process early and sustain it with focus.

Adopting inadequate governance models
When establishing the institutions, founders must design its governance model with long-term needs in mind. It is tempting to populate the board with the founders themselves, with a few board seats allocated to major investors.
Instead, founders should adopt a more robust approach. Founders should consider the capabilities required at the board, including expertise in financial services, experience in Islamic finance, strong relationships in the business community, risk management expertise, and credibility with regulators and investors. Even from inception, the collective skills of the board should cover all these areas.
Governance models should also adopt global best practices, including independent directors and committee structures. In the early days of an institution, a robust governance model will appeal to investors, regulators, and counterparties. As the institution matures, it will also be a key enabler of long-term commercial success.

Founders of Islamic financial institutions are catalysts of the industry. They are its pioneers, bringing Islamic financial services to new markets, business lines, and customer segments. Being mindful of common strategic pitfalls can allow founders to start their institutions on the right foot, better serving their customers and all their stakeholders.
Aamir Rehman is Managing Director of Fajr Capital Advisors.
The views expressed in this article are those of the author and do not necessarily represent the official policy or position of Fajr Capital Group.