Ever since Covid-19 came crashing into all our lives, there is inevitable anticipation of a recession across the Asia Pacific along with most other parts of the world. In response, the younger Muslim population is continuing to call for more Islamic finance innovation. This group, widely regarded as being more perceptive than previous generations, requires greater transparency regarding what they consume in their daily lives.
In Islamic and non-Islamic nations alike, shariah-compliant fintechs are popping up, promising to reach millions of young Muslims and broaden financial services to the underbanked. Islamic fintech is gaining significance against the backdrop of the coronavirus pandemic. While its positive effects on the general masses have never been doubted, the bigger question remains: how can Islamic fintech help fight against COVID-19 and the economic crisis?
What is Islamic fintech?
Islamic finance is designed to comply with the principles of Islamic, or shariah, law. The incentive for using Islamic finance is that borrowers and issuers of Islamic debt can gain access to Islamic institutions and thus a much wider base of investors by demonstrating compliance with the principles of shariah law. There is already a compelling track record of successful project financing compliant to the sharia.
The shariah is a complex combination of legislation, codes and rules. Although this subject cannot be covered in great detail in one article, key principles include avoiding uncertainty in dealings, prohibiting interest and prohibiting speculative activities.
The objectives of Islamic finance are, in very broad terms, to make sure that there is a balanced partnership between parties and that there is a component of profit and risk sharing that underpins financial transactions.
Islamic fintech focuses on delivering financial products, services and investments that comply with the syariah through innovative solutions. With roughly 1,400 Islamic financial institutions now operating across 80 countries, the prospects of Islamic fintech are enticing.
In the last few years, the number of Islamic fintechs has steadily increased, from 116 in 2017 to 136 in 2019. The main Islamic fintech hubs are Indonesia, Malaysia, the UAE, the United Kingdom and the United States, spread across major sectors such as digital banking, P2P finance and crowdfunding, payments and remittance, trade and personal finance, wealth management and blockchain (according to research by IFN Fintech).
It is likely that this number will continue to rise as more Islamic finance institutions begin to undergo digital transformation and look to fintechs for partnerships.
Islamic fintechs represent the next wave of growth in Islamic finance. Most Islamic fintechs are currently in their initial stages, tackling the challenges of financial inequality, exclusion or bad customer experience while facing and growing a 1.8 billion-people opportunity.
It opens up more opportunities
Islamic laws, or shariah laws, prohibit charging interest on financial services, or riba. Lines are blurred with common cashback rebates and discounts — clerics are divided on whether they are considered riba.
Recently, Indonesia’s top Muslim clerical body issued a decree that deems virtual money acceptable and that it can be used for shariah-compliant payments, provided it meets specific conditions.
Evidently, if successful, this presents the region’s fintech firms with a big business opportunity. These companies have been working hard to be innovative, while at the same time trying to ensure that their services are shariah-compliant.
Islamic fintechs prefer partnerships when it comes to market engagement, as they are a crucial growth strategy for Islamic fintechs, with the more sought-after partners being other Islamic fintechs and Islamic banks.
Geographically speaking, Muslim-majority Southeast Asian countries are expected to provide Islamic fintech with the highest growth potential in 2020, with Indonesia in particular at the forefront.
It encourages digitised efficiency for investors and enterprises
Big data, blockchain-based smart contracts, insurtech, and artificial intelligence (AI) all present an opportunity, with signs of these technologies being adopted by Islamic finance players. Focusing more on smart blockchain contracts could facilitate Islamic fintech’s growth as this technology develops product standardisation, efficiency and competitiveness against conventional peers.
Takaful technology is a key area which offers the ability to improve pricing, product design, handling and distribution channels with regards to claims.
There has also been increased adoption of peer-to-peer crowdfunding that encompasses real estate, and small and medium-sized enterprises within the Islamic fintech startup space. Untapped opportunities include the use of big data and AI for Islamic financial services, as well as blockchain solutions in areas like trade finance.
What’s more, smart contracts based on blockchain enable better transparency and standardisation of services provided by Islamic banks, with tangible indications of these lenders adopting the technology. This could be a way to convert the sukuk market to digitised platforms that offer lower costs for investors and increase transparency.
It allows for business inclusivity
Islamic fintech contains a prime example of a business advantage that can come when promoting inclusiveness and acceptance between local markets. Contrary to popular belief, it does not limit a business but rather encourages the expansion of the business into potentially profitable, untapped markets. It could also lay a strong foundation for future customer loyalty.
Inclusivity has to be on the modern business executive’s agenda. Not only is it the right thing to do, it also makes good business sense.
It offers some stability with regards to financing
From a vastly disrupted workforce to imminent global uncertainty, the coronavirus pandemic has left us one truth: the financial space in a post-COVID-19 world will probably never be the same again.
However, Islamic banks should have adequate buffers for loss absorption to meet near-term challenges, though we see factors for risks to asset quality and profitability should the COVID-19 outbreak be prolonged. Fitch Ratings indicated that Islamic financing's share of total system loans is backed by the regulatory backdrop that provides a level playing field, and banks that support and promote Islamic products.
Which is why Islamic banking is expected to grow faster than conventional loans in the medium term.
Consumers are warming up to ethical financing efforts
In Malaysia, we can expect to see half of the country’s banking assets becoming Islamic by 2030, as the growth of the industry could possibly exceed conventional banking. Loans that conform to the ban on interest are set to rise by 10 per cent to 15 per cent annually over the next five years, surpassing the 5 to 7 per cent growth observed with regards to non-Islamic loans. As a result, consumers are becoming more aware of products that comply with the shariah.
In addition, focusing on value-based funding, which calls for society and the environment to be protected, could help propel demand in the face of growing interest in ethical investment.
Zakat falls in line with sustainable and ethical solutions
Zakat is a compulsory welfare tax of 2.5 per cent, payable by all Muslims with wealth above nisab (a threshold or exemption). It is a cash contribution to the underprivileged that fosters cooperation, fair dealings, transparency and selfless spending on the needy.
Annual zakat efforts throughout the Islamic world amount to around USD1 trillion, representing an important source of SDG finance. In Indonesia, the UNDP has partnered with BAZNAs, the national collection body for zakat, to channel funds to SDG projects.
These include projects related to renewable energy in underserved communities. Zakat funds are also used to support small and medium-sized enterprises through Islamic microfinance structures.
In the midst of the COVID-19 pandemic, Islamic fintech is gaining the attention of many nations, both Islamic and non-Islamic. Among other things, Islamic fintech helps propagate fintech opportunities, allows for business inclusivity and offers some much needed stability in times of uncertainty.