Dr. Siti Muawanah Lajis, PhD in Islamic Finance, CPIF. (firstname.lastname@example.org)
Islamic fintech refers to new technologies that are capable of enhancing the ways Islamic financial services are delivered. These technologies include artificial intelligence, biometrics, blockchain, distributed ledger, 5G, internet of things (IOTs), robotics, quantum computing etc. The wider accessibility to internet in recent years and the outbreak of Covid pandemic have accelerated the advancement of these 4th Industrial Revolution technologies to disrupt traditional financial services, operations, business models and customer engagement.
Trends and Development
As of year 2020, Islamic fintech has reached the size of USD49 billion, experiencing an annual growth of 21%, and is expected to reach USD128 billion by year 2025. This development is indeed commendable when compared with the performance of conventional fintech which is growing at 15% annually. Notwithstanding this, in terms of transaction volume in comparison with its conventional counterpart, Islamic fintech is yet to make a formidable impact as it presently commands a mere 0.72% share of the global fintech market.
Development of Islamic fintech varies from country to country. A lot depends on the state of readiness of enabling institutions such as the legal and regulatory frameworks, innovation and creative centres as well as talents. According to DinarStandard, as of 2020 there are 93 Islamic fintech companies in the world. They are predominantly in financing services, followed by wealth management and funding. Indonesia is leading with the most companies offering Islamic fintech (i.e. 31 companies), followed by the US, UAE, UK, and Malaysia. Islamic fintech operators’ presence by region, SEA has 62, MENA-GCC 58, Europe 51, North America 18, South & Central Asia 17, MENA-Other 12, and Sub-Saharan Africa 7.
In terms of transaction volume effected via Islamic fintech in 2021, DinarStandard has ranked Saudi Arabia, UAE, Malaysia, Turkey and Kuwait as the top five OIC countries. Collectively, these five markets make up 75% of the OIC Islamic fintech market size. Saudi Arabia is leading the pack owing to its largest regional financial services and Islamic finance (IF) market, its strong government and regulatory support for entrepreneurs and presently the second largest outward remittance market in the world. The UAE is ranked second based on its progressive regulatory environment which provides greater access to capital. Meanwhile, Malaysia remains as an important destination for Islamic fintech operators, leveraging on its comprehensive fintech ecosystem. This comprises supportive legal and regulatory environment, strong market for Islamic financial services and abundant talents. To this end, the tech community regards Malaysia as a “great place” to set up an Islamic fintech company.
Covid pandemic was a boon for fintech to surface and flourish. The pro-longed pandemic effectively functioned as the test bed for app-based fintech to gain consumers’ confidence and thereby transforming the way of life. It is therefore not surprising that post-covid, fintech will become the prevailing mode of doing businesses and financial transactions.
Out of the world’s population of 7.6 billion, the World Bank in 2019 estimated that there are 1.7 billion retail customers and more than 200 million potential micro, small, and medium enterprises (MSME) that are categorised as unbanked. According to the Global Findex Report, bank account ownership is so much higher in high-income economies i.e. at 94%, in comparison to barely 37% in developing countries. Geographically, close to 75% of the world’s unbanked population lives in developing economies, with the highest hot spots found in Asia (i.e. India 20.8%, China 11.6%, Indonesia 5.6%, Pakistan 5.2%, and Bangladesh 3.7%). Meanwhile, the unbanked population residing in Muslim populated countries makes up a hefty half of the world’s unbanked population. In monetary terms, the World Bank’s estimate of the potential revenue in this unbanked retail and MSME market to be around USD200 billion.
The United Nations Development Programme of the UN works with 170 countries to eradicate poverty while protecting the planet. In order to achieve its Sustainable Development Goals (SDGs) an aggregate investments of USD5-7 trillion annually until 2030 is required. Based on the IMF’s estimate, developing countries face an annual funding gap of USD2.5 trillion in meeting their SDGs. This funding gap represents only 15% of developing countries’ GDP and thus underlines the need for additional investment required in health, education, and basic infrastructure (roads, electricity, water pipes, and sanitation services).
How can the gap be closed? Fintech can be the catalyst, capable of adding an estimated USD3.7 trillion to the GDP of developing countries by 2025, says the McKinsey Global Institute. To achieve this, some SDGs can be commercialized, combining profitability with social impact and incentivizing fintech providers to take the lead in increasing financial inclusion. Financially inclusive activities can help fulfil several SDGs which are related to financial independence and close the inequality gap.
While many challenges of the SDGs could be resolved through fintech and financial inclusion, there remains a large segment of people who voluntarily exclude themselves from financial services due to religious and other reasons. People that avoid bank accounts due to religious reasons can be provided with usury-free financial transactions based on risk-sharing principle. Risk-sharing finance requires that the transaction risk is borne by both entrepreneurs and the Islamic financial institutions, encouraging a partnership-based approach that develops robust businesses and eventually leads to an increase in the wealth of related individuals and MSMEs.
Implications to Islamic Finance (IF) Professionals
Covid pandemic has affirmed the arrival of fintech in almost all aspects of people’s lives. With the ubiquity of mobile phones, it is highly likely that post-Covid going forward, most financial transactions will continue to be performed via app-based platforms. In such scenario, Islamic fintech is well-placed to drive the Islamic finance industry to its next phase of evolution and opportunity. What would then be the implications to IF professionals?
Presently, Islamic fintech development tends to shadow the advancement of its conventional counterpart. Examples are the use of IOTs to enhance consumers’ experience, data analytics to enable directed push technology marketing, mobile wallets to replace physical wallet and payments interface that enable real time interbank peer-to-peer (P2P) and person-to-merchant transactions. Islamic fintech however is somewhat ahead in the social finance realm following the demands for online Zakat, Waqf and Sadaqat transactions. Feedback by the fintech community on the lukewarm attitude of the IF community points to the narrowly defined scope of IF. Often, it is confined to the Islamic banking, takaful and Islamic capital market. As a result, other sectors such as halal, logistics, health, blue and green economy are underexplored.
With regards to skills, the CEO of microLEAP (a P2P microfinancing platform) in October 2021 said that in the case of Malaysia, “it needs to improve the technology (tech) side in order to drive Islamic fintech. There is enough talent pool in the fintech industry in terms of Shariah knowledge. What is still lacking is those in the tech field.” He added that “there is huge demand for Islamic fintech in Malaysia and there will be more demand once people know exactly what Islamic fintech is and what it can do.”
The Halal Development Corporation (HDC) of Malaysia too shared similar stance. “The adoption of technology has become a challenge, not just for fintech companies but also those in the halal industry. IF professionals need to expand their efforts and continuously educate the people and the MSMEs to ensure greater awareness of fintech’s existence and benefits.” HDC’s engagement with the MSMEs revealed the latter’s lack of knowledge on what fintech actually is. As such, reaching out to the non-financial sectors would be an urgent matter to address. With heightened awareness, IF professionals would help to create the demands for Islamic fintech in those sectors.
The next urgent issue is the long neglected unique proposition of IF i.e. risk-sharing finance. Several factors have led to the low take-up on risk-sharing finance despite its potency in resolving financial exclusion. Regulations, technology, expertise and will-power have been the key inhibiting forces. The main concerns are trust and risk. Good news is the necessary technologies have arrived to alleviate those concerns. Blockchain technology is capable of functioning as the trust machine. Psychometric models can replace credit scoring which had excluded those without debt history. Psychometric assessments would function as an indicator for behavioral finance.
Risk-sharing model operates on pro-active/ex-ante risk management. It requires an investment type of risk management framework, not the traditional credit risk management. Therefore, having a large pool of risk experts becomes essential. The rapid rise of fintech could support those unique risk management needs and thereby accelerate the financial inclusion of the MSMEs previously excluded in risk-transfer system. Risk transfer is defined as the shifting of risk from one party to another. Examples include the use of credit enhancements such as Wa’ad, collateral and guarantees as conditional requirements imposed on counterparties as part of the financial contracts. The main objective of these credit enhancements is to effectively shift the risks of one party to the counterparty with or without the knowledge of the latter. The rationale for the origination of credit enhancements is believed to have been motivated by the need to achieve the same effect of conventional products.
An example of fintech based risk-sharing finance is the issuance of retail low-denominated risk-sharing securities through app-based crowd funding platforms. How risk-sharing investment works is well explained in the Investment Account Guideline issued by Bank Negara Malaysia on 10 October 2017. For better understanding, it should be read together with the Frequently Asked Questions (FAQ) in Investment Account issued in July 2016. In conclusion, IF professionals need to expand the breadth of their competencies beyond contract structuring or legal. Comprehension of emerging technologies coupled with good understanding of macroeconomics is essential. A well rounded IF professionals are necessary to lead the long awaited dawning of risk-sharing finance.