By Abdullo Kurbanov, Zuhursho Rahmatulloev and Khofiz Shakhidi
When it comes to fintech innovation, most conversations typically revolve around the diversification of a sector once dominated by legacy institutions. In the past decade, a new wave of high-growth companies has applied technology to digitally transform the financial sector for investors, businesses and consumers. More recently, established banks have also been changing the way they compete for market share by launching challenger brands that essentially position their services to a new generation of potential customers.
Fintech is entering what commentators are now deeming to be the third phase of its evolution. With technology firmly embedded into existing financial frameworks, attention is turning to the advantages blockchain could offer in improving the way different financial institutions operate, from operational efficiency to cost savings.
The financial services sector has an exciting future, enabled because of fintech innovations. Importantly, fintech is also empowering certain segments of investors and consumers who have yet been unable to take full advantage of 21st century banking. Of these, one area primed for digital disruption is Islamic finance.
According to Refinitiv’s Islamic Finance Development Indicator, the Islamic finance sector is projected to reach $4.9tn (£3.7tn) in 2025. S&P Global Ratings also projects the industry to grow by 10 to 12 per cent over 2021 and 2022. And the UK is on a mission to become a global hub for Sharia-compliant finance.
With 2022 set to be the year of expansion for Islamic finance, it is important for financial professionals to understand its basic principles as well as the impact that technology is having in fuelling a new rise of Islamic fintech companies.
The Rise of Islamic Finance
While Islamic finance has been part of banking systems for more than 50 years, only recently has it experienced significant growth. There are three main reasons for this.
The first is linked to population growth. As a demographic, the total number of followers of the Islamic faith is expected to reach 3bn by 2060. Naturally, this will increase demand for financial instruments that are Sharia-compliant.
The second factor is linked to the digital disruption of the financial services sector. Five years ago, Western economies experienced a surge in fintech start-ups offering more effective and efficient services through the creative application of software. Consequently, traditional finance institutions are now competing with challenger brands and neobanks to appeal to consumers, investors, and businesses.
In the UK, fintech challenger brands like Monzo and Revolut have become part of the banking landscape. Established banks like JPMorgan have responded by launching their own challenger brands to rival the new competition.
The scale and pace of digital disruption led by startups initially focused on the delivery of traditional financial services. The success of this first fintech wave has encouraged a new generation of start-ups, which are applying technology to deliver products and services designed specifically for certain demographics.
The creation of tech-enabled Sharia compliant banks is on the rise in both Western and Islamic jurisdictions. Particularly in regions like Central Asia where countries are undergoing economic modernization, fintech companies are playing an important role in giving consumers and investors the digital tools needed to effectively manage their finances. As more investment is directed into these Islamic fintech companies we are likely to see the sector grow.
The third and final factor concerns the growing market awareness of Islamic finance by big financial institutions.
Take Sukuk (an Islamic financial bond that effectively acts as a trust certificate) as an example. Sukuk supply has been rising in both Islamic and non-Islamic markets. Most Sukuk issuances are hybrid, with debt making up no less than 30 per cent. According to Fitch, the global amount of outstanding Sukuk reached $754.1bn in Q2 2021, which is 5 per cent higher than the same figure recorded in Q1. As the first western nation to issue a sovereign Sukuk, the UK has raised more than $50bn through 68 Sukuk issuances on the London Stock Exchange.
While there is general awareness of Islamic finance, actual knowledge of its basic principles is not typically high among financial professionals based in non-Muslim jurisdictions. This is an issue that has been raised on numerous occasions in the UK.
There have been attempts by the government to make the financial environment more religiously inclusive in the UK, yet the overall lack of available Sharia-compliant products has been a topic of recent debate. There are calls for the introduction of Sharia-compliant student loans by September 2022, enabling more students to access university education in the UK.
Moves to make the UK’s financial system inclusive and diverse will remain a top objective in 2022 and beyond. Part of this is due to the growing customer base. In the UK, there is estimated to be more than 100,000 Islamic finance retail customers. Government also puts the value of net assets of Islamic funds in the UK to £600m, with this figure set to rise in the ensuing years.
What Does The Future Hold?
Islamic fintech is an enabler of Islamic finance’s growth. The integration and use of technology that is Sharia-compliant will naturally increase the number of people able to engage with Islamic finance products and services, in turn boosting demand. However, there are still challenges on the horizon.
The first issue lies in the lack of qualified personnel who can provide Sharia-compliant products that meet evolving market expectations. For Islamic financial institutions, there is a need to educate and equip their staff with the skills to fulfil their clients’ needs.
Over the past year, demand for Islamic financial institutions has been rising with the nature of work increasing in complexity. This is a common problem being faced across the financial services sector – while demand for services is rising, the lack of skilled professionals is resulting in delays.
The second issue is changing public perceptions towards Islamic finance. As mentioned previously, there is a general lack of awareness when it comes to understanding the fundamentals of Sharia-backed products and services. In places like the UK, where Islamic finance has potential for growth, ongoing training and awareness campaigns for potential customers, financial professionals, public and private institutions will play key roles.
Regulatory environments that promote innovation and competition will also ensure Islamic fintechs are able to effectively scale-up and compete with other financial players. It will also allow for the proliferation of Sharia-compliant products. To accommodate the unique nature of the Islamic finance institutions, the legal landscape needs certain adjustments to achieve tax neutrality.
This is an evolving process, and in places like the UK important steps have already been made. For example, detailed rules and regulations governing collective investment schemes mean increased financial burden is placed on Sukuk products, making them prohibitively expensive when compared with conventional interest-bearing bonds.
However, once raised to the government, new legislation was introduced that defined Sukuk as ‘alternative finance bonds’, essentially excluding it from the financial costs attached to collective investment schemes. Despite these challenges, Islamic finance also has exciting developments on the horizon.
From a product standpoint, the Islamic fintech industry is set to grow dramatically in the ‘buy now, pay later’ (BNPL) schemes, where less documentation and Shariah requirements exist. Many renowned BNPL providers are not Sharia compliant for two reasons. The first revolves around the charging of interest and the second has to do with a lack of an Islamic contract, between the BNPL lender and the borrower.
BNPL is an evolving sector. Its rapid expansion has caught regulators off guard, which is why institutions like the Financial Conduct Authority have launched consultations to better understand the impact it could have on consumers. As BNPL establishes itself within the retail credit industry we are likely to see an emergence of Sharia-compliant providers, be it standalone brands or Islamic fintechs, expanding their service offerings.
The link between Islamic finance and impact investing linked to economic, social and governance outcomes is also a key trend. A core principle of Islamic finance is promoting activities that have a positive impact on society.
Screening of assets to ensure they are Sharia-compliant can encourage investment into ESG assets. 2019 research from Refinitiv’s Eikon database revealed that Sharia-compliant companies have ESG scores that are approximately 6 per cent higher than those that are not. With public awareness of ESG at the forefront of everyone’s minds following Cop26, Islamic finance has an evident role to play here.
Facilitating automated Shariah-compliant products is an ambitious endeavour that can bring financial stability and financial inclusion to the segments of the populace that is financially deprived. With Islamic fintech enhancing awareness and accessibility of Sharia-compliant products for consumers, investors and businesses, Islamic finance is poised for years of significant consolidation and expansion.
For now, it is advisable for financial professionals across all jurisdictions to expand their knowledge of Islamic finance.
Abdullo Kurbanov and Zuhursho Rahmatulloev are co-founders, and Khofiz Shakhidi is chairman of Alif Bank.
