While there is a general awareness of their growing significance, understanding how the actual application of sharia-compliant products and services is limited.
This knowledge gap is understandable, particularly in advanced economies like the UK. Despite the modern evolution of Islamic finance which can be traced back to the 1970s, the sector has not developed in the same way as conventional banking. There are two reasons for this.
The first has to do with the lack of a unified governing standard. Without a global legislative framework that standardises practices, the evolution of Islamic finance has differed significantly between jurisdictions. This has ultimately hindered its growth, though there have been recent efforts by the Islamic Development Bank to create a unified global legal and legislative framework for the Islamic finance sector, leading to its vertical and horizontal expansion in the coming years.
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This leads to the second reason, namely the region-centric nature of Islamic finance. Rather than reviewing Islamic finance on a global scale, there is a tendency to look at the sector by regions, such as the Middle East, Central Asia and Southeast Asia.
Presenting a globally unified Islamic finance sector is key to its future success and growth. Industry leaders are aware of this, which is why we are seeing more institutional initiatives link up regional markets.
On top of this, the evolution of Islamic finance is now being propelled by Islamic fintech. Similar to what was witnessed in the 2010s in Western economies, FinTech companies are enabling a digital revolution directly focused on Islamic finance. Heeding the lessons and experiences from cities like London and New York, Islamic fintech companies are employing next-generation technology to deliver banking services that are sharia-compliant.
Promoting recognition and adoption of Islamic finance in non-Muslim economies will take time. Looking at London, a report from S&P Global Ratings argued that until Islamic finance can demonstrate a real economic value and a comparative advantage over conventional banking players, it is unlikely to make significant in-roads.
I would argue that Islamic finance has already been demonstrating real economic value, from risk sharing to the avoidance of leverage. What is more, Islamic fintech companies are readily embracing next generation technologies to improve efficiency, transparency and security. Rather than just digitalising legacy banking systems, Islamic fintechs are looking to the web3.0 ecosystem in a bid to catch-up to their traditional banking counterparts. These new technologies include Open banking and blockchain.
Open banking
Open banking has completely transformed the manner in which financial institutions are able to engage and meet the needs of their clients. The provision of consumer banking, transaction and other types of open banking data to third party financial service providers through application programming interfaces (APIs) is core to the success of fintech sector's rapid scale-up in Western markets.
A similar projection can also be made for the Islamic finance sector. According to a study by IslamicMarkets, nine in ten Islamic finance professionals anticipate an ever-increasing adoption of open banking over the next three years. The rise in open banking is likely to be influenced by the introduction of better regulation in the Islamic finance sector. If effectively integrated, open banking could unlock a new wave of innovation led by Islamic fintechs, with a focus on retailer customers. Areas of particular interest include charitable endowment (waqf) and donations (sadaqah).
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Beyond the delivery of sharia-compliant financial services, open banking will also encourage the adoption of global regulation by the Islamic finance community linked to the protection and processing of data.
Blockchain
Transparency, cost-efficiency and security are synonymous with blockchain. These three principles serve to benefit all financial systems, including Islamic finance. Fintech companies will lead this innovation, exploring how decentralised finance can be integrated with Islamic finance to deliver sharia-compliant products and services.
Blockchain is concerned with the facilitation of transactions as opposed to an actual product and service. For this reason, the challenge with Islamic finance and blockchain is making sure that the transactions being facilitated are not involved in activities that are considered haram, or forbidden, according to Islamic legal systems. This is where Islamic fintech can play a role, exploring the integration of a review system to ensure the final output of the transaction is completely sharia-compliant. This form of due diligence is already in place for Islamic fintech companies facilitating business to business, business to consumer payments via traditional rails.
In Central Asia, where demand for Islamic fintech in countries like Tajikistan and Uzbekistan are on the rise, there are clear application cases. Cross-border remittance payments can naturally benefit from blockchain. Quicker and cheaper transactions could be facilitated via a blockchain, reducing the need to pay high transfer fees and commissions. What is more, takaful, a co-operative system of reimbursement or repayment which essentially mirrors the concept of insurance, can use blockchain to quickly and accurately process claims.
Unlocking the potential of Islamic finance
Just as we witnessed at the start of the 2010s in advanced economies, I believe we are about to witness a new wave of technological breakthrough linked to Islamic finance. The sector is thriving at pace, and with efforts to make a standardised global framework, fundamental infrastructures are now in place for sustainable growth. Led by open banking and blockchain, we could also be on the brink of what I deem to be an Islamic fintech revolution.
Khofiz Shakhidi is chair of Alif Bank