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DIGITAL ECONOMY & TECHNOLOGY

Fintech and the Rise of Islamic Finance

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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.


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DIGITAL ECONOMY & TECHNOLOGY

The Digital Currency that could Upend how the Gulf Trades

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By Shruthi Nair

Project mBridge – a China-led central bank digital currency initiative, which the UAE and Saudi Arabia are part of – could have “broad strategic implications” for regional trade, according to market analysts.

A CBDC is a digital form of a country’s fiat currency, which is backed by a government. It eliminates the need for intermediaries like banks, or even other currencies such as the US dollar, to facilitate real-time, peer-to-peer, cross-border payments.

“When we look at international trade, not much has changed over the decades. It is a primitive method in the digital age,” Arun Leslie John, chief market analyst at Century Financial, said.

China’s global digital yuan transactions amounted to 7 trillion yuan ($986 billion) in the first six months of this year. The UAE’s inaugural cross-border payment utilising the digital dirham amounted to AED50 million ($13.6 million).

Considering the UAE and China are major trading partners with the total volume of bilateral trade between the two countries reaching $95 billion last year, project mBridge would significantly reduce and replace the use of dollars in this case.  However, analysts believe that it might be too early to conclude whether CBDCs could result in global de-dollarisation.

“Dollar is the choice of transaction for global trade. The US has the deepest capital, debt and equity market. Many countries around the world would want to diversify away from the dollar but they aren’t able to do so,” John said.

While Europe does not have deep debt markets, the Chinese government has capital controls over the yuan. So the only remaining choice is the dollar.

Countries such as Russia and Iran that are facing sanctions stand to be beneficiaries of CBDCs and initiatives like mBridge too. While the Russian central bank announced plans to launch its CBDC next year, the central bank of Iran said that its digital rial will be used for retail transactions, including purchasing goods and services.

“In the current international payment structure, countries can arbitrarily kick out one country from the system. This reduces strategic autonomy and political power of other countries involved,” John said.

To find out how CBDC’s work and its retail use cases, click to watch the video above


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DIGITAL ECONOMY & TECHNOLOGY

How Blockchain can Enhance Islamic Finance by Overcoming Barriers

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Blockchain technology is making waves in the financial sector with its promise of transparency and immutability. These features align closely with the principles of Shariah law, which governs Islamic finance, creating significant opportunities for blockchain to overcome barriers and unlock growth. The Islamic finance sector is projected to reach approximately $6.7 trillion in assets by 2027, as noted in LSEG’s Islamic Finance Development Report. In this evolving landscape, blockchain technology is emerging as a crucial tool for addressing the unique challenges faced by Islamic finance.

Islamic finance operates under Shariah law, which prohibits practices such as interest (Riba), excessive uncertainty (Gharar), and speculative transactions (Maysir). Blockchain technology’s core attributes—transparency and decentralization—are well-suited to address these constraints. Blockchain can effectively enhance compliance with Shariah principles by providing a tamper-proof ledger and facilitating decentralized transactions. Its ability to create a permanent, verifiable record of transactions aligns well with the Islamic finance requirement for clarity and accountability.

According to Moody’s, innovations like smart contracts are poised to improve Islamic finance transactions significantly. Smart contracts are self-executing contracts with terms written directly into code. They automatically enforce Shariah-compliant rules, reducing human error and enhancing transparency. These advancements support real-time settlements, which align with Islamic finance principles of fairness and clarity. By using blockchain to overcome barriers related to transparency and automation, financial processes can become more efficient and compliant with Shariah.

Enhancing Transparency and Efficiency

One of the most significant ways blockchain can overcome barriers in Islamic finance is through its ability to enhance transparency. The immutable nature of blockchain ensures that every transaction is recorded in a tamper-proof ledger, providing a clear and verifiable record of all financial activities. This transparency is crucial for maintaining compliance with Shariah principles, which demand a high level of clarity and accountability in financial transactions.

Blockchain technology facilitates smart contracts that automate the execution of Shariah-compliant financial agreements. This not only streamlines processes but also reduces the need for intermediaries, lowering transaction costs and increasing the speed and accuracy of financial transactions. By addressing long-standing challenges in Islamic finance, blockchain technology is helping to create a more efficient and reliable financial system.

Modernizing Charitable Giving

Blockchain technology also holds promise for modernizing Zakat, the obligatory charitable giving in Islam. Traditionally, the collection and distribution of Zakat have faced challenges related to efficiency and transparency. Blockchain can address these issues by providing a more transparent and efficient platform for managing charitable contributions.

With blockchain, Zakat collection and distribution can be streamlined, ensuring accurate tracking of funds and effective distribution to eligible recipients. This technology allows donors to see exactly how their contributions are used, enhancing trust and accountability. Additionally, blockchain can facilitate the creation of smart contracts to automate the distribution of Zakat, ensuring compliance with Shariah guidelines and reaching those in need more efficiently.

Addressing Challenges and Compatibility Issues

Despite its potential, the integration of blockchain into Islamic finance comes with its own set of challenges. The compatibility of digital assets, including cryptocurrencies and tokenized assets, with Shariah principles, is a topic of ongoing debate. Concerns about speculation and anonymity associated with these assets pose significant challenges, as they contrast with the Islamic finance emphasis on transparency, accountability, and ethical conduct.

Digital assets, particularly unbacked cryptocurrencies, have sparked discussions about their suitability for Islamic finance. The potential for speculation and the lack of intrinsic value associated with some digital assets diverge from Islamic finance principles that prioritize stability and ethical behavior. As a result, Shariah scholars and financial institutions are actively evaluating the compatibility of these assets with Islamic financial principles.

A promising alternative is Central Bank Digital Currencies (CBDCs), which align with Shariah principles by emphasizing transparency, fairness, and social welfare. CBDCs offer a way to digitize national currencies, providing a more efficient and accessible payment system while maintaining compliance with Islamic financial principles. This approach could address some of the concerns associated with speculative digital assets and provide a stable alternative for Islamic finance.

Islamic Finance Innovation in the UAE

The UAE serves as a notable example of how blockchain can be integrated into Islamic finance effectively. With a well-regulated Islamic finance sector, the UAE is at the forefront of digital assets innovation. The country’s regulatory framework for digital assets is overseen by key federal bodies, including the Securities and Commodities Authority (SCA) and the UAE Central Bank. While the SCA focuses on securities-related matters, the Central Bank regulates digital currencies and stored value.

The UAE also has three additional jurisdictions for digital assets regulation: the Dubai International Financial Center (DIFC), regulated by the Dubai Financial Services Authority (DFSA); the Abu Dhabi Global Market (ADGM), regulated by the Financial Services Regulatory Authority (FSRA); and the Virtual Assets Regulatory Authority (VARA). Each jurisdiction approaches digital assets regulation with a unique focus, contributing to the dynamic regulatory landscape in the UAE.

The UAE’s proactive stance on digital assets regulation and innovation underscores its commitment to leveraging blockchain technology to enhance its Islamic finance sector. The country’s regulatory framework continues to evolve, aligning with international trends and addressing emerging challenges.

Strategic Integration and Collaboration

For Islamic finance institutions to fully capitalize on blockchain technology, comprehensive adoption strategies are essential. These strategies should include technology integration, Shariah compliance, regulatory adherence, risk management, and customer education. Collaboration with Shariah scholars and experts will be vital to ensure that blockchain initiatives and digital asset offerings align with Islamic ethical and legal principles.

Many Islamic banks and financial institutions are exploring blockchain technology to streamline their operations. However, they face challenges related to regulatory compliance and interoperability with existing legacy systems. To overcome these obstacles, institutions are seeking solutions to integrate blockchain effectively while ensuring alignment with regulatory requirements and Shariah principles.

In conclusion, blockchain technology holds significant promise for overcoming barriers and unlocking growth in Islamic finance. By enhancing transparency, efficiency, and compliance with Shariah principles, blockchain can address the unique challenges of Islamic finance. As the technology continues to evolve, its integration into Islamic financial practices will likely become increasingly sophisticated, driving further innovation and growth in the sector. The potential of blockchain to transform Islamic finance underscores the need for ongoing collaboration, research, and strategic planning to fully realize its benefits.


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DIGITAL ECONOMY & TECHNOLOGY

How Blockchain Can Enhance Islamic Finance by Overcoming Barriers

Published

on

By

Spread the love

Blockchain technology is making waves in the financial sector with its promise of transparency and immutability. These features align closely with the principles of Shariah law, which governs Islamic finance, creating significant opportunities for blockchain to overcome barriers and unlock growth. The Islamic finance sector is projected to reach approximately $6.7 trillion in assets by 2027, as noted in LSEG’s Islamic Finance Development Report. In this evolving landscape, blockchain technology is emerging as a crucial tool for addressing the unique challenges faced by Islamic finance.

Islamic finance operates under Shariah law, which prohibits practices such as interest (Riba), excessive uncertainty (Gharar), and speculative transactions (Maysir). Blockchain technology’s core attributes—transparency and decentralization—are well-suited to address these constraints. Blockchain can effectively enhance compliance with Shariah principles by providing a tamper-proof ledger and facilitating decentralized transactions. Its ability to create a permanent, verifiable record of transactions aligns well with the Islamic finance requirement for clarity and accountability.

According to Moody’s, innovations like smart contracts are poised to improve Islamic finance transactions significantly. Smart contracts are self-executing contracts with terms written directly into code. They automatically enforce Shariah-compliant rules, reducing human error and enhancing transparency. These advancements support real-time settlements, which align with Islamic finance principles of fairness and clarity. By using blockchain to overcome barriers related to transparency and automation, financial processes can become more efficient and compliant with Shariah.

Enhancing Transparency and Efficiency

One of the most significant ways blockchain can overcome barriers in Islamic finance is through its ability to enhance transparency. The immutable nature of blockchain ensures that every transaction is recorded in a tamper-proof ledger, providing a clear and verifiable record of all financial activities. This transparency is crucial for maintaining compliance with Shariah principles, which demand a high level of clarity and accountability in financial transactions.

Blockchain technology facilitates smart contracts that automate the execution of Shariah-compliant financial agreements. This not only streamlines processes but also reduces the need for intermediaries, lowering transaction costs and increasing the speed and accuracy of financial transactions. By addressing long-standing challenges in Islamic finance, blockchain technology is helping to create a more efficient and reliable financial system.

Modernizing Charitable Giving

Blockchain technology also holds promise for modernizing Zakat, the obligatory charitable giving in Islam. Traditionally, the collection and distribution of Zakat have faced challenges related to efficiency and transparency. Blockchain can address these issues by providing a more transparent and efficient platform for managing charitable contributions.

With blockchain, Zakat collection and distribution can be streamlined, ensuring accurate tracking of funds and effective distribution to eligible recipients. This technology allows donors to see exactly how their contributions are used, enhancing trust and accountability. Additionally, blockchain can facilitate the creation of smart contracts to automate the distribution of Zakat, ensuring compliance with Shariah guidelines and reaching those in need more efficiently.

Addressing Challenges and Compatibility Issues

Despite its potential, the integration of blockchain into Islamic finance comes with its own set of challenges. The compatibility of digital assets, including cryptocurrencies and tokenized assets, with Shariah principles, is a topic of ongoing debate. Concerns about speculation and anonymity associated with these assets pose significant challenges, as they contrast with the Islamic finance emphasis on transparency, accountability, and ethical conduct.

Digital assets, particularly unbacked cryptocurrencies, have sparked discussions about their suitability for Islamic finance. The potential for speculation and the lack of intrinsic value associated with some digital assets diverge from Islamic finance principles that prioritize stability and ethical behavior. As a result, Shariah scholars and financial institutions are actively evaluating the compatibility of these assets with Islamic financial principles.

A promising alternative is Central Bank Digital Currencies (CBDCs), which align with Shariah principles by emphasizing transparency, fairness, and social welfare. CBDCs offer a way to digitize national currencies, providing a more efficient and accessible payment system while maintaining compliance with Islamic financial principles. This approach could address some of the concerns associated with speculative digital assets and provide a stable alternative for Islamic finance.

Islamic Finance Innovation in the UAE

The UAE serves as a notable example of how blockchain can be integrated into Islamic finance effectively. With a well-regulated Islamic finance sector, the UAE is at the forefront of digital assets innovation. The country’s regulatory framework for digital assets is overseen by key federal bodies, including the Securities and Commodities Authority (SCA) and the UAE Central Bank. While the SCA focuses on securities-related matters, the Central Bank regulates digital currencies and stored value.

The UAE also has three additional jurisdictions for digital assets regulation: the Dubai International Financial Center (DIFC), regulated by the Dubai Financial Services Authority (DFSA); the Abu Dhabi Global Market (ADGM), regulated by the Financial Services Regulatory Authority (FSRA); and the Virtual Assets Regulatory Authority (VARA). Each jurisdiction approaches digital assets regulation with a unique focus, contributing to the dynamic regulatory landscape in the UAE.

The UAE’s proactive stance on digital assets regulation and innovation underscores its commitment to leveraging blockchain technology to enhance its Islamic finance sector. The country’s regulatory framework continues to evolve, aligning with international trends and addressing emerging challenges.

Strategic Integration and Collaboration

For Islamic finance institutions to fully capitalize on blockchain technology, comprehensive adoption strategies are essential. These strategies should include technology integration, Shariah compliance, regulatory adherence, risk management, and customer education. Collaboration with Shariah scholars and experts will be vital to ensure that blockchain initiatives and digital asset offerings align with Islamic ethical and legal principles.

Many Islamic banks and financial institutions are exploring blockchain technology to streamline their operations. However, they face challenges related to regulatory compliance and interoperability with existing legacy systems. To overcome these obstacles, institutions are seeking solutions to integrate blockchain effectively while ensuring alignment with regulatory requirements and Shariah principles.

In conclusion, blockchain technology holds significant promise for overcoming barriers and unlocking growth in Islamic finance. By enhancing transparency, efficiency, and compliance with Shariah principles, blockchain can address the unique challenges of Islamic finance. As the technology continues to evolve, its integration into Islamic financial practices will likely become increasingly sophisticated, driving further innovation and growth in the sector. The potential of blockchain to transform Islamic finance underscores the need for ongoing collaboration, research, and strategic planning to fully realize its benefits.


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