Developing Islamic Fintech Solutions to Reach the Next Generation of Muslims

Melanie Noronha, senior editor for The Economist Intelligence Unit's (The EIU) thought leadership division in EMEA, writes, "Advanced technologies, from blockchain to artificial intelligence, are transforming financial services. Islamic finance is no different. Sharia-compliant fintechs are popping up in Islamic and non-Islamic nations alike, promising to win over millions of young Muslims and extend financial services to the underbanked. Against the backdrop of the coronavirus pandemic, Islamic fintech is ever more important."

Islamic fintech: Reaching the next generation of Muslims is the second paper in a series by The EIU on "Innovation in the Islamic Economy." (A blog post about Ms. Noronha's first paper may be read here.) Supported by the Dubai Islamic Economy Development Center, Ms. Noronha notes: "Muslims make up about a quarter of the world's population and are said to be the fastest growing religious cohort. As such, the potential market for Islamic financial services is enormous. The median age for Muslims globally is just 24 years old, making a majority of them 'digital natives' ready for digital Islamic financial solutions."

"Islamic fintech marries sharia compliance with digitally-delivered financial solutions," Ms. Noronha explains. "This makes it easier for Muslims to access savings, investments, insurance and mortgages that are in line with the principles of their faith."

What is more, "Businesses offering Islamic investment solutions digitally must deliver on two fronts: compliance and access.

"To ensure compliance with sharia law, fintechs have to navigate an intricate set of rules. Interest charges, or riba, are prohibited. So too are investments in 'sin stocks' of businesses profiting from alcohol, arms, tobacco and gambling. The rules also prohibit profiting from debt and require investments to be backed by real assets. This has led to the creation of sukuk—sharia-compliant financial certificates, similar to bonds, which give an investor part-ownership of an underlying asset. ... There are also detailed investment criteria surrounding a company's leverage and interest income."

As for access to Islamic fintech, "selecting the right technologies is key. Fintechs are deploying a growing array of halal payment platforms, e-wallets, insurtech and remittance services through mobile phone apps. New digital Islamic banks such as the UK's Niyah and Germany's Insha are offering interest-free products through similar channels," notes Ms. Noronha.

She adds that "[b]eyond product delivery, technologies used by fintech firms promise to bolster Islamic finance by driving efficiencies and reducing costs. In turn this could cut costs of payment services and transactions says Mohamed Damak, global head of Islamic finance at ratings agency S&P Global Ratings. Technologies such as artificial intelligence might also help to improve compliance."

For example, "Blockchain, if deployed at scale, has the potential to reduce the risk of fraudulent transactions according to Mr Damak. Emirates Islamic Bank is already using the technology to authenticate paper checks in the United Arab Emirates."

Blockchain, which is loosely defined as a distributed ledger, or database, shared across a public or private computing network, could have an important use in Islamic finance:

To address high costs and a lack of transparency within the sukuk market, "blockchain could literally be the missing link" according to Mr Damak of S&P Global Ratings.

He expects blockchain technologies will open the market to smaller companies by cutting the cost of issuing a sukuk. In 2019 an Indonesian microfinance institution, BMT Bina Ummah, used a platform created by startup company Blossom Finance to raise US$50,000 in what it claimed to be the first blockchain sukuk.

With respect to transparency, Mr Damak explains: "At present an issuer can substitute one underlying asset with another without informing investors, even though it can completely change the risk profile of the transaction. Blockchain will resolve that by documenting every change." In addition, in instances where there are dozens of assets underlying a single certificate, he predicts that the technology will show investors in real time which ones are underperforming.

Looking into the future, Ms. Noronha encouragingly says: "Deploying sharia-compliant financial solutions through digital channels could drive the next wave of growth for Islamic finance. Islamic fintech is poised to deliver financial services sought by a young, middle-class Muslim community that has largely been ignored as well as those seeking ethical financial solutions at the speed and cost of modern finance."

Which sharia-compliant financial solutions do you think will be of value to a growing young, middle-class Muslim community?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of Solutions for a Sustainable World.

The Use of Green Sukuk Grows to Support Environmental Projects

"If the world is to avoid catastrophic climate change, trillions of dollars of sustainable investments will need to be made every year between now and 2050," writes Melanie Noronha, senior editor for The Economist Intelligence Unit's (The EIU) thought leadership division in EMEA. "Much will have to come from capital markets where investors have already demonstrated an appetite for 'green bonds' which tie the proceeds to environmental projects. There are hopes that sukuk—a sharia-compliant financial instrument similar to a bond—could also be channeled towards environmental investments."

Supported by the Dubai Islamic Economy Development Center, Ms. Noronha's article, "A new shade of green: Sukuk for sustainability," is the first in a series by The EIU on "Innovation in the Islamic Economy." According to the article, "The first shoots of a similar 'green' instrument in the Islamic finance sector emerged not too long ago. In 2017, renewable energy group Tadau Energy issued the first 'green' sukuk, raising US$59m to finance a solar power plant in Malaysia, the birthplace of conventional sukuk in the 1990s. Indonesia issued sovereign green sukuk worth US$1.25bn in 2018 and US$750m in 2019 to fund environment-related projects."

Moreover, "There is activity in the Arabian Gulf countries as well. In 2019 Majid Al Futtaim, a UAE-based retail company, raised US$600m with the region's first corporate green sukuk. This was followed by a €1bn (US$1.12bn) green sukuk by Saudi-based Islamic Development Bank to finance renewable energy, green transportation and pollution control in its member countries."

Ms. Noronha explains that "[c]ompared to conventional sukuk, the market for green sukuk is tiny. Conventional sukuk issuance totaled US$162bn in 2019, while the total outstanding debt for green sukuk amounts to only US$7.9bn..." She adds that "some view it as a natural solution for low-carbon investment. Islamic finance is based on assumptions of fairness and social responsibility, and—while it has not always been observed—environmental stewardship is intrinsic to sharia principles."

What is more, "Since sharia forbids the receipt of interest, sukuk are backed by assets and investors are paid an agreed share of the profits before being returned the principal at maturity. This structure gives them confidence that their capital is being used for a particular purpose."

As a way to combat the effects of climate change, I am witnessing a rise of business and investment opportunities in Africa, Asia, and the Middle East in the automotive (electric vehicles) and renewable energy (wind, solar, and biogas) sectors. Recognizing an increasing interest among investors to support environmental, social and governance initiatives (ESG), I concur that "[t]he combination of investors seeking sharia-compliant investments and those with ... ESG priorities provides a wide investor base for green sukuk."

What instruments are you seeing used to support sustainable investments?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of Solutions for a Sustainable World.