Innovation in Islamic finance

April 2017  |  FEATURE  |  BANKING & FINANCE

Financier Worldwide Magazine

April 2017 Issue

April 2017 Issue


Islamic finance is one of the fastest growing areas of international finance. Finding its basis in the ethical teachings of Islam, it is steadily growing in appeal, thanks in no small part to the scale of the available market. Indeed, there are 1.6 billion Muslims around the world and there is clearly room for continued growth. According to the World Bank, Shariah-compliant financial assets are currently estimated at roughly $2 trillion, covering bank and non-bank financial institutions, capital markets, money markets and insurance.

The mid 1990s saw Islamic finance offer a remarkably limited number of services, predominantly deposit-taking and retail financing schemes. Today, Islamic finance is a fully integrated financial system which spans continents. Much of the expansion is concentrated in emerging markets, particularly those with Muslim majorities. Organisations like the Association of Southeast Asian Nations have played a vital role in helping to bring Islamic finance to the fore. Developed nations have also played their part – London, for example, has become a focal point of Islamic finance activity.

Modernisation of the practice has also been driven, at least in part, by technological advances. Islamic financial institutions, like their non-Islamic counterparts, are now able to offer services to their clientele via digital means. While there has been some pushback from more conventional customers, many of whom would prefer to conduct their business in a traditional brick-and-mortar bank, the digital revolution has continued. New services such as online and mobile banking and payment services are essential. Financial institutions are also responding to the emergence of digital currencies and the blockchain which underpins them.

Improving access to Islamic finance is an important part of the market’s growth. Embracing technological developments will undoubtedly help Islamic finance to fulfil its potential and grant the scale, access and outreach it needs to connect with would-be customers in developing markets.

Islamic finance is increasingly considered as an alternative source of funds for many companies, particularly as the industry embraces FinTech. It is also receptive to asset financing.

Geopolitical challenges

However, while Islamic finance has become increasingly influential over the last few years, it has remained in a somewhat delicate position. As Tarek El-Assra, a partner at Morgan, Lewis & Bockius LLP, explains, the Islamic finance industry has been at the mercy of a number of geopolitical challenges which have reigned-in the industry’s progress. “The Islamic finance market has been slowly paced over the last two years, with factors such as a decline in oil prices and the Arab Spring having an effect on investor confidence and market liquidity. Spending cuts in the Middle-East have resulted in lower economic growth and lower credit demand, meaning that the cost of funding for banks has increased,” he says.

But it is not all bad news. “The fact remains that Islamic finance continued to grow last year and this stabilised growth will continue in 2017,” says Adil Hussain, a partner at Clyde & Co. “Such growth will be fuelled in particular by new markets opening up, demand from new customers looking to tap into Islamic liquidity and the impact of regulatory and technological developments.”

By offering ethical, non-haram forms of finance to its almost 2 billion strong marketplace, Islamic finance has become a genuine force in the financial services industry.

Digital technology is changing the financial services landscape. As customers continue to seek faster and more personalised services from banks, robotics and automation have emerged as viable tools. Robo-advice, for example, can be both cost and time effective. “The Islamic finance market is embracing both fintech and robo-advisors as it continues its growth into 2017,” says Imam Qazi, a partner at Foot Anstey LLP. “Islamic finance institutions are embracing robo-advisory methods through access to Shariah-compliant portfolio management using fully automated real-time software to analyse thousands of global securities and pinpoint those with the highest growth potential.”

An example of a robo-advisory firm in the Islamic finance market is Wahed Invest Inc. Wahed analyses thousands of halal securities worldwide in order to create portfolio allocations with the highest growth potential for its clients. There is also a large non-Muslim market of potential clients who may be interested in ethical investing, which Wahed and other similar ethical investment platforms may be able to tap into,” says Nilish Chadha, co-founder of Wahed. “We believe that this is the future of the wealth management and ethical finance industry. We have developed our technology to combine Wall Street-level portfolio management with socially responsible track records and investment principles, to create a new niche in the industry of ethical finance,” he says.

Aside from FinTech, other Islamic microfinance models have had a larger impact over the last couple of years. Platforms such as Micro-Takaful and social finance have gained traction. According to Mr El-Assra, the number of Islamic microfinance institutions is expected to reach up to 400 in 2017. There is a burgeoning demand from Muslim countries for FinTech products and services – and these companies are responding. They are introducing new Shariah-compliant financial products designed to help Islamic banks become more efficient when dealing with complex transactions.

Shariah-compliant platforms

In other jurisdictions, such as Malaysia, cross-border multicurrency channels have been designed to link regional and global economies, such as the recently launched Investment Account Platform (IAP). The IAP is a Shariah-compliant investment platform which will help reposition Islamic banks as investment intermediaries rather than just credit providers. The plan, drawn up by six Malaysian banks, will see the IAP act as a marketplace for SMEs looking for funding. Businesses will be vetted by the banks, and there will also be a secondary market for investors. This secondary market has attracted comparisons to peer-to-peer lending and crowdfunding, providing investors with direct access to the businesses which interest them. A similar project – Bursa Suq Al-Sila in Malaysia – has seen been active since 2009 and demonstrates the appetite for this kind of banking.

Other FinTech platforms are also adding Shariah compliance to complement their core markets. In Janaury, Canadian FinTech company Goldmoney certified its gold-based financial products Shariah-compliant, strengthening the firm’s standing in the Middle East and Southeast Asia.

Though some FinTech companies have made strong advances, there are still hurdles to overcome, particularly in areas such as education, marketing and achieving Shariah certification. BI Intelligence, in a recent report, suggested that FinTechs should partner with a legacy Islamic finance institution in order to get up to speed. P2P lending and robo-advice platforms are well positioned to benefit from FinTech’s burgeoning relationship with Islamic finance and Shariah compliance.

Asset finance

Innovation in Islamic banking is not just limited to technological progress, however; asset financing is also playing an important role. The International Monetary Fund noted in 2015 that Islamic finance assets had seen double digit growth between 2003 and 2013, from $200bn to around $1.8 trillion. “It is clear that Islamic finance is in many ways ideally suited to asset finance. As a result of this, and with less conventional liquidity available, over the last few years we have seen major growth in this area,” says Mr El-Assra. “Examples of this include the multi-billion dollar Shariah-compliant aircraft leasing fund managed by the International Airfinance Corporation, which is the first Shariah-compliant aircraft leasing fund. We have also seen a number of airlines entering the Islamic finance market and many of the world’s leading airlines, including Emirates, Etihad Airlines and Saudi Arabian Airlines, have issued sukuk to raise funds via the debt capital markets, generally for the purpose of funding the acquisition or leasing of new aircraft.”

Future

Many legacy financial institutions have failed to evolve with the times and are trailing newer, more disruptive market entrants. Islamic finance is no different. But arguably, given the speed at which it has developed in recent decades, it might be better placed than other tranches of the global financial services market to take advantage of FinTech. FinTech is ideally suited to achieving Shariah compliance and will continue to prosper along with Islamic finance.

The future of Islamic finance looks positive, particularly as it opens up new markets and industries. “There is plenty to be excited about,” says Mr Hussein. “A number of African countries are are expected to issue sovereign sukuks this year and we can expect further legal and regulatory changes being introduced by them to facilitate their issuances. There are likely to be new and innovative Islamic products coming to the market in the crowdfunding and FinTech space.”

Islamic real estate investment trusts (REITs) have also become more popular over the last decade. Following the launch of the first Islamic REIT by the United Arab Emirates in 2010, fellow GCC country Bahrain also launched its first REIT. Southeast Asia is also a hotbed of activity. “Malaysia took the initiative of issuing the Islamic REIT guidelines and since then the promotion and development of Islamic finance by the Malaysian authorities has been exemplary,” notes Mr Qazi . “The Al-Aqar KPJ REIT, with seven hospitals within the KPJ Healthcare group as its main asset, was the first Islamic REIT to be established worldwide. The success of Islamic REITs in Malaysia and Singapore give weight to the assertion that Islamic REITs have strong prospects to be launched in global markets as an alternative real estate investment product.”

By offering ethical, non-haram forms of finance to its almost 2 billion strong marketplace, Islamic finance has become a genuine force in the financial services industry. While it is still some way away from appealing to a mass market outside of traditional Muslim countries, its ethically sourced products may gain favour with non-Muslims. And as FinTech services continue to complement the Islamic finance model, we may see growth accelerate.

Clearly, financial inequality is not a new phenomenon; however, there is a perception that the gap between the ‘haves’ and the ‘have nots’ is widening. Given that almost half of the world’s wealth is now owned by just 1 percent of the population and the richest 10 percent hold 86 percent, it is clear that economic growth and development has not benefitted everyone equally. For some, including those in the World Bank and the Islamic Development Bank Group, Islamic finance can play a role in balancing wealth inequality and ending extreme poverty by promoting greater financial inclusion and promoting the use of financial institutions. Current estimates suggest that of the 1.6 billion Muslims in the world, only 14 percent use banks. Many are unable or unwilling to engage with conventional interest-based financial institutions due to religious convictions, educational difficulties or geographical problems. Islamic finance can, and must, overcome these issues if it is to reach its transformative potential.

Thanks to the nascent appeal of FinTech, the Islamic finance model will continue to go from strength to strength. Though some analysts may assert that Islamic finance has already entered the financial services mainstream, there is still a lot of work to be done.

© Financier Worldwide


BY

Richard Summerfield


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