The Islamic finance industry reached a value of around $2 trillion in 2015, including banking assets, Islamic funds’ assets, and other Islamic financial instruments, according to the Islamic Financial Services Board. This was up a very modest 1% from 2014, but the industry is predicted to grow at a CAGR of 15%, to reach $3 trillion by 2018. That faster growth will be due in part to fintech making the creation of Sharia-compliant products cheaper and easier, while also facilitating access to the booming Islamic markets in Sub-Saharan Africa and Asia.
Islamic financial instruments must be certified Sharia-compliant before they can be deemed halal, or permissible. This means the large majority of Muslims cannot use conventional financial instruments to manage their money. Meanwhile, Islam is the fastest-growing world religion, with the global Muslim population expanding in particular in developing nations across Africa and the Asia-Pacific region.
This is creating significant demand for Sharia-compliant financial services products — but legacy financial institutions haven’t kept up.
For many Muslims, their religious practice requires they use Sharia-compliant financial products. These are products that are approved by Islamic scholars and meet certain requirements like not offering interest or involving any risk. Investments must be made in firms that meet strict financial criteria, and are not involved in certain trades such as alcohol or arms.
The Islamic finance industry reached a value of around $2 trillion in 2015, including banking assets, Islamic funds’ assets, and other Islamic financial instruments, according to the Islamic Financial Services Board. And the industry is predicted to grow at a compound annual growth rate (CAGR) of 15% to reach $3 trillion by 2018. Meanwhile, Islam is the fastest-growing world religion, with the global Muslim population expanding in particular in developing nations across Africa and the Asia-Pacific region.
The legacy Islamic finance industry hasn’t kept up with demand. This is partly due to the complex nature of Sharia-compliant products and the opacity of the Islamic finance market. In addition, the industry has been held back by conflicting schools of thought among scholars as to what constitutes Sharia compliance, as well as a lack of competition that has left legacy players unmotivated to innovate.
This is creating a huge opportunity for fintech. Some fintech concepts such as robo-advisory, marketplace lending, and P2P insurance are well suited to serve the Islamic finance market with little alteration. Fintechs are also more agile than legacy players, enabling them to bring products to market faster. And many automate typically manual processes, which reduces cost and removes the need for expensive physical infrastructure.
Fintechs are well positioned to take advantage of broader technological changes. In developed markets, fintechs can capitalize on growing smartphone penetration and the ability of technology to reduce the cost and complexity of creating Sharia-compliant products. Meanwhile, booming mobile phone penetration and the growth of mobile money services in developing nations is providing fintechs with a wider potential market that is welcoming of mobile financial products.
And governments in Islamic states are getting on board. Both Abu Dhabi and Dubai are encouraging fintechs from abroad to relocate to their regions by extending generous tax benefits to startups. And Abu Dhabi has created a sandbox for the exploration of innovative financial services under lenient regulatory conditions. In addition, the central bank of Malaysia has launched its own sandbox and vowed to review the country’s regulatory framework to assess risks and opportunities presented by fintech.
But fintechs looking to enter the Islamic finance market will have to overcome significant hurdles. These include getting certified by a qualified Sharia board, which can be expensive, as well as gaining acceptance from a population that is already cautious about financial products. They also face the challenge of understanding the differences in what constitutes compliance between different Islamic schools of thought and how that might impact their ability to scale.
Fintechs will likely need to partner with a legacy Islamic financial institution. Partnering can help fintechs clear key hurdles like compliance and consumer education, and by allying with an established firm, they can take advantage of their partner’s superior expertise in the Islamic finance industry. This will help fintechs spread understanding of their products, and ultimately drive adoption.
There are several ways that fintechs attempting to enter the Islamic finance market can maximize their chances of success.
Creating products for developed markets. The greatest opportunity for fintechs in Islamic finance likely lies in developed markets — at least for now. Muslim consumers in these regions are typically more exposed to conventional finance, and therefore more aware of the full range of financial services products that exist. They may also be more exposed to fintech, which suggests firms would have less of a hurdle to overcome when it comes to conveying the benefits of fintech products. In addition, these consumers would likely have greater access to educational materials regarding what is acceptable under Sharia law, and an increased propensity to own smartphones.
Launching in states that actively encourage fintech. Governmental support has been hugely beneficial in helping fintechs establish their businesses and raise consumer awareness of their products in countries such as the UK. So it makes sense that fintechs looking to enter the Islamic finance market should begin in states such as the UAE and Malaysia, which are actively encouraging the development of fintech industries. Once fintechs have been established in these supportive markets, they can look to expand elsewhere.
Partnering with a legacy Islamic financial institution. Partnership is perhaps the single greatest strategy for fintechs in Islamic finance right now. Fewer Islamic legacy institutions have existing solutions such a robo-advisors and online lending platforms than conventional firms, which means fintechs that can work alongside incumbents may find greater demand for their products. Partnering can also help fintechs clear key hurdles like compliance and consumer education, and by allying with an established firm, they can take advantage of their partner’s superior expertise in the Islamic finance industry.