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Social distancing, resulting from the coronavirus pandemic, is likely to be the catalyst for Islamic banks across many countries to accelerate their digital transformation strategies, especially with financial inclusion being a major issue in many of the countries where Islamic finance is active.
At present, digitalization is the focus of well-established Islamic banks in more digitally advanced and developed Islamic finance countries, like the United Arab Emirates (UAE) and Malaysia. This could widen their competitive advantage against the less agile countries and even against smaller players in the same country, leaving the smaller banks behind who cannot compete on this scale.
A Matter of Ranking
In the World Digital Competitiveness Ranking 2020, issued by the IMD World Competitiveness Centre at the end of September 2020, the UAE maintained the top-ranking among Islamic countries, despite falling from 12th place last year to 14th this year. Malaysia is the second-highest-ranking Islamic country, retained its 26th position with no change.
Among the eight Islamic countries in the 2020 Ranking, Qatar, Saudi Arabia and Turkey improved their positions. Qatar moved up from 31st ranking last year to 30th in 2020. Saudi Arabia moved up by five places to 34th Turkey improved the most, jumping from 52nd last year to 44th this year.
The potential market for Islamic fintech services is vast. There were 1.8 billion Muslims in the world as of 2015 - roughly 24% of the global population - according to estimates from Pew Research Centre. Fintech may already have an embedded edge in helping to balance out the disproportionate inclusion in many member countries of the Organization of Islamic Cooperation (OIC), which is home to an unbanked population of around 70% (based on World Bank Global Findex data).
This could also be supported by the emergence of a growing tech-savvy middle class as well as high mobile and internet penetration rates in many of the countries where Islamic finance is active. The need for more agile and simpler financial services and the shift toward technological and mobile financial services could underpin growth in the industry in the foreseeable future. Innovation is a cornerstone of the development of Islamic finance itself.
As such, fintech has the potential to play a major role in the Islamic finance industry primarily to improve processes and cost-effectiveness, while maintaining Sharia compliance. Furthermore, it would provide Islamic banks with an opportunity to streamline services and attract new segments, with the key being digital-savvy millennials.
Additionally, crowdfunding and P2P financing options create hopes for individuals or SMEs that require financing but do not qualify to obtain financing from traditional Islamic financial institutions.
Sukuk markets can also benefit from market efficiencies brought by FinTech. The expected decrease in costs, time and access to a larger investors pool (like retail investors), through increased usage of technologies. Sukuk market liquidity could also be improved if higher demand for secondary trading can change the largely buy-and-hold Sukuk investors. Takaful is another area where fintech can improve pricing, product offering and distribution channels.
The Islamic finance industry already faces many moving targets, be it standardization, development of Islamic finance regulation and innovating of new products. The application of fintech could also bring with it multiple challenges, the principal one being to comply with Sharia principles. Regulatory limitations and concerns could also hinder the ability of Islamic finance institutions like Islamic banks, Takaful and fintech companies to forge ahead in adopting new models linked to various fintech themes, such as P2P, crowdfunding and big data.
Fintech's Small Player Curse
Furthermore, the application of fintech has its own cost and integration requirements to consider as well. This could push Fintech to the backburner especially for small players, which in time could turn into a significant hindrance to future growth. Accordingly, it will be vital for the industry to carefully identify what aspects of Fintech are most suitable and necessary, prioritize and manage such initiatives, and finalize how to use Fintech to its advantage.
Another major challenge is skill and talent shortage in key technological areas relevant for fintech such as machine learning and data analytics. There is a need for more technology-adept personnel and investment in suitable technology. Banks also need to equip their existing staff with essential technology skills through training initiatives.
This does not take away the other risks that institutions face when considering fintech like regulatory risks, balancing innovation and security, infrastructure capabilities and limitations. Regulators have a significant challenge ahead of them in balancing between ensuring financial stability and consumer protection while promoting innovation and competition.
About the Author
Mr Bashar Al-Natoor is the Global Head of Islamic Finance at Fitch Ratings.