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Sunday, October 11, 2020 /06:00 AM / Fitch Ratings/ Header
Image Credit: Fitch Ratings
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.
Funded Hope
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.
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