Fintech in Islamic Finance

Theory and Practice

Umar A. Oseni, S. Nazim Ali, Umar A. Oseni, S. Nazim Ali

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781351025560
• Edition: 1
• Topic: Commerce
• Subtopic: Finance

Featuring high-level analysis of Islamic law, this book examines fintech in Islamic finance from both theoretical and empirical perspectives. Whilst building on existing approaches, it also discusses the current application of fintech in promoting financial inclusion through innovative solutions in Muslim-majority countries, identifying future directions for policy-makers.

With original chapters written by prominent academics, senior lawyers and practitioners in the global Islamic finance industry, this book serves as the first standalone pioneering reference work on fintech in Islamic finance. It also, for the first time, examines the position of Islamic law on cryptocurrencies, such as bitcoin. Besides the conceptual analysis of the Shar??ah and legal aspects of fintech in Islamic finance, this book provides relevant case studies showing current and potential developments in the application of fintech in various sectors ranging from crowdfunding and smart contracts, to Online Dispute Resolution, Investment Account Platform and identity verification in the KYC process.

Setting the agenda for researchers in the field, Fintech in Islamic Finance will be useful to students and scholars of Islamic finance and financial technology.

Part I

Introduction

1

Fintech in Islamic finance

Umar A. Oseni and S. Nazim Ali

Just as we were completing the editing of this book, Malaysia introduced a new subsidiary legislation to regulate cryptocurrencies in the country. The news hit global headlines, particularly among the tech communities. The law, Capital Markets and Services (Prescriptions of Securities) (Digital Currency and Digital Token) Order 2019, which regulates all initial coin offerings (ICOs) and cryptocurrencies, came into force on 15 January 2019. It classifies cryptocurrencies and digital tokens or digital assets as securities. Without doubt, cryptocurrencies seem to be the most visible albeit controversial example of fintech. This further justifies the need to clarify the legal, regulatory and Sharī‘ah issues pertaining to such fintech applications.

Fintech is changing our lives for the better through unending technological applications in the finance industry. The daily lives of human beings, and even non-humans, are now tied to technological applications where robots have taken over the roles of financial advisors. While regulators and lawmakers try to catch up with the rapid developments in financial technology, it appears the rapid rate of development in the fintech sector is outpacing regulatory frameworks. This uncertain situation is more complicated in a niche industry such as the Islamic financial services industry, which has additional faith-based filters in its product-development process. This therefore makes a case for the need for thought leadership in relation to this uniquely important subject in order to guide policymakers, regulators, and practitioners on the dynamics of fintech in Islamic finance, and provide a good understanding of the Sharī‘ah and legal and regulatory parameters for fintech solutions.

A quick search of the available books on fintech reveals that one of the earliest publications on this subject was published in 2016. With the exception of a few books on fintech published in earlier years, most leading books on fintech were published in 2016 due to the novelty of the phenomenon.¹ It thus appears the academic response to practical applications in the financial technology industry is not as fast as the emergence of innovative fintech applications in different sectors of the financial industry. This makes a case for the need for deeper studies beyond the discourse of the disruption of the banking sector which has dominated the whole idea of fintech in the past few years.

Fintech should be understood to cover all aspects of the application of technological advancement in delivering, facilitating, or enabling financial services. Therefore, fintech includes blockchain applications and other web-based services utilised in the financial services industry as well as offline-to-online (O2O) and Internet-of-things (IoT) applications. One could simply say the list is endless and such should be the general understanding of fintech rather than confining it to the most prevalent applications such as blockchain technology and cryptocurrencies.

Being a pioneering book in the field of fintech in Islamic finance, this book offers fresh and alternative ideas of fintech applications while addressing some socio-economic, legal and Sharī‘ah issues associated with such applications within the general purview of the Islamic financial services industry. While there has been too much emphasis on crowdfunding, cryptocurrencies and blockchain technology in the general discourse on fintech, this book provides additional areas of application within the transaction spectrum of Islamic financial contracts such as legal documentation, e-commerce and dispute resolution which is at the tail-end of the whole transaction process. For this, the book addresses online dispute resolution (ODR) and its relevance to Islamic financial transactions with specific reference to how such a mechanism could be applied under the existing legal and regulatory framework in Malaysia (Oseni and Omoola 2015).

Just like the conventional fintech landscape, the list of fintech applications or solutions in Islamic finance is endless. In fact, besides areas such as anti-money laundering and anti-terrorism financing and customer due diligence, fintech could also be applied to aspects of Sharī‘ah verification of transactions and robo-Sharī‘ah advisors. These unique aspects, which might not be necessary in the conventional application of fintech, necessitate the need to specifically address fintech from the Islamic finance perspective. This huge vacuum is what this book seeks to fill in its length and breadth.

Fintech in Islamic finance should be generally understood in a broad manner as Islamic financial services transcend mere banking. The Islamic financial services spectrum comprises of Islamic banking, Islamic insurance or takāful, Islamic capital market and Islamic money market. From the transactional perspective, the understanding of fintech in Islamic finance includes all aspects of a typical Islamic financial services transaction starting from the negotiation phase, credit scoring/checking phase, documentation phase, execution phase and up to the post-transaction issues such as managing defaults, addressing disputes and enforcement of contractual terms, judgements of the courts/arbitral tribunals or settlement agreements.

Current trends in fintech application

In an Ernst & Young Report titled Banking in Emerging Markets: GCC Fintech Play 2017, it was revealed that the private sector investment in fintech increased from less than US$3 billion in 2012 to US$19 billion in 2015. This promising and disruptive technological innovation in the financial services sector is being considered as the future of the global financial system. Though the fintech aggressive revolution is said to enhance consumer value proposition in the financial services sector, one would also like to consider whether there is an additional proposition in infusing Sharī‘ah-compliant principles in the disruptive innovations to further enhance the consumer experience of a segment of the financial consumers who are biased towards Sharī‘ah-compliant financial services.

For the purpose of identifying the applicable Sharī‘ah principles, it may be helpful to define fintech in its general sense and identify its different components and applications. Therefore, adopting the Wharton Fintech Club definition, fintech may simply be referred to as “an economic industry composed of companies that use technology to make financial systems more efficient” (McAuley 2014). The Sharī‘ah principles will only apply to each of the components or applications after a careful study of the specific details rather than the generic term “Fintech”. This is why this book does not use the term “Islamic Fintech”, which is becoming popular among Muslim finance professionals. Although, from the branding perspective, “Islamic Fintech” appears to be more appropriate to demonstrate the uniqueness of fintech solutions in Islamic finance, it is preferable to use the terms “Sharī‘ah-compliant Fintech” or simply, “Fintech solutions in Islamic finance”. Giving fintech the “Islamic” label presupposes that it is truly Islamic – a feature which can only be determined upon obtaining a formal Sharī‘ah approval. After all, fintech is merely a means to an end and not the end itself; hence, it should not necessarily carry the full “Islamic” label.

Moreover, there is some sort of confusion in identifying what is and what is not of fintech. While there has been much emphasis on blockchain technology, there are other less complicated applications that may also fall under the general purview of fintech. This is probably why it is difficult to address all operational issues affecting fintech applications. The same thing is true for applicable Sharī‘ah principles. It might be difficult to address all Sharī‘ah issues relating to fintech, as this remains an evolving phenomenon whose components and features have not been exhaustively discussed. However, it is important to agree on what fintech entails through the identification of what it applies to. In this context, one could say fintech includes any technological application to financial services transactions from the negotiation stage through the documentation, execution and closing stages of the transaction, including matters connected to how disputes emanating from such transactions are resolved.

Understanding this book

With the complex fintech ecosystem, which according to a Fintech Report by PwC, has the following key players – financial institutions, tech companies, infrastructure players, start-ups, regulators and government, consumers and users, investors/incubators/accelerators – this emerging field requires close scrutiny, regulation and consideration of applicable legal and Sharī‘ah principles. Emerging technologies and tools have undoubtedly disrupted the traditional financial tools, and, as such, Sharī‘ah scholars ought to be far ahead of such developments. Therefore, in order to address these issues, this book is divided into six distinct but related parts. After this Part I, the next part, Part II focuses on fintech and financial intermediation, while considering the unique opportunity fintech creates for Islamic finance development. Part III sets the Sharī‘ah parameters for fintech, which serves as a valuable guide to innovators and regulators alike. It also clarifies the position of Islamic law on cryptocurrencies such as bitcoin. Part IV examines the legal and regulatory issues in fintech, including the potentials of smart contract in Islamic finance.

Having set the Sharī‘ah and the legal and regulatory framework for fintech solutions in Islamic finance in the previous parts, Part V provides useful case studies on fintech applications in Islamic finance. It also provides potential use cases of fintech applications, which could be taken to the next level. Such significant discussion on case studies, which transforms concepts to real-time applications, will be useful for technopreneurs. Finally, Part VI provides some future directions and impact of fintech in Islamic finance.

Fintech and financial intermediation

Though some studies have raised some concerns on how fintech might potentially exclude a larger segment of the society from financial services, one may conversely argue that with the proliferation and penetration of mobile and internet connectivity across remote societies in developing countries, fintech will better enhance financial inclusion. However, what does fintech have to offer to a vulnerable segment of society which prefers Sharī‘ah-compliant financial services, and is thus self-excluded due to the non-availability of financial services that are in consonance with its religious ideals? This is where the discussion on fintech and its potentials for furthering the goal of Islamic social finance is germane.

It appears the original DNA of fintech, which relies on a group of participants and in some cases big data, is similar to the communal principles in Islam otherwise known as ummah, where social solidarity is paramount. The ability to mobilise funds for a common or communal cause through crowdfunding, which in some cases is more of donation or interest-free loans, presents a new mode of financing that mirrors the traditional Islamic principles of social finance. Therefore, one may ask whether fintech is a natural form of Islamic finance. A further question that may be addressed is whether the emergence of fintech and the increasing adoption of fintech solutions in Islamic financial services presents a unique chance to re-orientate Islamic finance and streamline its value proposition towards social finance.

From the social finance perspective, can fintech promote financial inclusion in Muslim majority countries? While some have argued that fintech will further deepen the surge of financial exclusion, the rate of internet penetration and adoption of mobile technologies in most rural areas in Muslim countries presents a different scenario. Hence, it is believed fintech has the potential of promoting financial inclusion and has some inherent developmental objectives which will help promote the 17 Sustainable Development Goals (SDG) of the United Nations in Muslim-majority countries. It is pertinent to note that fintech in Islamic finance will not only be relevant in ending poverty and hunger, it will also help to improve health and education, make cities more sustainable, combat climate change, and protect oceans and forests. This social dimension to fintech in Islamic finance is important to emphasise the need to come up with Sharī‘ah-compliant solutions which can be funded through Sharī‘ah financing to promote sustainable development (Ansari et al. 2012; Bennett 2015). There are increasing interests in green financing which has seen the issuance of Green Sukuk in Malaysia based on the Malaysian SRI Sukuk Guidelines (Moghul and Safar-Aly 20...