Artificial Intelligence and Islamic Finance

Practical Applications for Financial Risk Management

Adel M. Sarea, Ahmed H. Elsayed, Saeed A. Bin-Nashwan, Adel M. Sarea, Ahmed H. Elsayed, Saeed A. Bin-Nashwan

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000528121
• Edition: 1
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

This book provides a systematic overview of the current trends in research relating to the use of artificial intelligence in Islamic financial institutions (IFIs), across all organization of Islamic cooperation (OIC) countries.

Artificial Intelligence and Islamic Finance discusses current and potential applications of artificial intelligence (AI) for risk management in Islamic finance. It covers various techniques of risk management, encompassing asset and liability management risk, credit, market, operational, liquidity risk, as well as regulatory and Shariah risk compliance within the financial industry. The authors highlight AI's ability to combat financial crime such as monitoring trader recklessness, anti-fraud and anti-money laundering, and assert that the capacity of machine learning (ML) to examine large amounts of data allows for greater granular and profound analyses across a variety of Islamic financial products and services. The book concludes with practical limitations around data management policies, transparency, and lack of necessary skill sets within financial institutions. By adopting new methodological approaches steeped in an Islamic economic framework (e.g., analysing FinTech in the context of Shariah principles and Islamic values), it devises practical solutions and generates insightful knowledge, helping readers to understand and explore the role of technological enablers in the Islamic finance industry, such as RegTech and artificial intelligence, in providing better and Shariah-compliant services to customers through digital platforms.

The book will attract a wide readership spanning Shariah scholars, academicians, and researchers as well as Islamic financial practitioners and policy makers.

1 Introduction

Adel Sarea, Ahmed Elsayed, and Saeed Bin-Nashwan

DOI: 10.4324/9781003171638-1

Artificial intelligence has given rise to new foundations for research within the interdisciplinary universe of the Fourth Industrial Revolution (Industry 4.0). Over the last decade, AI has attracted the attention of researchers, practitioners, and policymakers in an attempt to see how technological advances can support financial services in particular, FinTech, Blockchain, RegTech and Internet of Things (IoT) in the Islamic finance industry. AI in Islamic finance is the digitization that has significantly influenced the Islamic financial services, with financial products being the major financial developed area, e.g., credit contracts, stock trading contracts, online payment contracts, and payment transaction contracts through different modes of Islamic finance such as Murabaha contract, Musawamah contract, etc. considering all contracts under Shari’ah principles.

Artificial intelligence is useful in Islamic finance industry due to the development of information technologies for automating processes, such that with new business models that automate financial services are underpinned by information technology. Therefore, the AI idea will lead to evolution. More recently, several examples have emerged in this regard, such as online Islamic banking, Islamic insurance (e-Takaful), charity sector, endowment (e-Waqf), Islamic levy (e-Zakat), and other Islamic financial institutions across Muslim and non-Muslim countries.

This book highlights the current trends of technological advances and adoptions in the Islamic finance industry. The interest in this subject, AI and Islamic finance, is continuously growing due to its importance in this era of digitalization. However, the application of AI in Islamic finance and the book content is highly important and relevant across all business sectors, due to the increasing scope of AI in Islamic business and finance that is linked to Sharī’ah principles and compliance.

The contributors have highlighted several key issues in 15 chapters related to AI and Islamic finance as follows:

The first chapter is an introductory chapter dealing with a brief introduction of artificial intelligence and its relationship with the Islamic finance and banking industry.

In chapter 2, “Understanding Governance Compliance for RegTech”, this chapter highlights the potential governance regulatory issues related to the Financial Technological (Fintech) firms. After the public listing of FinTech firms, a proper regulatory framework of corporate governance is essential for FinTech firms to enhance the shareholders’ value and protect the stakeholders’ interests. Regulatory Technologies (RegTech) is a new and vital dimension to Fintech; it regulates and facilitates governance challenges faced by FinTech firms. In this chapter, the authors highlight the corporate governance challenges faced by Fintech firms and how RegTech can be useful for governance compliance. FinTech firms face three key governance challenges: extended executive directors’ tenure, family member shareholding, and founders working as board members. Organization for Economic Co-operation and Development (OECD) provides a clear guideline for corporate governance, suggesting that more extended period of executive directors, family member shareholding or family member part of a corporate board and founder holding board office are signs of weak governance. The RegTech can expedite FinTech firms to deal with these governance challenges. This chapter contributes to the existing literature of RegTech in terms of conceptualizing its role in Fintech governance.

Chapter 3, “Waqf Efficiency and Its Transformative Technology in Improving Waqf System in Malaysia”, discusses a case study of Waqf efficiency in the context of the Malaysian economy. As one of the established Muslim countries, Malaysia is not invisible to the issues in managing the waqf as one of the Islamic finance products. The regulations governing the administration and management of the waqf in Malaysia may be different from the other Muslim countries, such as Singapore and Indonesia, but one aspect these countries have in common is their continuous effort in reforming their waqf administrations. The mismanagement and slow progress in waqf development are not something new to the Malaysian scenario. Therefore, this study has taken an initiative by examining the efficiency of 13 waqf institutions in Malaysia over the period 2007 to 2013. The measurement of the technical efficiency uses two basic models of Data Envelopment Analysis (DEA). This study finds that only one waqf institution is fully efficient and the other 12 waqf institutions are inefficient when analysis is done on a full sample of 13 waqf institutions. Further analysis on the technical efficiency components reveals that the inefficiency of waqf institutions mostly caused by managerial inefficiency and not scale inefficiency. Due to these findings, it should be recommended to shift away from manual assessment to automation using artificial intelligence (AI) to reduce time and human errors and improve the existing ones.

In chapter 4, “Islamic FinTech and Artificial Intelligent (AI) for Assessing Creditworthiness”, the authors highlight the potential value of the Muslim market worldwide as the Muslim population is huge, reaching out to a quarter of the world’s population, yet it receives little attention from industry players. The data showed that the median age for Muslims globally was just 24 years old, making a majority of them were digital-savvy. They become more sophisticated and well-informed. The existence of Financial Technology (FinTech) plays a significant role as a potential market due to the demand for an Islamic financial system. Peer to peer lending platforms (P2P) is one of the vital FinTech’s products that also enhances financial inclusion and the financial well-being population to access financial services. This chapter discusses P2P lending that accordance with the Islamic principle. Islamic P2P lending promotes an interest-free mechanism and based on a profit and loss partnership. An Islamic P2P lending platform could be developed, and they must not involve Riba (interest/usury), Gharar (uncertainty), Maisir (gambling), or Non-halal (prohibited) activities. The challenge of the system comes from the area of technology to improve the overall financial system efficiencies, especially in mitigating financial risks. The chapter proposes AI-based Islamic P2P lending with instant credit scoring that will speed up the process of measuring creditworthiness. The credit score engines are AI-enabled that can be expected to generate reliable decisions.

In chapter 5, “Managing Islamic Financial Risks and New Technological Risks”, this chapter discusses current and potential applications of artificial intelligence (AI) for risk management in Islamic finance. The paradigm shifts brought on by digital transformation is altering the customers’ behaviors towards financial services and how it is being managed and deployed. We cover the techniques of risk management that encompass asset and liability management (ALM) risk, credit risk, market risk, operational risk, liquidity risk, and regulatory and Shari’ah risk compliance within the financial industry, across sectors. We also recognize AI’s ability in combatting financial crime such as monitoring trader recklessness, anti-fraud, and anti-money laundering. The capacity of machine learning (ML) to examine huge amounts of data allows for greater granular and profound analyses in various financial products and services. We also note that using AI itself adds another dimension of risk in the financial risk management framework. We conclude with some practical limitations within financial institutions pertaining to acceptance, competency, and readiness.

In chapter 6, “Exploring the Relationship between Artificial Intelligence and Islamic Finance”, the major cyber risks faced by banks include phishing attacks, ransomware, credential stuffing, and Internet of Things (IoT) exploitation. In such circumstances, use of artificial intelligence can take care of the system-related vulnerability in a much better and faster way than any human ever can. Artificial intelligence is modelled around some algorithms that can better tackle cybersecurity applications, providing greater value to customers, improving employee productivity, etc. In order to reflect on the salient benefits, interests, and issues pertaining to the use of artificial intelligence in Islamic finance, this chapter tries to critically explore the relationship between the two, which has not been explored before. It attempts to provide diverse and contrasting perspectives on the application and utility of artificial intelligence in Islamic finance in general, besides the traditional narratives, like the historical, philosophical, socio-cultural, economic, and policy perspectives. The broad themes include differences between Islamic finance and conventional finance, evolution of Islamic finance, understanding of artificial intelligence, the connection between Islamic finance and artificial intelligence, scope of artificial intelligence in Islamic banking, benefits of application of artificial intelligence in Islamic banking, and the challenges in applying artificial intelligence in Islamic banking. This chapter concludes that artificial intelligence in the near future will become the nerve center of Islamic finance.

In chapter 7, “Islamic Financial Technology Applications in Indonesia”, the authors discuss how the presence of financial technology (Fintech) in Islamic finance has lifted up the development of the Islamic finance industry. This innovation offers multiple financial advantages and solutions in society. Indonesia as a Muslim majority country has shown positive growth in this emerging area of innovation. This chapter aims to investigate the development of Islamic financial technology and its potential risk that may impact the development of the economy and business in Indonesia. Several significant benefits are presented from Islamic Fintech including cost-effectiveness, process business efficiency, and financial inclusion. Apart from its competitive advantage, there are challenges that may occur from the development of Islamic Fintech. Therefore, robust regulations should be established, particularly regarding the issue of Shariah-compliant.

In chapter 8, “Artificial Intelligence (AI) Applications in Islamic Finance and Banking sector”, the authors point out that artificial intelligence (AI) is a phenomenon as it has changed the way business used to be in the finance world. It is a disruptive technology and it has disrupted almost every walk of life and provides great benefits to every business. When it comes to the finance industry, the potential benefits of AI are manifold. There are estimations that millions of dollars can be saved by adopting AI in the finance sector. The chapter aims to briefly describe artificial intelligence and to review the relevant literature on artificial intelligence and its importance to the Islamic finance industry. In addition, this chapter aims at outlining the prominence of AI to the Islamic finance industry and how Islamic finance can maintain its steady growth with the wide adoption of the disruptive innovation, artificial intelligence. The chapter concludes that the Islamic finance industry can benefit to a huge extent from the mass adoption of AI by reducing costs and therefore providing financial services at a competitive rate, increasing transparency, bringing speed in delivery of services to the growing needs of the modern digital age customers.

Chapter 9, “Artificial Intelligence, Financial System, and Islamic Finance: Addressing Issues Prior to Technology Adoption”, discusses the anticipated power resulting from the introduction of artificial intelligence into the financial system, particularly the Islamic finance system. This chapter introduces the reader to the consequence of financial crisis to explain the need for another financial system model. Subsequently, an overview of scholars’ urgent warnings about a coming financial crisis is discussed. After that, the chapter embarks on the problem of money and explains how the World Bank and the IMF have failed to solve the current issues resulting from the current financial system followed by an Islamic finance overview. In the last part, this chapter discusses the expected impact of artificial intelligence on Islamic finance.

Chapter 10, “Applications of Financial Technology in Islamic Finance: A Systematic Bibliometric Review”, highlights the fact that Financial Technology (FinTech) is a multidisciplinary field that integrates finance and technology using mathematical, statistical, computational, and economic models. FinTech is dependent on new technology for its growth. Several technologies are used in the finance industry, including artificial intelligence, machine learning, robotic process automation, the Internet of Things, cloud computing, big data, and blockchain. FinTech applications in Islamic finance are emerging not only as means of enhancing financial results but also as means of enhancing the sustainability and productivity of the financial industry. Some examples of FinTech applications in Islamic finance are Islamic gold dinar, Islamic investment platforms, digital Sukuk, digital takaful, Islamic crowdfunding, Islamic microfinance, and Islamic robot advisors. This chapter aims to conduct a comprehensive systematic bibliometric analysis of the FinTech applications in Islamic finance. It starts by reviewing 225 research articles published in the Scopus database between 2009 and 2020. This chapter, using bibliometric analysis, describes the most significant literature, denotes the related discipline fields, and offers insight into the existing research patterns and possible future trends in FinTech applications in Islamic finance. The findings establish a solid grounding for future research in the field of FinTech applications in Islamic finance.

In chapter 11, “Harnessing Blockchain for the Development of Islamic Social Finance: An Emphasis on Waqf”, the authors demonstrate the vital role played by Waqf in Muslim society. It has been one of the main instruments of wealth redistribution and public welfare improvement. From the time of the Prophet (PBH) until the beginning of the 19th century, particularly in the Ottoman Empire, Awqaf institutions played a crucial role in supporting the State by providing a variety of social welfare schemes covering multiple objectives. However, the contributors’ base expanded in the 21st century with the development of Cash-Waqf, as it allows the acceptance of Waqf in the form of cash and other movable assets. Contributions are no longer limited to the wealthy since donations can be made in small or large amounts. In addition, the traditional approach of managing Waqf has been transformed and adapted to the rapidly changing world of financial technology, and the evolution of capital markets to allow Waqf linked investment structures. The potential of blockchain-based crowdfunding in Waqf sector has made Waqf players very optimistic about the huge amount that can potentially be raised. Nowadays, contributing to Waqf is much easier than in the past, through Waqf-based small contributions. The objectives of this paper are to examine the sustainable role of Waqf, and to emphasize the importance of optimal allocation of the collected Waqf funds. Using Finterra Global Plantation as a case study, this chapter describes the process of this Waqf-based multi-impact financial arrangement.

Chapter 12, “Artificial Intelligence, Financial Risk Management and Islamic Finance”, focuses on how artificial intelligence (AI) helps the human being get the services from the machine where the transformation of the human thinking ability into the machine works at the back end. It is believed that AI is the intelligence that is highly associated with human thinking capabilities in decision making and complex problem solving with an ability to reason, think, and improve as a human. Like other industries, AI also has the prospect in financial industries, including Islamic Financial Institutions (IFIs), in ensuring cost reduction alongside the improvement in the service quality with the efficient utilization of the resources. As the financial services sector undergoes groundbreaking journeys utilizing emerging technologies such as AI, IFIs need to be part of this stream. To get under way, IFIs should build an AI strategy and concentrate on some AI technologies such as machine learning and some other popular technologies on their existing system. Many conventional banks are using AI on a large scale, so IFIs can take help from those firms. This would encourage IFIs to provide a personalized touch and improve their customer service. This chapter develops into a brief introduction to AI in connection with the financial industry, highlight the existing AI technologies used in both conventional and IFIs, identify some of the prospects of using AI in IFIs, and before the conclusion, identify some challenges related to the implementation of AI in IFIs.

In chapter 13, “Rise of Islamic Robo Advisory in the 21st Century”, the Asian-Pacific area has a sizable pool of robo-adviser users and Assets Under Management (AUM), both of which are expected to develop in the near future. Because of its lower cost structure compared to the conventional labor-intensive advisory approach, Robo-Advisory (RA) allows wealth management players to charge lower fees, and therefore extend their target market beyond High Net Worth Individual (HNWI) clients to a new and younger clientele involved in active investing. This chapter would argue that Islamic Finance (IF) is not only compatible with FinTech, but that IF is using emerging financial technology like artificial intelligence and robotics to become more inclusive and resilient in the current financial environment. After reviewing the literature, the paper describes the key features of Robo-Advisory and how it applies to finance. The main emphasis of the chapter would be on the rise of Robo Advisory with a case study on Wahed Invest, which is a known Islamic Robo Advisory cooperation based in the USA. This chapter concludes with suggestions and discussions about emerging start-ups in the same domain.

Chapter 14, “Risk Mitigation for Cash Waqf Collection Using Financial Technology and Internet of Things”, looks carefully at innovations of financial technology that have emerged in the 21st century and have impacted different sectors and industries on their efficiency and effectiveness. Among the industries that adopted Fintech widely is the financial industry. Also, at the same time, the application of Islamic social finance is widely accepted around the world, especially in Muslim countries. Cash waqf is among the mechanisms that have been applied by Islamic institutions to sustain their financial funding. This chapter proposes a conceptual framework for cash waqf institutions applying fintech for cash waqf collections. It explains the adoption of technology can increase efficiency but also expose users to technological risk that could have a negative impact if not well mitigated, especially with the big data and Internet of Things (IoT) environment. The factors under investigation include awareness, Fintech knowledge, relative advantages, social norms, and perceived trust as the independent variables and Fintech adoption as the dependent variable, where risk mitigation is another independent variable. This model will provide benefits to cash waqf institutions in Malaysia for their efficiency and policy decisions in enhancing cash waqf collection. It is expected that the conceptual model will provide contributions to cash waqf collection, efficiency, and transparency in Malaysia. This would directly help the State Islamic Religious Councils (SIRCs) and their subsidiaries in resolving cash waqf collection management issues.

In chapter 15, “Disrupting Islamic International T...