The emergence of cryptocurrencies and blockchain technologies is going to radically shake up many sectors of the economy. Not least of which will be banking and finance, which of course includes the Islamic financial sphere, which is a large and significant part of the world economy.
“This innovation called the blockchain will play a crucial role in boosting the financial sector (banking, insurance, investment, etc.) including the Islamic Finance sector. Addressing the digital revolution that is happening right now will foster competitive advantage for the Islamic Finance industry. It is clear that the digital revolution in financial services is under way, and digital disruption has the potential to shrink the role and relevance of today’s banks, while simultaneously creating better, faster, cheaper services that will be an essential part of everyday life in the new economy.” Hazik Mohamed, PhD, Islamic Finance.
The installation of blockchain in Islamic Banking will primarily affect the way payments, remittances and trading activities are conducted. This technology is moving forward towards the mainstream and promises to provide benefits in several areas. It can:
- Modernise legal documentation through the application of smart contracts
- Significantly reduce transaction processing time
- Reduce costs for providers, and transaction fees for consumers
- Eliminate the need for documentation and manual reconciliation of transactions
- Reduce the need for centralized regulation
- Eliminate the risk of errors and duplication
- Reduce or eradicate fraud
- Manage counterparty risk
Although in the past, Islamic finance has been at the forefront of technical innovation — it invented the cheque, for example, around the 9th century, so merchants would not have to carry money on long and dangerous journeys, recently it has not been so dynamic. Of the $50bn in fintech investment globally since 2010, according to consultancy Accenture, only 1% have gone to the Middle East and North Africa.
Does the Islamic Financial System Need Innovation?
Although the MENA area has many wealthy people, with a need for top-notch financial services, about four-fifths of the population are unbanked — this suggests there is a requirement for new, competitive and value-for-money financial services. For example, remittances from workers to their home countries have high levels of charges, up to 29%, which cuts into the money they send back, and of course, does not boost the local economy.
Blockchain can provide quick, low cost, transparent, alternatives.
It can reduce transaction costs, and make fraud and error less likely.
Zareen Roohi Ahmed, Founder of IFCC, a UK-based think tank on Islamic finance and cryptocurrency, highlights two opportunities for Islamic finance to make good use of blockchain technology: resolving uncertainty (gharar) in transactions, and providing banking services to unbanked Muslims. On the second point, Ahmed explained, “When combined with mobile phone technology, the capacity for low-cost remittances and microfinance loans using blockchain technology can transform the payment ecosystems within developing regions.”
Across the Middle East, major states are looking at blockchain developments. Sharia Law is complex, and not all scholars agree, but the ethos of Islamic Finance was to create an economic environment beneficial to all and to encourage positive developments. There are strictures against things like gambling, fiat currency, and interest. “In fact, several Islamic scholars hold the view that Bitcoin is more Halal than fiat money (e.g. US dollars) in use today. For example, in Islamic literature, money needs to have intrinsic value. This is not true for paper-money in use today, but is true for Bitcoin because its value comes from the proof of work protocol…,” wrote Tim Lea, CEO of Veridictum and cryptocurrency expert.
The Saudi Arabian Islamic Development Bank (IDB) has put its staff onto the task of researching and developing blockchain-based products. They are particularly attracted to the managing of counterparty risk and the reduction in settlement time and complexity, which Sharia-compliant financial agreements tend to possess. The development of smart contracts will facilitate the automation of the entire contractual process for Islamic institutions, alleviating the additional administrative and legal complexities and redundancies associated with Islamic financial products. One objective is to liberate Muslim investors, growing the sector, and another is to make available socially-acceptable forms of banking and insurance throughout the 57 countries where the IDB operates.
Emirates “Cheque Chain”
In June 2017 Emirates Islamic Bank, part of the wider Emirates NBD group announced it was incorporating blockchain into its paper cheques.
Termed ‘Cheque Chain’, Emirates Islamic is the first Islamic bank in UAE to undertake this initiative to enhance security in the popular payment method. Emirates Islamic will issue new cheque books carrying a unique QR (Quick Response) code on every page, along with a string of 20 random characters.
“Blockchain has the potential to significantly increase security and protection in banking transactions and we are delighted to be among the first in the UAE to utilize this new technology,” said Suhail Bin Tarraf, Chief Operating Officer, Emirates Islamic. “We anticipate that Cheque Chain will dramatically reduce cheque frauds in this market helping us provide our customers greater peace of mind and security.”
Interestingly, this marries old-style bank cheques with the latest technology. Cheque fraud is a perennial problem for banks, and as this project develops it will be informative to see if it is effective in reducing bad transactions, which are a cost to the bank. The intention is to have every cheque registered on the blockchain so counterfeiting will be discovered immediately.
Quite quickly, blockchain developments in Dubai have boomed. In August, Dubai Financial Services Authority (DFSA) and the Securities and Futures Commission (SFC) in Hong Kong cemented an agreement on fintech cooperation between the two centers, with the intention to pave the way for start-ups in the MENA and East Asian markets. Several countries, including Russia, have expressed an interest in becoming major players in the blockchain-fintech world, but Dubai appears to be moving towards this goal rapidly. UAE has announced an ambitious plan to become the first blockchain government by 2020. Applications proposed include:
- Reducing the cost of document processing by billions of dollars through eliminating manual processing of residencies, passport documentation, and visas through a partnership with ConsenSys
- Improving governmental operations and Islamic banking by moving inter-governmental paperwork onto the blockchain through a new local startup called ArabianChain
Various other blockchain initiatives are being explored, including partnerships with IBM, using Hyperledger’s Fabric technology. Of course, being the first mover in a technology confers advantages in seizing market share, but challenges and disadvantages become apparent, so this is not without risks.
Islamic Credit Cards
One of the most interesting developments concerns credit or debit cards. Normally these prohibit the purchase of haraam products or services: alcohol, gambling, pornography, or pork. However many stores sell non-prohibited items as well: so this causes difficulty. A devout Muslim could go to a restaurant which serves alcohol and pork food, and not consumes either, eating other foodstuffs but be unable to pay for these with an Islamic credit card. By using blockchain systems, the card could be obstructed from paying for wrongful purchases but allowed to pay for other items.
Emerging Opportunities for Islamic Financial Institutions using Blockchain and FinTech
Several MENA nations have been very active in encouraging new FinTech developments:
- Dubai has created the FinTech Hive accelerator, and the Innovation Testing Licence, a regulatory sandbox
- Abu Dhabi has launched the RegLab, also a regulatory sandbox
- Bahrain has launched a Regulatory Sandbox, a FinTech Unit for the central bank, and FinTech Bay, planned for rollout in February 2018, expected to be the largest FinTech hub in MENA
In FinTech parlance, a “sandbox” is a prototyping environment, where a startup can build and test its product, without having to adhere to all the sector’s regulations, which might stop it getting a practical product off the ground. It also allows “White Hat” hackers to test security procedures, and ensure that the product is not going to be compromised by cyberattacks when it is launched.
According to Forbes Magazine, “Sharia-compliant investment funds are currently being designed to use to invest in micro, small and medium-sized enterprises and digital infrastructure.” These developments will complement emerging blockchain developments. With 1.8 billion potential customers worldwide, and a legacy of over-complex and user-unfriendly Islamic financial structures, smart contracts will revolutionize the sector, by cutting the costs of financial services and making ethical Islamic financial products widely available. Of course, there will be casualties — organizations that fail to adapt — but this is how business-disruptive technologies create opportunities.
One structure that is needed is an Islamic World regulatory structure, where Islamic financial products can be certified as sharia-compliant, then made available in different countries. This would be similar to the EU Passporting system, for financial products and services. Unfortunately, the Middle East does not have a history of excellent cooperation, and it is possible that the larger countries, for example, Egypt, would design their own regulatory system and ignore other countries, leading to a fragmented market. This would not be a satisfactory system.
New FinTech systems should be:
- Easily accessible, via smartphone, apps, and the internet
- Convenient to use, and customer-friendly
- Transparent — a certified Sharia-compliant FinTech product with validation that is recognized and respected by both consumers and institutions across national borders
- Low-cost, speedily-delivered, minimum bureaucracy to fit with modern requirements
The challenge is, of course, whether the governments and regulators in MENA countries can be forward-looking, and agile enough to respond to the new opportunities. Many of these countries are known for their conservative tendencies, and perhaps a reluctance to embrace new technologies. Cash transactions are often preferred among the population and businesses. However, it seems that many projects, even if of an experimental or pilot nature are being greenlighted, which will pave the way for wider adoption if they are successful.
Some new projects are already outflanking banks. Peer-to-peer financing (P2P) and crowdfunding through restricted modarabah investment are two types of online lending platforms which have been making progress in the past few months in the more advanced MENA economies. New FinTech players such as Beehive and BlossomFinance, based in UAE and Indonesia respectively, both operate Shariah-compliant platforms. These two companies aim to provide low-cost alternative financing to small and medium-size enterprises. Each company focuses on connecting creditworthy business looking for funding with smart investors to build mutually beneficial partnerships, by applying the innovative technology of crowdfunding to eliminate the costs and complexity historically associated with banks, both Islamic and non-Islamic. Start-up and initial seed finance are notoriously difficult to fund conventionally, which is why national and local authorities, and organizations like the EU, have backed various initiatives for new products and services. However these have still used “Trusted Third Parties” — banks, insurers, consultancies, accountants, credit reference agencies and the like. This makes the process of raising finance complex, time-consuming, burdensome — for non-finance experts — and costly. New forms of funding will create opportunities for small businesses and innovative products which could not exist before the internet revolution. The Blockchain Revolution will take this on to the next stage in the coming few years.
According to Ernst & Young, FinTech products have the potential to attract 150 million customers to the Islamic banking sector by 2021. A new appetite for innovation is evident in the Middle East with the recent formation of innovation centers as noted above.
Islamic banking together with the technological innovations of FinTech, the blockchain, and cryptocurrencies, can create growth and wealth for the Middle East, streamline Sharia-compliant ethical financial instruments, free up finance for new enterprises, reduce costs, and benefit many people and businesses throughout the Muslim world.
Ali H. Askar
Cloud Solutions Consultant, Zero & One