Fintech and Islamic Finance: Digitalization, Development and Disruption

By Nafis Alam, Lokesh Gupta and Abdolhossein Zameni

Financial Technology (Fintech) has revolutionized the financial world as one of the fastest-growing segments in both the technology and financial sectors. With the usage of underlying principles of Blockchain technology, Fintech is bringing the financial community together and making financial services accessible to everyone. Fintech has far-reaching implications for Islamic finance such as banking, investment, insurance (takaful) and wealth management, which are benefitting from this usage. This book provides a comprehensive review of how Fintech is shaping the Islamic finance industry through three key aspects: Digitalization, Development and Disruption. The book will provide insight on the Shariahtech (Fintech in line with Shariah principle) and its application in the Islamic finance industry. The book also gives an overview of Blockchain and Fintech evolution and how they act as the building blocks of the digital financial landscape.

Readers of the book will also get a detailed discernment on the Islamic viewpoint on cryptocurrency as well as the application of the smart contract in different Islamic financial services. The book provides students, academics and researchers with a detailed description of the Blockchain and Fintech application in Islamic finance.

• Language: English
• Publisher: Palgrave Macmillan
• Release date: Oct 2, 2019
• ISBN: 9783030246662

Book preview

© The Author(s) 2019

N. Alam et al.Fintech and Islamic Financehttps://doi.org/10.1007/978-3-030-24666-2_1

1. Digitalization and Disruption in the Financial Sector

Nafis Alam¹  , Lokesh Gupta²   and Abdolhossein Zameni¹  

(1)

Henley Business School, University of Reading Malaysia, Iskandar Puteri, Johor, Malaysia

(2)

RM Applications, Kuala Lumpur, Malaysia

Nafis Alam (Corresponding author)

Lokesh Gupta

Abdolhossein Zameni

1.1 Introduction

The digital revolution is dramatically changing the global business environment and financial services (finserv) is no exception to it. Technology-enabled financial services institutions (FSIs) are changing the way humans are fulfilling basic financial needs. For FSIs, the digital transformation does not mean only adopting technologies such as cloud capabilities, big data, artificial intelligence (AI), mobile capabilities or dominant social media presence. It is aimed more towards creating new business models to develop an ecosystem where all markets and consumers could participate.

FSIs are operating in a very customer-centric industry where banks and finserv players are not only competing among themselves to attract customers’ attention and loyalty but also facing stiff competition from technology players who are venturing into the financial world. This has completely changed the financial ecosystem making digital transformation inevitable for the FSIs’ survival. The dire need for digital transformation in the financial sector is impelled by the way customers want to interact with the FSIs and the growing threat from the disruption caused by the challenger banks and technology firms offering financial services also known as techfins .

Digital transformation is often confused as the use of information technology and digitalization in an organization but it has a wider application. In the context for FSIs, digital transformation can help FSIs to move away from face-to-face engagement with customers to online as well as innovate their business model to cater for the changing need of their stakeholders. Digital transformation is mainly achieved by the digitalization of the operations and services provided by the institution, and the firms which are slow to embrace it are getting disrupted by the new incumbents. Many progressive financial institutions (FIs) are already deploying machine learning (ML) and artificial intelligence (AI ) to meet their strategic objectives such as usage of ML to identify anomalies in transactions which can reduce fraud and money laundering problems.

1.2 Digitalization of the Financial Sector

According to Gartner, digitalization is the use of digital technologies to change a business model and provide new revenue and value-producing opportunities. Digitalization is rapidly transforming the way in which the financial sector is operating. By employing innovation and digital technologies, management and delivery of financial services have been completely transformed. For instance, in the banking sector, digitalization has brought new business models for the industry, developed new concepts and provided areas for continuous improvement.

Digitalization has provided FSIs, whether it is a bank, a wealth management company or an insurance firm, an opportunity to reach out to potential customers and has helped them to improve their customers’ experiences. By use of a mobile app or virtual communication, it is much easier for FSIs to handle a large set of customers without a delay which increases their efficiency and reduces the cost. In the banking sector, digitalization is changing the way banks used to operate.

The following discussion will provide a brief overview of emerging digital technologies which are being applied to the different domains of the financial sector. Detailed discussion on these digital technologies will be dealt with in Chap. 3 (Table 1.1).

Table 1.1

Applications of digital technologies to the financial services

Source: Author’s view

Blockchain , which is based on distributed ledger technology (DLT), is in the simplest of terms, a time-stamped series of immutable record of data that is managed by a cluster of computers not owned by any single entity. Each of these blocks of data (i.e. block) are secured and bound to each other using cryptographic principles (i.e. chain). The blockchain is used for know your customer (KYC) compliance or to streamline financing application processes which involve documentation from various parties.

The exponential increase in digitalization of finserv is primarily due to big data analytics . By using big data analytics in finserv , FSIs are taking a more proactive approach to gain a deeper understanding of their customers. Use of big data analytics can help FSIs to understand the customer preferences which can aid to increase the efficiency and effectiveness of the financial products and services.

Artificial intelligence (AI) is a branch of computer science which involves algorithm and machine learning to create intelligent machines. AI helps institutions including FSIs in learning, decision making and providing useful predictive analytics . FSIs are using AI in many applications such as market and customer analysis, credit scoring, usage-based insurance, data-driven trading, fraud detection and beyond.

Augmented reality (AR ) is an enhanced version of the real physical world with the use of visual elements, sound or any other sensory stimuli. AR helps FSIs to decode complex data streams by providing powerful data visualization which aids quick decision making.

Biometrics refers to the study of measurable biological characteristics such as the face, fingerprints, retina, and iris. For authentication purposes, biometrics rely on measurable physical characteristics that can be automatically checked. Using biometrics in financial activities helps to control fraud and identity hacks.

Internet of things (IoT) is a network of connected devices which receives and sends data over the internet. Using data coming from the use of different devices for financial transactions allows FSIs to have an overview of customer finances and financing need in real time. Customer information will also help FSIs to provide value-added services, financial assistance and customized products to ensure a win-win situation for both parties.

Cloud computing allows users to run software applications and store, edit and retrieve data over the internet from large networks of remote web servers rather than on users’ own computers. FSIs are using cloud services for their business and IT needs such as core banking cloud services and insurance management services.

It can be seen from above that there is a rapid increase in the digitalization of the financial sector which is leading to both disruption and transformation of the financial sector. Disruption in the financial sector is discussed below.

1.3 Disruption in the Financial Sector

Technology is changing the landscape of the financial sector by rapid changes in the way customers interact with financial services providers. Financial tasks once handled by humans and dealt with paper currency are now being completely transformed by technological innovation . Well-established FSIs are freaking to respond to a variety of technology-enabled financial services including cryptocurrencies , peer-to-peer lending , mobile payments , e-wallets and distributed ledger technology . Banks and financial services providers used to be the stronghold of traditional financial institutions having a very high barrier of entry such as capital and stringent regulatory requirements. As the demand and expectations of consumers evolved over the period, these barriers have been reduced gradually giving rise to technology-focused entrants known as financial startups t hat have disjointed the financial service value chains and challenged the traditional incumbents.

Financial startups with innovative financial products and services pose a threat to incumbent FSIs. The business models of these startups which work on data-driven models and require very little capital and fixed assets are aiding them to disrupt traditional financial institutions and gain market share quickly. For instance, Revolut, a UK-based digital bank, has no physical branches but offers traditional banking services such as prepaid debit card, currency exchange , crypto exchange and peer-to-peer payments . It has a banking licence from both UK and European Central Bank and has over 4 million customers dealing in 250 million transactions. As the dominance of incumbent financial institutions is dwindling, the void in customer-driven demand is being filled by new entrants. These startups are getting popular by means of customer-oriented services which are fast, cheap and efficient and aimed at fulfilling one specific objective rather than providing bundled services.

Such is the level of disruption that Gartner Inc., a research think tank, believes that within 12 years, 80% of financial firms will either go out of business or be rendered irrelevant by new competition, changing customer behaviour and advancements in technology (Gartner 2018). Report further added that banks could be doomed if they persist with outdated business models and only those which use digital platforms to lower its cost and provide services as and when customer needs it will survive. Customer expectations are changing with the pace of technological innovations in the financial landscape which is making incumbent FSIs difficult to compete with startups. Digital savvy millennials care little about where they source their financial services need from, whether it is a challenger bank, startup or technology giants such as Google, Facebook and Amazon.

While startups have managed to improve customer experience by making it easier and more intuitive to perform financial transactions and by providing more transparency in the process, startups are also able to provide better access to financial solutions using advancements in technology to allow customers and businesses to have timeless and borderless transaction and across a range of devices. The advantage of these startups lies in lower operating costs and increased process efficiency using the new tools developed through technological innovations which are transforming the way FSIs operate by making the processes faster and efficient. With these advantages, startups are disrupting the business model of traditional incumbents as well as customers are having a preference of startups over the incumbents. Preference of customers lies in better experience, lower transaction cost, better financial solutions and over and above value-added services.

It is high time that FSIs as an industry need to think differently to overcome the disruption caused by the startups . FSIs should look for ways to integrate their products and services and technology as per the users’ lifestyle and need. They need to move away from institution-oriented services to customer-oriented services where products and services are designed as per the need and demand of the customers to serve them efficiently. Even though the market share of startups is minimal in the finance industry, but they have arrived and aiming to eat up incumbents’ portion. Traditional FSIs would not be able to keep tech giants and startups from becoming a major player within the financial services sector given the funding at their disposal, as well as the continuous innovation to enter new business areas, and providing a better customer experience. Instead, FSIs should be looking at the future development of the financial sector which will be transformed in the age of AI and big data.

If not catered for the digital disruption, the startups have the potential to shrink the role of and relevance of incumbent FSIs; but if the incumbents adapt the technological advancement and digitally transform themselves in the wake of digital disruption, they have the potential to serve the customer better. With the use of digital disruption tools, traditional FSIs can increase customer experiences in ways such as:

Using technology-enabled channels, such as mobile payments to provide financial intermediation services at a significantly lower cost compared to the old traditional way;

Making use of digital means to reach a large number of customers at a significantly lower cost and identifying, monitoring and managing a variety of risks associated with financial service provision using technological approaches of AI and machine learning.

1.4 Digital Transformation and Islamic Finance

Islamic finance is a fast-growing industry and currently commands a volume of US$2.05 trillion which is expected to reach US$2.5 trillion by the end of 2019 (Salaam Gateway 2019). Islamic banking is the largest sector in the Islamic finance industry, contributing to 71%, or US$1.72 trillion, of the industry’s assets. Islamic finance, especially banking segment, is also getting digitally transformed due to the emergence of digital-only subsidiaries, such as Gulf International Bank’s Meem in Bahrain and Saudi Arabia, and Albaraka Turk’s Insha in Germany and other European countries with large Muslim communities.

Islamic finance is one segment of the finance industry which offers a lot of potential for digital transformation due to a tremendous amount of opportunities available for Islamic finance institutions (IFIs ) to embark on in order to achieve multiple strategic objectives. With the help of digitalization, IFIs can achieve financial inclusion, offer customer-oriented financial services , operation excellence and gain a competitive advantage over their peers. Crowdfunding , peer-to-peer model and payment platforms, smart contracts and blockchain, cryptocurrencies , cybersecurity and so on are among a few emerging channels of digital transformation that could be utilized in the Islamic finance industry.

Recently, the Islamic finance industry has started putting attention on digital transformation. In a recent survey conducted by the General Council for Islamic Banks and Financial Institutions (CIBAFI) of 103 global Islamic bank managers found 70% of the respondents’ view that digital transformation is an extremely important strategic area (CIBAFI 2018). Many banks in the Middle East and Africa are launching technology departments and forming joint ventures with fintech firms, with almost 45% of respondents planning to increase or launch digital branches in the future.

Digital transformation within Islamic finance has always shown a value proposition for the industry. According to EY’s Banking in Emerging Markets GCC FinTech Play 2017 report fintech can propel Islamic banks into the mainstream space in 20 promising markets by 2021, up from five markets in 2017 and can increase the customer base by adding 150 million new Islamic banking customers (EY 2017). In fact, the impact of digitalization on the main Islamic finance centre such as Gulf Cooperation Council (GCC ) countries could have been higher but there is still lack of clarity with regard to technology adoption and regulations surrounding startups.

Even though Islamic banks are at par with their conventional counterpart when it comes to technological development but the Shariah aspect of the financial transaction can be a hurdle to digitalize the process. Knowhow about the blockchain or the permissibility of cryptocurrency can deter the adoption of fintech within the Islamic finance industry. Islamic banks in the GCC are setting their own R&D unit to develop technological banking services to catch with up the influx of startups especially in the domain of payment and remittance services. Sometimes given the complexity of Islamic finance services such as takaful (Islamic insurance) model add a deterrence to adopt Insurtech solutions. Another concern is the lack of legislation, appropriate standards and standardization within the Islamic finance industry which act as a barrier for technological adoption .

In order to compete with the technological disruption in the financial sector where Islamic finance is a major player especially in GCC and South East Asia, Islamic finance industry needs to innovate in the realm of customer-oriented products, seamless payment and remittance system, enhanced customer interface solutions and adoption of smart contracts and blockchain technologies in Islamic financial services . Digital transformation has a bigger role to play in the Islamic finance industry particularly in the domain of financial inclusion which is also one of the key Shariah objectives.

1.5 Conclusion

With the acceleration of disruption in the financial services arena, it is high time for the Islamic finance industry to take a leap from the playbook of conventional banks and start to solicit more strategic advice from outside parties as a core part of their strategy and planning process. Given the lack of resources in this realm, this book is a humble approach to highlight how fintech is shaping the Islamic finance industry through three key aspects, digitalization, development and disruption. The book will provide the reader with an insight into the Shariah-tech (fintech in line with Shariah principle) and its application in the Islamic finance industry. Apart from providing detailed application of fintech in Islamic finance, the book also aims to give an overview of blockchain and fintech evolution for basic understanding and how they act as the building blocks of the digital financial landscape.

The rest of the chapters of the book deal with the emergence of fintech with special emphasis given to the region dominant in Islamic finance. The book will build upon the use of fintech in the financial industry and its application in the different domain of financial services before moving on to provide a detailed description of application of emerging financial technologies in Islamic finance and Shariah issues surrounding the application. One of the key highlights of the book is to look into the challenges surrounding fintech application in Islamic finance and how fintech can transform the Islamic finance industry in the major jurisdictions.

References

CIBAFI. (2018). Global Islamic Bankers’ Survey 2018. Available at: http://​cibafi.​org/​ControlPanel/​Documents/​Library/​Pdf/​EnglishGIBS2018-Final-Online.​pdf

EY. (2017). Banking in Emerging Markets GCC FinTech Play 2017. Available at: https://​www.​ey.​com/​Publication/​vwLUAssets/​ey-banking-in-emerging-markets-gcc-fin-tech-play-2017/​$FILE/​ey-banking-in-emerging-markets-gcc-fin-tech-play-2017.​pdf

Gartner. (2018). Digitalization Will Make Most Heritage Financial Firms Irrelevant by 2030. Available at: https://​www.​gartner.​com/​en/​newsroom/​press-releases/​2018-10-29-gartner-says-digitalization-will-make-most-heritage-financial-firms-irrelevant-by-2030

Salaam Gateway. (2019). Islamic Finance Volume Expected to Hit $2.5 Trillion in 2019. Available at: https://​www.​salaamgateway.​com/​en/​story/​islamic_​finance_​volume_​expected_​to_​hit_​2.​5_​trillion_​in_​2019_​zubair_​mughal-SALAAM0201201902​3533, https://​www.​gartner.​com/​it-glossary/​digitalization/​, https://​www.​revolut.​com/​about-revolut

© The Author(s) 2019

N. Alam et al.Fintech and Islamic Financehttps://doi.org/10.1007/978-3-030-24666-2_2

2. Fintech Emergence and Global Evolution

Nafis Alam¹  , Lokesh Gupta²   and Abdolhossein Zameni¹  

(1)

Henley Business School, University of Reading Malaysia, Iskandar Puteri, Johor, Malaysia

(2)

RM Applications, Kuala Lumpur, Malaysia

Nafis Alam (Corresponding author)

Lokesh Gupta

Abdolhossein Zameni

2.1 Introduction

Fintechs are redefining the financial services customer journey. The digital era has unleashed