Impact of Fintech to Islamic Finance

Fintech has been a favourite topic at Islamic finance forums lately. It was the focus at the World Islamic Banking Conference 2015 held in Manama, Bahrain, in December 2015. 

The topic also made its rounds at the Euromoney Islamic Finance and Investment Conference (February 2016, London, UK), Islamic Finance Conference 2016 (March 2016, Kuala Lumpur, Malaysia) and Islamic Banking & Investment Asia/Middle East Congress 2016 (April 2016, Singapore). I happened to be a speaker at the latter two of these events.

What is Fintech?

Fintech, the contraction of the words finance and technology, broadly refers to the application of technology within the financial industry. It covers a wide range of activities including financing, payments and infrastructure, operation and risk management, data security and monetisation, and customer interface. 

Fintech applies to the segment of the technology start-up that is disrupting sectors such as mobile payments, money transfers, loans, fundraising and asset management.

The fintech revolution started post 2007-2008 financial crisis. At that time, policymakers were busy supposedly making finance safer while financial institutions were investing heavily in the solutions for the newly introduced compliance requirements. In between, information technology “geeks” partnered with venture capitalists to introduce a solution that was set to disrupt traditional financial services. The financial solution was technology-based, more convenient, more accessible and more cost effective.

Since then, fintech has been growing rapidly with a global investment reported to be US$12 billion (RM46.92 billion) in 2014 compared to only US$4 billion the year before.

The main types of fintech services are peer-to-peer (P2P) lending, crowdfunding, money transfer, mobile payments and trading platforms. There are also fintech services for other sub-sectors such as wealth management, insurance, etc. Some names involved in fintech are Funding Circle, FundedByMe, TransferWise, TradeCrowd and Kantox.

Fintech has also penetrated the Islamic finance space. A few prominent fintech companies that offer Shariah-compliant financial solutions are Dubai-based Beehive, Jakarta-based Blossom Finance, and Singapore-based KapitalBoost and ClubEthis. These fintechs are in the segments of P2P lending and crowdfunding.

Fintech’s penetration into Islamic finance is still in its infancy with a relatively small number of participants. However, the potential disruptions to traditional Islamic finance should not be underestimated. The disruptions can swing both ways.

From the Islamic finance consumer perspective, fintech disruptions are largely positive. Fintech innovation provides choices which are more aligned to individual needs. With more options, consumers enjoy more competitive financial services cost. 

Latest technology embraced by fintech leveraging on Internet, mobile devices and social media integrations make financial transactions more automated, user-friendly and more convenient, thus a superior customer experience.

Crowdfunding and P2P financing options from fintechs are also a blessing for individuals or SMEs (small and medium enterprises) that require financing but do not qualify for financing from traditional Islamic financial institutions (IFIs). Investors are also entitled to higher potential returns by investing directly into the business ventures that they finance via the online financing marketplace. 

Furthermore, one of the best things that has happened with fintech is that it is able to provide access to financial solutions for the roughly two billion adults who are currently unbanked, as reported by World Bank.

On the flip side, traditional Islamic finance providers face more intensified competition with fintech sharing their pies. In order to remain competitive, they have to reduce financing profit margins and service fees. 

With consumer options to invest through the online P2P and crowdfunding marketplace, IFIs may end up with reduced deposit and investment portfolios. 

With customers spoilt by the fintech innovations of convenient online services anytime, anywhere, integrated and automated, IFIs are facing demands for digital channels to perform transactions. 

The impact is not all negative for traditional IFIs. It is worth noting that fintech is not about to kill traditional players. There are still sizeable customer segments that are only comfortable dealing with brick and mortar banks. 

However, over time, traditional IFIs may face significant reduction in their customer base when digital natives (those who have grown up using the Internet and mobile devices) form the majority of the population unless the traditional IFIs embark on the digital banking journey. 

Traditional IFIs need to consider collaborating with fintech players and leverage on their technology partners. At the same time, IFIs can focus on specialisations in the business segments that cannot be easily replicated by non-traditional players.

On the overall Islamic finance scene, fintech in the Islamic finance space positively contributes to the evolution of the Islamic finance products and services offering. Elimination of credit intermediaries results in lower prices and/or higher potential returns. 

Last but not least, crowdfunding and P2P financing provides the platform for Musharakah- and Mudharabah-based equity financing, which have not been very successful in the traditional IFI environment.

My column as appeared in THE MALAYSIAN RESERVE 11 April 2016