Islamic fintech for financial inclusion
By Jason Loh & Jennifer Ley Ho Ying
Last year, Bank Negara announced the five successful applicants of the digital banking licences under the respective Financial Services Act (FSA) 2013 and Islamic Financial Services Act (IFSA) 2013. This followed the issuance of the Policy Document on Licensing Framework for Digital Banks in 2020. Three out of the five successful applicants are majority-owned by locals.
The successful applicants will have “to undergo a period of operational readiness that will be validated by Bank Negara through an audit before they can commence operations. This process may take between 12 to 24 months” (Bank Negara press release, April 29, 2022).
As part of the conditions for the licence application, digital banks would have “to offer banking products and services to the underserved or unserved markets and address the financial inclusion gaps in the country” (“Fostering financial inclusion through digital banking in Malaysia”, The Edge Markets, August 8, 2022).
The presence of digital banking is in line with the country’s broader digitalisation vision – to transform the economy and industry of which the banking and financial sectors are encompassed.
Digital banking which is driven by fintech (financial technology) is, thus, on the march in Malaysia – propelled by a conducive and supportive regulatory, institutional and policy environment and with an eye on a potentially untapped domestic market.
As Malaysia is a Muslim-majority country, Islamic fintech represents a promising platform to provide financing solutions that’re not only cost-effective, convenient, and Shariah-compliant on the one hand (in relation to the lenders), but which are also supportive of financial inclusion and economic empowerment on the other hand (in relation to the borrowers).
Funding/financial access has been a major issue for many Malaysians – whether on the retail side (for the individual and household consumer) or business side (MSMEs – micro, small, and medium sized enterprises).
Although accessibility (i.e., in terms of geographical location-wise) as such isn’t a huge problem for a country like ours, ease and convenience, i.e., from the viewpoint/perspective and experience of the consumer is something which fintech, overall, holds the “trump card”.
Now, with the (domestic) banking industry downsizing and cutting costs by reducing operations (by transferring staff from front-end to back-end roles and vice-versa) or completely shutting down operations via branch closures (including retrenchment), the issue of accessibility is also rapidly becoming a practical issue – which digital banking can leverage on.
According to Roland Berger, “there will be an 18% net reduction of retail bank branches across Southeast Asia by 2030 as lenders increasingly move away from branch-based services”. Roland Berger also estimated that “… there will be 567 closures in Malaysia within the decade, with the number of physical branches projected to drop by 23% to about 1,900 in 2030 from 2,467 in 2020” (“‘Nearly 600 bank branches in Malaysia to close by 2030”, The Edge Markets, May 17, 2021).
Foreign-based HSBC – which already lacks a substantial presence in Malaysia – announced in 2021 that it’ll shut down 13 branches nationwide. And recently, 13 branches under CIMB have closed (to be merged or relocated) due to the growth of online banking.
Islamic fintech may be the best contender to harness innovative solutions to address issues of access and accessibility, and tap into the overall market (i.e., comprising of both Muslims and non-Muslims alike).
Industry findings estimate 55% of the country’s adult population is unbanked (unserved) or under-banked (underserved), and just 39% of Malaysians are able to get a loan from their banks (“Tapping into the potential of digital banking”, The Star, June 06, 2022). Furthermore, 77% of SMEs remain only at a basic digitalisation stage (“Challenges in Digital Adoption”, SME Corp, October 20, 2021).
Similarly, Indonesia has an unbanked population of 51% and has only 30% of MSMEs in the digital market (“Indonesia strives to expand coverage of digitalization of MSMEs”, Antara News, September 16, 2022).
The lack of digital adoption in MSMEs can significantly hold back the economic potential of both countries. Digitalisation and digital tools help businesses reduce costs, standardise and automate business processes and reduce the reliance on manpower.
Digitalisation is also a prerequisite to remaining competitive in a world that’s constantly transformed by technology – from the way one can now enjoy their entire shopping (e.g., retail automation) or dining experience (i.e., robotic restaurants) without a single human employee, to the way one can now instantaneously communicate with another despite the distance (including topographical barriers) in between.
Digitalisation enables businesses to innovate solutions and achieve efficiency.
One of the biggest hurdles standing in the way of widespread digital adoption amongst business-owners in Malaysia is the financing costs associated with all the hardware and software.
With a majority of the population also being unbanked or under-banked, this means that essential financial services providing credit access are largely inaccessible to those who need it most.
Thus, digitalisation for economic empowerment is also a problem of financial inclusion.
Islamic fintech can drive solutions for SMEs and unbanked retail users as well as reducing the cost of services and innovating payment solutions to improve market expansion (“Leveraging Islamic Fintech to Improve Financial Inclusion”, World Bank, November 18, 2020).
The untapped potential of Islamic fintech is also in part reflected in the projected 21% CAGR (compound annual growth rate) by 2025 (compared to only 15% for conventional fintech), exponential growth of the Muslim birthrate, and also the increased global demand for socially responsible investing (SRI) and business practices, or ESG, which co-aligns nicely with Islamic finance principles (“Islamic FinTechs Rise in Southeast Asia”, FinTech News Malaysia, October 18, 2022).
Islamic fintech is based on the four main principles of Islamic finance – which are:
- profit-and-loss sharing (musharakah/ mudarabah);
- all wealth must be asset-backed and have a real economic purpose;
- investments should also have a social and ethical benefit beyond mere monetary returns; and
- harmful (haram) activities and industries should be avoided. It’s also characterised by the prohibition of interest (riba), excessive uncertainty (gharar), and gambling (maysir).
The principle of profit-and-loss sharing protects the borrower from disproportionately bearing the brunt of the risk in a business venture and the principle of wealth being asset-backed has led to Islamic investments being historically less volatile.
Zakat, sadaqah, waqf, Islamic microfinance, and micro takaful models also reduce the number of unbanked by providing them with financial access, thereby contributing to financial inclusion (please refer to the Glossary at the bottom of the article for definitions on zakat, sadaqah, waqf, and takaful).
Examples of Islamic fintech in Malaysia include HelloGold – an award-winning and Malaysian-grown Islamic fintech app that enables individuals to protect their savings via gold in a Sharia-compliant way. Other notable examples include MicroLEAP, Malaysia’s first Shariah-compliant P2P (peer-to-peer) financing platform for MSMEs, and also PayHalal, the world’s first Shariah-compliant payment gateway/ digital payments solution.
Indonesian success stories include PayTren, a payment gateway service that facilitates everyday monetary transactions alongside ALAMI, an award-winning and world’s first Sharia challenger bank as well as Kapital Boost, an Islamic-based P2P platform that offers short-term, ethical investment opportunities to global investors.
However, as it is, the Islamic fintech industry in both Malaysia and Indonesia is still nascent.
We’re still lagging behind in the share of equity-based financing products, i.e., based on the contractual principles of Musharakah (profit and loss-sharing) and Mudarabah (profit sharing) and also the lack of a distinct and specialised institutional structure to adjudicate on Islamic-based financial disputes – which still have to rely on the civil courts (“A Comparison Between Malaysia And Indonesia In Islamic Banking Industry”, Research Journal of Business and Management, Atikullah A., Vol. 4, Issue 3, 2017).
Meanwhile a report from a global news platform shows that Indonesia has the fifth largest share (USD2.9 billion) of the Islamic fintech market in the world. Reports also noted that millennials dominate the borrower category. The first in line is Saudi Arabia with USD17.9 billion followed by Iran with USD9.2 billion, United Arab Emirates (UAE) USD3.7 billion, and Malaysia USD3 billion” (“Indonesian Shariah Fintech Market 5th Largest in the World”, OpenGov, May 11, 2021).
According to a journal article published in F1000Research (“Business Trends & Challenges in Islamic FinTech: A Systematic Literature Review”, Vol. 11, Issue 329, 2022), current issues holding back Islamic fintech developments further in Malaysia are as follows:
- lack of specialist talents (in both Islamic finance and fintech);
- lack of regulatory guidance; and
- lack of a standardised Shariah-benchmark for Islamic fintech
However, bilateral cooperation between Malaysia and Indonesia could address these shortcomings via strategic synergies.
Beyond the cultural and religious commonalities (ties of kith and kinship) as well as geographical proximity (which enables economies of scale and market integration, among others), Malaysia and Indonesia also share a common vision to utilise Islamic fintech to achieve greater financial inclusion and economic empowerment.
In 2020, the Securities Commission (SC) of Malaysia and Indonesia’s OJK (Financial Services Authority) entered into a fintech cooperation agreement to facilitate information sharing and referrals for businesses seeking to operate in the other’s jurisdictions (“SC Inks Fintech Cooperation Agreement With OJK, Expanding Collaboration Between Malaysia – Indonesia”, Securities Commission Malaysia, August 24, 2020).
This is no surprise as these two countries bring to the table distinct and complementary strengths and contributions.
Malaysia is a country that’s been ranked first among 81 countries for 9 years in a row as the global leader in Islamic finance (“Islamic FinTechs Rise in Southeast Asia”, FinTech News Malaysia, October 18, 2022). Indonesia is among one of the fastest growing SEA countries with the world’s largest Muslim population (“Economy of Indonesia”, Indonesia Investments, 2022).
In order to fully unlock the wealth of opportunities in Islamic fintech, EMIR Research would like to propose the following policies:
1. SC and OJK to implement a framework to provide bilateral accreditation for Islamic fintech courses
This would take the existing cooperation agreement a step further by encouraging and paving the way for convergence and an emerging solid consensus on Islamic fintech standards, at least in the wider Southeast Asian region.
Such a convergence and consensus could then serve as a model and template – to be replicated and duplicated – in other parts of the world with significant Muslim populace (e.g., in South Asia).
2. SC and OJK to implement a framework to co-develop Islamic fintech consumer protection guidelines and regulations
At the same time, both countries can also step up with the existing cooperation agreement through maximum co-integrations of Islamic fintech principles and practices by co-developing consumer protection guidelines and regulations.
Together, both Malaysia and Indonesia could be the leading players in the global Islamic fintech industry – incubating creative and start-of-the-art solutions where social and ethical benefits are at the core of an Islamic financial ecosystem (4.0 and beyond).
Glossary of words:
Zakat = Annual payment for certain kinds of property for charitable purposes – a duty for Muslims who meet the wealth requirements.
Sadaqah = Voluntary charity contributions.
Waqf = Endowment by an owner of property for public benefit or wellbeing.
Takaful = A co-operative system of reimbursement or repayment in case of loss.
Musharakah = A joint partnership where two or more persons combine either their capital or labour, forming a business in which all partners share the profit according to a specific ratio, while the loss is shared according to the ratio of the contribution.
Mudarabah = A partnership in profit whereby one party provides capital and the other party provides skill and labour.
Haram = Forbidden by Islamic law.
Halal = Permissible by Islamic law.
Riba = Charged interest.
Gharar = Excessive risk and uncertainty.
Maysir = Gambling, where simply transfer of wealth takes place from losers to winners without real economic value being created.
Jason Loh and Jennifer Ley Ho Ying are part of the research team at EMIR Research, an independent think tank focused on strategic policy recommendations based on rigorous research.
The views, article and press release expressed are those of the writer(s) and do not necessarily reflect those of ANT