Asia is driving new developments in fintech. With an estimated USD 22.7 billion in fintech funding funneled into the region by the end of 2018, the region’s financial industry has been seeing a steady technological shift.
This includes the world of Islamic finance, which has been a focus in countries in Southeast Asia with significant Muslim populations, such as Indonesia and Malaysia. By definition, Islamic finance, or shariah-compliant finance, refers to financial activities conducted in accordance with Islamic shariah law. Asia has over 1.6 billion Muslims—the majority of which are in Indonesia—and they require shariah-compliant financing solutions that are inclusive and convenient, allowing a wider reach to various segments within society, including the unbanked or under-banked.
According to global accounting firm KPMG, there are around 438 million unbanked individuals in Southeast Asia, with the majority of consumers in economies like Indonesia, Malaysia, or the Philippines lacking access to financial services. For Southeast Asia’s 240 million Muslims, shariah-compliant fintech companies represent alternative financing solutions, such as crowdfunding and P2P platforms, with fast approval processes and wide accessibility.
Shariah-compliance
According to Shabana M Hasan, an expert at the Malaysia-based International Shariah Research Academy for Islamic Finance (ISRA), Islamic finance represents a financial system that is derived from the Islamic holy text (Qur’an) and prophetic traditions (Sunnah). The basic tenets of the Islamic financial system are the enforcement of justice and equality in all dealings and transactions. This is manifested through four fundamental prohibitions: usury (riba), speculation (qimar), unearned income (maysir), and uncertainty (gharar).
In a nutshell, usury (riba) refers to all forms of interest that provide a predetermined, fixed rate of return to the lender. In Islamic finance, this is forbidden as it may encourage wealth inequality, increase indebtedness, and lead to exploitation. Speculation (qimar) is a “zero-sum game” where, in financial transactions, the winner gains wealth at the expense of a loser. Islam forbids financial speculation as it represents a form of immoral inducement. Unearned income (maysir) refers to a type of income that is randomly generated or luck-based. Uncertainty (gharar) covers any transactions that possess elements of ambiguity, uncertainty, and hazard. For instance, a sale where the price or nature of the goods is unclear is considered invalid. This is also the main reason for the prohibition of various financial instruments such as derivatives—such as futures and options—in Islamic finance.
“In a bid to avoid usury and other prohibited elements, shariah-compliant financial institutions presently utilize various equity-based and asset-backed arrangements with the aim of promoting risk-sharing. The reason for this is to align the interests of all parties in a manner that is equitable and fair,” Shabana said.
The arrival of fintech, according to Shabana, could bring substantial benefits to customers, especially when it comes to financial inclusion and convenience. “Islamic fintech start-ups have opened up a new source of funding for SMEs [small and medium enterprises], who in reality will find difficulties in getting shariah-compliant financing from banks. Overall, with Islamic fintech services, the unbanked segment of society is now able to create a new form of credit history, thus achieving financial inclusion.”
Islamic fintech companies also make financial activities simpler, more convenient, and user-friendly for end customers who require their transactions to align with tenets set by their faith. “This efficiency and transparency enabled through fintech not only provides greater convenience to customers, but it also establishes public trust and confidence in the overall system.”
To date, fintech has transformed many areas of Islamic finance in Asia. The main types of services offered by Islamic fintech companies are peer-to-peer (P2P) lending, crowdfunding, money transfers, mobile payments, trading platforms, wealth management, and insurance.
A Thriving Landscape
With shariah-specific requirements, how challenging is it for a shariah-compliant fintech company to thrive? According to IFN Islamic Fintech Landscape—an international initiative mapping out fintech companies catering to the Islamic finance market—there are plenty of firms that are tossing their hats into the ring. As of the end of 2018, a total of 113 companies are active or at the launch phase; 46% of them are located in Asia.
Alami, a company that provides a marketplace for shariah-based SME financing, has managed to channel financing worth IDR 17 billion (USD 1.2 million) through its platform to various SMEs in Indonesia as of August 2019. According to Alami’s founder and CEO Dima Djani, there is a significant market demand for shariah-based fintech solutions in the country.
“Indonesia has the most Muslims in the world, with more than 200 million people, yet with only 8% penetration of Islamic banking industry,” Dima said. “We believe the total market potential will be at least double that amount in five years’ time, following the Indonesian government’s plan to increase market penetration to 15% by 2023. While the SMEs demand for shariah-compliant financing solution was skyrocketing, the Islamic banks moved slower than anticipated. This is why Alami decided to adopt our P2P financing approach to scale faster.”
P2P financing, which is also known as term-based shariah crowdfunding, is a common fintech solution offered in Islamic financing. Under this format for lending, investors contribute to shariah-compliant projects listed on the fintech’s company platform, in return for principal repayment with profits.
Dana Syariah, another Indonesia-based shariah-compliant fintech company, also operates on a term-based shariah crowdfunding basis. The company ended 2018 with IDR 80 billion channeled through its crowdfunding platform for the year, with a target of IDR 500 billion of annual financing by the end of 2019.
Atis Sutisna, founder and CEO of Dana Syariah, explains that in order to ensure that all projects on the platform are shariah-compliant, the company employs a high level of scrutiny during the selection process and until each project’s completion. “For instance, prior to financing a property project, our analysts will first analyze whether or not the project is eligible for funding. When all the requirements are met, our team will work together to determine the actual cost for building materials, as well as other operational costs that will require funding. We will then monitor the entire development project to make sure that everything is shariah-compliant and according to the contract.”
Atis also said that every transaction made on the platform has to follow shariah law, as it’s subject for approval from the Shariah Supervisory Board. In Indonesia, this advisory board is appointed by the Indonesian Ulema Council.
Dima Djani from Alami confirms this regulatory requirement. “Our business model and product must first be screened by the Shariah Supervisory Board, and then by the shariah division in the Indonesian Financial Services Authority (OJK). Our CEO and head of product also joined the shariah financial training provided by the Indonesian Ulema Council. In Alami, we are not only focusing on shariah compliance, but also shariah principles.”
In Indonesia, to be officially registered, OJK and the Indonesian Ulema Council require every shariah-compliant fintech company to have its own Shariah Supervisory Board.
Trust Issues
While the demand for Islamic financing remains buoyant, earning market trust is an uphill battle for shariah-compliant fintech companies. Dana Syariah’s Atis Sutisna says credibility is crucial within the sector. “Market demand for shariah-compliant financing is high, they’re looking for an alternative investment that has no element of usury. However, the biggest challenge that we’re facing is when it comes to our brand credibility.”
“There’s stigma around Islam-related businesses. In the past, there have been cases of business fraud using religion, and this has created negative perceptions among the public for businesses claiming to be shariah-compliant. This is why public outreach is very important for us,” Atis said. “We try to educate the public about our company through community engagement, digital marketing, radio talk shows, and TV appearances.”
Alami’s Dima Djani concurs. “We take our credibility seriously. Alami has won several prestigious awards, such as the INSEAD Venture Competition and Taqwatech at Malaysia Tech Week. Our team also consists of former bankers, who understand the business and the market.”
“However, there’s a credibility issue for Islam-related business in Indonesia for being run by individuals who are not professionals. This is related to the public understanding of the shariah finance concept itself. We feel that there’s a lack of market education for P2P models and shariah finance,” Dima said. “Indonesia is the country with the largest Muslim population in the world, but Islamic finance is not taught in schools, and we think this creates significant challenges when it comes to educating the public about our services.”
That makes it difficult for shariah-compliant fintech firms to recruit the personnel they need, particularly when major tech conglomerates are soaking up talented labor. “As an early stage shariah-compliant fintech startup, we find it challenging to compete with the unicorns when it comes to hiring top IT professionals from the talent pool,” Atis said.