A number of Islamic financial institutions are embracing blockchain, viewing it as a sharia-compliant tool that can simplify cross-border transfers, cut costs, promote financial inclusion and ease the administrative burdens of sharia certification. James King reports.
The modern Islamic finance industry has not always been known for its commitment to innovation. Over the past few decades, sharia-compliant financial institutions have grown at a rapid pace but they have done so, in part, by replicating and modifying conventional products and services.
This has led to many Islamic banks receiving a reputation for being too conservative. As evidence, critics of the industry have pointed to the lack of original products and services being generated for a digital age.
But times are changing. Today, these same banks are shaking the foundations of the market by partnering with fintechs – and increasingly progressive regulators – to deploy new technologies to meet their long-term growth plans. This is taking place as a range of Islamic start-ups, from new banks to sharia-compliant fintech groups, are questioning the traditional ways of doing business and forging their own growth stories through the use of technology.
Supporting innovation
Taken together, these trends are reshaping perceptions of the industry and offering a timely reminder of Islam’s support for innovation. “When we speak about innovation in technology or economics, for example, then Islam strongly recommends coming up with solutions to help solve the problems that mankind faces,” says Mansoor Munir, acting general manager at the Shariyah Review Bureau, a sharia advisory firm licensed and regulated by the Central Bank of Bahrain.
Blockchain technology lies at the heart of this innovation drive. Over the long term, some of the industry’s biggest challenges, including the structure of sharia-compliant contracts, could ultimately be solved by the application of blockchain. For good reason, many industry participants are excited about the changes that are taking place. “What I am seeing, from a personal perspective in terms of the application of blockchain, is amazing. If the institutions that are using this technology are successful, it could transform the Islamic finance industry,” says Mr Munir.
Today, Islamic banks, fintechs and other financial institutions from the Gulf Co-operation Council (GCC) to Malaysia are trialling blockchain offerings. At the forefront of this innovation wave is the world’s largest Islamic lender, Al Rajhi Bank. Under the leadership of chief executive Steve Bertamini, who was appointed in 2015, Al Rajhi has embarked on a sweeping reform of its business, including a core emphasis on digital excellence.
To this end, the bank has been an early adopter of artificial intelligence and today employs about 150 back-office bots that execute 19,000 transactions per day. But it is in distributed ledger technology that the bank, along with the wider industry, is making the most impressive strides. In 2017, Al Rajhi became the first bank in Saudi Arabia to make of use blockchain technology by executing a transaction between its Jordanian unit and its Saudi head office.
“Al Rajhi Bank is betting big on technology. Blockchain is just one initiative that falls under our digital growth strategy,” says Anil Pathak, a spokesperson for the bank. Since this initial transaction in 2017, Al Rajhi has gone on to complete a cross-border transfer outside of its network with Kuwait Finance House in early 2018. At the time of writing, the bank was also scheduled to complete a transaction with India’s Axis Bank in late October, marking a first for Al Rajhi in using blockchain technology to facilitate a transaction both outside of its network and outside of the Middle East region.
Al Rajhi’s success with blockchain stems from its partnership with US fintech group Ripple. Through RippleNet, the tech company’s global payments network that runs on advanced blockchain technology, more than 100 banks and payments providers are able to transact around the world.
“Ripple has engaged with a variety of financial institutions, including the largest Islamic finance bank, Al Rajhi Bank in Saudi Arabia,” says Dilip Rao, Ripple’s global head of infrastructure innovation. “Distributed ledger technology offers a more collaborative and democratic platform that can reduce costs and extend the reach of financial services into both the banked and unbanked sectors of the global economy.”
Targeting remittances
In the Middle East region, the push to use blockchain technology makes sense, particularly given the size of the regional remittance market. In the GCC alone, total remittance outflows reached more than $100bn in 2016, according to data from First Abu Dhabi Bank. With the average cost of remittances remaining high, and well above the UN’s Sustainable Development Goal target of 3%, there is massive scope for blockchain technology to reduce costs for consumers and improve the efficiency of these transactions for banks.
“Islamic banks can engage with fintechs such as Ripple to transform their own systems and extend reach – especially for use cases such as remittances, which they will be able to offer in real time, at lower cost and on a 24/7 basis,” says Mr Rao.
The size of this business opportunity is increasingly attracting the interest of non-Islamic players. In July 2018, California-based fintech group Stellar received sharia certification for its blockchain platform and cryptocurrency, known as Lumens, which comes as the firm is looking to tap into the Gulf region’s remittance market, among other opportunities.
In Saudi Arabia the central bank, the Saudi Arabian Monetary Authority (SAMA), is noting these developments. In February 2018, SAMA signed an agreement with Ripple to launch a pilot programme that will support the country’s lenders as they explore the US group’s cross-border payments solutions. It was the first agreement pilot of its kind to be launched by a central bank anywhere in the world.
“Our work with [SAMA] is a great example of collaboration that has enabled all Saudi banks to understand our solution and to engage safely with regulatory clarity on a collaborative programme to share learning by doing,” says Mr Rao.
According to ratings agency Moody’s, the programme will deliver cost savings of between $200m and $400m per year. It notes: “A successful pilot likely will lead Saudi banks to integrate distributed ledger technology into their existing payment infrastructure, improving payment transparency and efficiency. Saudi banks will potentially improve their profitability on cross-border transactions by reducing the cost of each transaction, while gaining revenue with higher volume as the customer experience improves with the saving of money and time.”
In the neighbouring United Arab Emirates, Islamic institutions are also engaging with blockchain. In June 2017 Emirates Islamic, the sharia-compliant unit of Emirates NBD, announced that it had become the first Islamic bank to integrate the technology into its cheques as a fraud prevention mechanism. Labelled ‘Cheque Chain’, the bank now issues cheque books with a unique QR code on each page, coupled with 20 random characters. Each cheque is then registered on the bank’s blockchain, enabling it to validate a cheque’s authenticity at source.
Small bank thinks big
Beyond large established banks, more nimble Islamic players are also utilising blockchain, including fintech operators and new start-up digital banks. The example of Hada DBank – which bills itself as the first digital bank to fuse Islamic finance with blockchain technology – is a case in point. Based in Malaysia, the team behind Hada DBank saw a gap in the market and seized the initiative.
“Hada DBank started off as a project to introduce a much more socially focused banking proposition. It is based on Islamic principles because operating this way brings benefits not only to the bank but to the wider community,” says Linda Azmi, co-founder of Hada DBank.
On this sharia-compliant foundation, Hada DBank’s team then turned to blockchain. “We opted to develop the bank around blockchain because of its simplicity. If the technology is used in the right way, we can eliminate most of the traditional paperwork. This is because, with blockchain, we are able to not only transfer data but also transfer value,” says Ms Azmi.
With an official launch expected some time in 2019, the Hada DBank team is now working on the completion of its own blockchain platform. According to Ms Azmi, this is the biggest challenge because, as a bank, it cannot release customer data on a third-party network. Hada DBank will also make use of its own currency, Hada Coin, expected to launch in late October 2018.
The team have plans to take Hada DBank international by opening offices in south-east Asia, Europe and beyond. “Our costs are considerably low. Blockchain cuts costs and when that happens the customer benefits,” says Ms Azmi.
This lower cost base will also help the bank with the planned roll-out of its ‘limited account’ product that will cater to the unbanked, including refugees and displaced populations. By registering at a Hada DBank kiosk, fingerprint and facial recognition technology will upload an individual’s details to the blockchain. “Once that is done they can get a limited account which will hold a maximum of $200 and enable small value transfers,” says Ms Azmi.
Solving problems
As the industry pushes forward with these new innovations, some of its long-term challenges look set to be solved. For one, Islamic financial institutions are burdened by the increased cost and time linked to the structure of their contracts. In some transactions, for example, profit-sharing agreements, agency contracts and partnership arrangements all require the sequential signing and arrangement of paperwork. At times this paperwork can be signed at the same time, or out of sequence, which renders the deal non-compliant in terms of meeting sharia standards.
Meeting these standards is not only time consuming, it also adds to the cost of doing business for Islamic banks, who are competing against conventional peers which need only sign a document between the institution and the borrower covering a loan with interest. Blockchain addresses this problem through the provision of smart contracts.
“The use of smart contracts through blockchain will enable Islamic banks, and their clients, to sequence the required paperwork and do so in a completely transparent manner. As a result, Islamic financial institutions will be faster, more efficient and more competitive,” says Mr Munir.
Tackling authenticity
Indeed, blockchain could also answer a challenge for sharia advisory groups such as the Shariyah Review Bureau. “We are exploring the ways in which blockchain can be used to tackle fake fatwas. The Shariyah Review Bureau is trying to see how blockchain can be used to authenticate sharia certification processes and sign-off by adopting a hybrid public/private ledger. In the future, this could be extended for use by other fatwa-issuing institutions around the world,” says Mr Munir.
There is little doubt that the Islamic finance market is set to change in profound ways as the use of blockchain accelerates. A growing number of banks and other financial institutions adopting the technology will only increase the ways in which it will alleviate the market’s growing pains. In doing so, blockchain is likely to play an outsized role in levelling the playing field between Islamic and conventional financial institutions across some products and services. As a result, a more competitive, efficient and customer-focused market is likely to emerge in the coming years.
“Blockchain can help reduce ‘gharar’ [uncertainty/risk] in cross-border payments, improve financial inclusion and lower barriers to commerce, in line with the very ethos of Islamic finance, which promotes the creation of an inclusive economic environment,” says Mr Rao.
