Introduction

There is growing demand for digital solutions from Islamic Financial Institutions (IFIs) in the UK and globally, especially amongst young Muslims. A Mambu report found that 74% of millennial and Gen Z Muslims desired Islamic finance mobile banking apps. Additionally, 76% considered online banking options a deal breaker for converting from conventional finance to its sharia-compliant counterpart. Whilst some efforts have been made, the digital solutions offered by IFIs are far behind non-Islamic finance. A major reason for this is that sharia-compliant fintechs, capable of providing innovative solutions to IFIs, have not grown as quickly as the rest of the market. But why is this the case?

Background to Islamic Finance

To understand where the challenges stem from, we must first look at the nuances of Islamic finance, which refers to a system of banking and financial practices that align with the principles of Sharia, or Islamic law. This framework prohibits interest, (riba), uncertainty and risk, (gharar), and investments in businesses considered haram (or forbidden) such as those involving alcohol, arms, gambling and tobacco. Sharia compliance ensures that all financial transactions are conducted ethically and equitably, promoting risk-sharing and asset-backed financing. Islamic finance also encourages investments in socially responsible and sustainable projects, which aligns with the ethical values of many consumers and investors. This holistic approach which adheres to Islamic religious principles serves 1.8 billion Muslims globally.

Regulatory and Financial Challenges

Because of this, sharia-compliant fintechs must navigate complex regulatory environments that differ from country to country, often requiring new types of licenses and regulatory approvals. For example, in Malaysia, the regulatory framework for Islamic finance is well-defined and centralised, with the Sharia Advisory Council (SAC) providing clear guidelines and approvals for Islamic financial products and services. In contrast, the UAE requires companies to secure approval from both the Central Bank and adhere to the Sharia Governance Framework. This mandates that each financial institution establish its own sharia board, leading to varied interpretations and implementations of sharia principles. As such, this makes global expansion for these fintechs very difficult.

These challenges are furthered by limited investment flowing into sharia-compliant fintechs. This is partly due to a lack of general awareness of the Islamic Finance market, and its benefits. For instance, a report by Fitch Rating  stated that in Indonesia, which has the largest Muslim population in the world, the sharia financial literacy rate was as low as 9.1% in 2022. Furthermore, due to the rigorous operational requirements such as sharia reviews, audits, disclosures and reporting, all of which come at a cost, the credit profiles of sharia-compliant fintechs are often relatively poor when compared with other fintechs. As such, venture capital and private equity firms remain cautious to invest in this nascent market, hindering expansion and innovation.  

For example,  IFG published a report highlighting the strong demand for Sharia-compliant products, particularly in insurance, credit, and personal finance. However, it also addressed the significant funding challenges faced by UK Islamic fintechs. Sharia-compliant property sharing startups, such as Strideup and Wayhome, exist but none are currently operational, as IFG estimates that they require between £30m to £100m patient capital to launch and survive. As there are no dedicated funds specifically targeting investments in Muslim-focused ventures, these fintechs continue to face significant barriers in securing the necessary capital to grow in the market.

Potential Solutions

So what can be done to overcome these challenges? One solution is the forging of partnerships between IFIs and sharia-compliant fintechs. Collaborations can push for and work with regulators globally to create a more unified regulatory framework, making it easier for fintechs to navigate different regulations and operate across borders. By pooling resources, banks and fintechs can ensure there is enough liquidity to meet customer demands, through the development of new products. Finally, joint ventures between fintechs and Islamic Banks can focus on training and upskilling staff to handle new technologies effectively and embrace the digital shift.

Emirates Islamic Bank, based in the UAE, is doing just this. They have launched a  global campaign to attract sharia compliant FinTechs and start-ups who can offer  solutions to improve their services around SME finance, trade finance and financial wellbeing. Therefore, this campaign shows that they understand the desire in the market for more digital solutions, and thus are turning to sharia-compliant fintech’s to help them meet this demand. This campaign also highlights the importance of the vendor selection process, involving rigorous application processes and shortlisting rounds, an area in which Woodhurst has supported multiple UK FIs.

Similarly, Al Rayan Bank, a UK Sharia-compliant institution, has embraced digital transformation and understands the importance of offering digital products, such as mobile banking apps, to meet customer demand. The bank published an article regarding the UK’s position as a thriving fintech hub and outlined the benefits that could be obtained by IFIs from leveraging this technology. Dr Alamad, Head of Sharia Compliance and Product Development stated that IFIs ‘role is vital in reinforcing the UK’s position as a fintech hub and in growing awareness of Islamic finance overall’. To build on this momentum, Al Rayan could look to emulate Emirates by focusing on utilising Sharia-compliant fintech’s to further improve digital transformation journey. This would ensure that all areas of their practice remain compliant with Sharia law, whilst also helping to support the growth of the Islamic fintech industry in the UK.

Conclusion

To summarise, in the age of digitalisation, IFSs have immense growth potential by partnering with and supporting the growth of sharia-compliant fintechs. These advancements could help them to better attract the younger Muslim and non-Muslim demographic through offering more innovative digital banking services.