In my previous posts, I discussed how Fintech with a social impact could be a viable business model. Would Financial Services and banking be viable if it got more ethical? Post recession, we have had regulations force good business practices within banks. Decades ago, with products, processes and policies driven by cultural values, Islamic banking has just done that – taken an ethical route to Financial Services. Yet, Islamic banks have struggled to compete due to those constraints. We may have just found an answer to make this system more competitive in Fintech. Yielders, a UK based equity crowdfunding provider, has just attained the first Islamic Banking certification and become the first FinTech firm in the West to do so. Yielders have developed a proposition that looks pretty innovative, pragmatic and competitive in a low yield environment. In the process, they might well have set themselves on a path to pioneer viable Islamic Fintech in the UK and possibly in the West.
Islamic banking in the formal sense has been around for well over 60 years. However, Financial institutions that comply with Sharia laws only manage 1% of assets globally. This has been attributed to some of the principles, which act in ethically regulating the business, hence make Islamic banking less competitive. The key principles are,
- No Interest (Riba): Sharia compliant banks cannot charge interest on their products. This is because of the principle that the banks can’t charge someone interest because they had access to money that the clients didn’t. And money can’t create money, which will result in rich becoming richer and the poor becoming poorer. Lending can be only against tangible assets.
- No Uncertainty (Gharar): Institutions have to be transparent to its customers on the products they are being sold. There cannot be an open ended or uncertain contractual relationship between a Sharia compliant institution and its customers. In the west, this is now being enforced, under Conduct based regulations.
- No Gambling: This is clearly prohibited under Sharia laws. But this is not just about not lending to a casino business (Gambling). Products that are based on making money in an uncertain situation (Speculating) like derivatives (Futures, Forwards, Options etc.,) are also prohibited.
If the whole of the Non-Muslim world had followed the above principles, we wouldn’t have had a credit crunch in 2008. Now, following these principles come with various overheads.
Product Development: Islamic Financial Institutions (IFI) need to be more innovative than their Non-Islamic counterparties to remain competitive. In the UK, there are 5 Islamic banking entities, and only one of them provide products for retail customers, and those products aren’t competitive on returns when compared to high street banks.
Regulation and Standardisation: There is no central body to regulate and support IFIs as we have the FCA in the UK for banks. This ends up in a lack of awareness with the institutions that want to understand this space better. Also, interfacing between Islamic and Non-Islamic Financial Institutions is quite challenging without the standardisation of products and operational processes. Most IFIs self-certify with certain authorities or with a panel of experts in the field.
Liquidity: As a result of the above two points, there is poor liquidity for Islamic banking products, with low volumes and transactions. This is also worsened by inefficient back office processes that are yet to be upgraded to 21st century standards.
Innovation: Islamic banks are still trying to get into digital banking, when this has been well on its way in the West for almost a decade. Most records are still paper based, and information exchange is not automated.
Yielders leads the way:
Most of the current challenges could be solved by thinking Islamic banking and its products ground up, which is what Yielders have attempted to do. Yielders, an equity crowdfunding provider, led by Irfan Khan proves Fintech could be an answer to most of the above issues. Irfan was born in the UK and has spent 15 years specialising in developing technology solutions within Banking. His passion to bring to light the principles behind Islamic banking, and make them work in a Western context was the driving force behind Yielders. Today Yielders is the only Western FinTech firm that is Sharia compliant.
Over the years, Irfan has seen and understood the challenges that IFIs have had in the UK and wanted to change the landscape. One of the key issues with existing IFIs in the UK has been that, they have only targeted the Muslim community in the country. None of the IFIs in the UK have a non-Muslim name for example. In his opinion, they establish themselves in the west with almost an acceptance that their products wouldn’t be competitive enough for the non-Muslim world, and they would play the “ethical-product” marketing route with their Muslim customers. Irfan has turned this approach on its head by establishing Yielders as a Western financial institution that complies with Sharia principles. This he believes would attract more Western customers who the traditional IFIs haven’t even bothered targeting.
The other fundamental issue with IFIs operating in the west was that they were “shoe-horning” their products to the western markets. Irfan is taking a ground up approach with a Fintech hat on. At Yielders he is able to be more innovative with his products as he has structured them to be compliant with Sharia laws. However, he doesn’t think this is possible in a traditional IFI (yet) that lacks the agility of a Fintech firm. As a result, he is able to offer competitive returns on his products that are currently focused on Real estate, and could soon be extended to ISAs, SIPs etc., Yielders currently offer up to 6% net yield (without leverage) plus capital appreciation. This is a very practical and differentiated proposition for middle class consumers in a low yield environment.
It also became evident during the interview with Irfan that apart from agile product innovation, innovative data sourcing/interfacing is needed to make back office operations more efficient for IFIs to run on a lower cost base. As the operational costs go down, products can be priced more competitively which will bring liquidity to the market. Fintech could also improve interfacing and interactions between IFIs and Non-IFIs through various API and data exchange technologies, and automate back office processes.
Several years ago when I was doing my business degree there was a session on corruption. The course material started with Anna Hazare’s movement in India against corruption, and pretty much went on to project corruption as a thing with the emerging markets. There was a challenge from a Chinese student, who asked the professor “why is corruption being projected as a problem in the developing world, when Billions got wiped out of people’s pensions during the Credit crisis in 2008. Isn’t wall street the most corrupt place?”. Something I have noticed in the West is that if something is legal, it’s considered to be right. No wonder business schools run courses on Ethical business practices. There are a few things that the banking world, driven by capitalistic ideals, could do to make it more principles/values based. And if done so, it would most likely look like Islamic Banking. A few more players in Islamic Fintech could spark a new wave of opportunities both in the West and in the Islamic world. Inshallah! (God willing)