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The $3tn Islamic finance {industry} is projected to develop by as a lot as 10 per cent in 2023-24, as greater digitalisation and fintech collaboration are anticipated to strengthen the {industry}’s resilience whereas creating new avenues for development, based on S&P World Rankings.
Regardless of the {industry}’s gradual digitalisation in comparison with typical monetary companies, a brand new wave of digital pioneers is reshaping how Islamic finance is evolving.
A examine by the Islamic Improvement Financial institution and the UNDP revealed that Islamic monetary establishments are embracing digital currencies and blockchain applied sciences amid a wave of digitalisation within the {industry}.
Islamic finance operates on rules that prohibit curiosity, uncertainty, and involvement in speculative actions. Blockchain know-how aligns properly with Shariah rules by selling transparency, lowering fraud, and facilitating decentralised transactions.
“Blockchain know-how is changing into more and more common within the finance {industry} due to its skill to enhance transaction effectivity, transparency, and safety. It’s used for duties resembling simplifying funds and cash transfers and enhancing clearing and settlement programs,” says Bashar Al-Natoor, international head of Islamic Finance at Fitch Rankings.
Al-Natoor notes that the modern know-how can be utilized in commerce finance for record-keeping, identification verification, and digital securities issuance.
The shortage of standardisation in Islamic finance is a big constraint on the {industry}’s development. To draw curiosity from non-Islamic finance markets and drive development, the {industry} is capitalising on technological alternatives and re-evaluating the issuance course of whereas standardising Islamic bond-related requirements.
Business specialists anticipate that blockchain know-how will improve transparency and safety in monetary transactions, whereas sensible contracts can automate Shariah-compliant agreements and guarantee adherence to Islamic rules.
Harmonising Islamic finance
Islamic finance has been on the rise for a few years throughout markets within the Center East and Southeast Asia (MEASA). Nevertheless, the {industry} stays fragmented, with uneven rule implementation throughout jurisdictions, curbing its development past core markets within the MEASA area.
Standardisation in Islamic finance and the adoption of worldwide greatest practices have enabled the {industry} to evolve from being a distinct segment providing to being recognised by the Worldwide Financial Fund and supplied by greater than 300 monetary establishments throughout 60 international locations.
In its 2024 version of Islamic Finance Outlook, S&P World mentioned that Islamic finance faces interrelated challenges, together with the excessive complexity of buildings and transactions that restrict its enchantment past the {industry}’s authentic turf.
The efforts of {industry} our bodies, together with the Dubai Worldwide Monetary Centre, have largely diminished variations within the interpretation and follow of Shariah rules to make sure soundness, stability and integrity of the Islamic finance {industry}.
Digitalisation is a central theme in finance, and there was hypothesis about what modern applied sciences resembling blockchain, also called distributed ledger know-how, may imply for Islamic finance and its potential to speed up industry-wide development.
Blockchain know-how guarantees to modernise Shariah compliance by means of embedded sensible contracts, up to date and clear administration of compulsory charitable giving (Zakat) and a extra environment friendly platform for Islamic bond issuance.
Moody’s mentioned in an April report that the modern know-how’s core characteristic would possible enhance Islamic transactions by streamlining processes, rising transparency, automating enforcement of Shariah-compliant guidelines, lowering the chance of human error, and facilitating real-time settlements.
With embedded Shariah-compliant phrases and situations, sensible contracts may foster adherence to Islamic finance rules, resembling profit-sharing (Mudarabah) and cost-plus financing (Murabahah), whereas mitigating the chance of fraud and lowering transaction prices.
Blockchain also can enhance the accountability and auditability of Zakat funds, offering real-time visibility into their use and affect. The modern know-how presents a promising avenue for compulsory charitable giving in Islam that will modernise its assortment and distribution processes.
Harmonising requirements presents a big alternative for Islamic finance. The adoption of blockchain within the {industry} is anticipated to streamline and strengthen processes and practices, enhancing the enchantment of Shariah-compliant merchandise.
Digital sukuk issuance
S&P World projected that sukuk issuance would attain $160-$170bn in 2024, down from $168.4bn the earlier 12 months and just under $179.4bn in 2022. Nevertheless, the {industry} faces quite a few challenges, together with the excessive complexity of buildings and transactions, which limits the enchantment of Islamic bonds past their authentic market.
“Over the previous 18 months, we rated round $1.6bn of digital bonds issued by sovereigns, multilaterals, native and regional governments, companies, and monetary establishments. The bonds have been principally issued on non-public blockchains, with funds made off-chain and through conventional rails,” says Mohamed Damak, managing director at S&P World Rankings.
Damak explains that although S&P World has not but rated any digital sukuk, the Islamic bond market can considerably profit from the adoption of blockchain.
Moreover, sukuk issuance is linked with excessive prices and the chance of human error on account of a number of intermediaries concerned within the issuance course of. However every time there’s a problem, there is a chance, and the development in modern applied sciences offers alternatives to unlock future development.
The tokenisation of Islamic bonds utilizing blockchain know-how is anticipated to cut back prices related to the issuance course of, probably permitting startups and SMEs to enter the sphere. Moody’s acknowledged that blockchain may present a extra inclusive and environment friendly platform for capital market transactions according to Shariah rules.
Damak notes that blockchain can simplify the monitoring of underlying belongings, supply visibility into the asset, make monetary and Shariah audits simpler, and, as an modern know-how, simplify the decision-making course of.
Prioritising threat administration and buyer training is essential for the profitable adoption of blockchain and digital belongings in Islamic finance, Moody’s cautioned in a report in April, whereas noting that Shariah-compliant monetary establishments should determine and mitigate potential dangers resembling cybersecurity threats.
Al-Natoor explains that establishing a regulatory framework that encompasses the monetary and technological nuances of blockchain is important, but it surely stays underdeveloped in lots of core Islamic finance markets. “This creates extra authorized dangers, such because the enforcement of sensible contracts or the definition of the standing of digital belongings,” he says.
By leveraging blockchain, sukuk issuance would develop into extra clear, as all transaction information could be recorded on a tamper-proof and immutable ledger. This may foster belief amongst buyers and guarantee Shariah compliance.
The know-how additionally permits fractional possession and secondary market buying and selling, democratising entry to sukuk investments and increasing their attain globally. Going ahead, {industry} specialists say that blockchain frameworks for Islamic finance, regulators, and innovation can be important.
