The realm of Islamic finance is currently undergoing a significant transformation, largely attributed to the ground-breaking impact of blockchain technology. This innovative technology is paving the way for considerable advantages within the Islamic finance sector, including heightened transparency and the development of state-of-the-art financial products.
According to recent projections by S&P Global Ratings, the Islamic finance industry, valued at an astounding $3 trillion, is poised to experience substantial growth of up to 10% in the years 2023-24. This growth is credited to the escalating digitalisation and collaboration with fintech, which are expected to fortify the industry’s resilience and create new avenues for expansion.
Despite the traditionally sluggish pace of digitalisation in Islamic finance in comparison to conventional financial services, a new wave of digital pioneers is revolutionising the landscape and reshaping the evolution of Islamic finance.
A pivotal study conducted by the Islamic Development Bank and the UNDP has revealed that Islamic financial institutions are increasingly embracing digital currencies and blockchain technologies in response to the prevailing wave of digitalisation in the industry.
Islamic finance operates on the principles that prohibit interest, uncertainty, and involvement in speculative activities. Blockchain technology aligns seamlessly with Shariah principles by promoting transparency, reducing fraud, and facilitating decentralised transactions.
According to Bashar Al-Natoor, the global head of Islamic Finance at Fitch Ratings, blockchain technology is being sought after in the finance industry due to its ability to enhance transaction efficiency, transparency, and security. It is being utilised for various tasks such as simplifying payments and money transfers, as well as improving clearing and settlement systems.
Furthermore, the lack of standardisation in Islamic finance has long been a significant restraint on the industry’s growth. To address this issue, the industry is leveraging technological opportunities and re-evaluating the issuance process while seeking to standardise Islamic bond-related standards in order to attract interest from non-Islamic finance markets.
The adoption of blockchain technology is expected to bring about enhanced transparency and security in financial transactions, while smart contracts can automate Shariah-compliant agreements and ensure adherence to Islamic principles.
Islamic finance has witnessed significant growth in markets across the Middle East and Southeast Asia, yet the industry continues to be fragmented, with inconsistent rule implementation across different jurisdictions, thereby limiting its expansion beyond its core markets in the MEASA region.
Efforts to harmonise Islamic finance and its adoption of global best practices have enabled the industry to transcend its niche offering to being acknowledged by the International Monetary Fund and offered by more than 300 financial institutions across 60 countries.
In its 2024 edition of Islamic Finance Outlook, S&P Global mentioned that Islamic finance is confronted by interrelated challenges, including the high complexity of structures and transactions that restrict its appeal beyond the industry’s original turf.
The inevitability of digitalisation in finance has led to extensive speculation about the potential of blockchain and its influence on Islamic finance to accelerate industry-wide growth. This technology promises to modernise Shariah compliance through embedded smart contracts, transparent management of obligatory charitable giving (Zakat), and a streamlined platform for Islamic bond issuance.
In a report by Moody’s, it was highlighted that blockchain technology is expected to enhance Shariah-compliant transactions by simplifying processes, increasing transparency, automating enforcement of Shariah-compliant rules, and reducing the risk of human error.
The tokenisation of Islamic bonds using blockchain technology is poised to reduce the costs associated with the issuance process, potentially enabling startups and SMEs to enter the field. This innovation is also expected to provide a more inclusive and efficient platform for capital market transactions in line with Shariah principles.
While embracing these innovative advancements, it is imperative for Shariah-compliant financial institutions to prioritize risk management and customer education to ensure successful adoption. Additionally, the establishment of a regulatory framework that encompasses the financial and technological nuances of blockchain is vital for a secure and sustainable transition.
In conclusion, the integration of blockchain technology into Islamic finance presents a transformative opportunity to strengthen processes, enhance transparency, and expand the appeal of Shariah-compliant products on a global scale. As the industry continues to evolve, the adoption of blockchain frameworks for Islamic finance, regulators, and innovation will play a pivotal role in shaping its future.