How Islamic Finance Promotes Financial Inclusion

A sukuk is a form of financial certificate that is issued in compliance with Islamic finance principles and Sharia law. Sukuk is an Arabic word meaning 'deed, cheque, or legal instrument'.

The main purpose of a sukuk is to create returns for investors that are similar to the returns available on traditional fixed income bonds.

As the Islamic finance market has grown over the last few decades, so has the interest in and demand for sukuk bonds. Essentially, sukuk bonds are similar to traditional bonds in that they have parties who are involved in seeking a return on investment, and sukuk bonds are subject to the same credit rating as conventional bonds.

Sukuks are commonly used by corporations and even governments to finance their business operations.

Islamic Finance Principles And Sukuk

Sharia law does not permit investors to partake in investment activities that involve riba. The payment or receipt of riba (interest) is strictly forbidden in Islam.

Most conventional Western market bonds are based on an interest paying structure, and this is not permissible for investors who do not want to receive or pay interest on their financial investments.

Sukuks were first issued over a decade ago in Malaysia who were forward-thinking when it came to creating and supporting financial investment products that Muslims could be involved in. Bahrain was quick to follow Malaysia in issuing sukuks, and these days sukuks can be found in economies across the globe.

Sukuks take up a respectable share in the fixed income market globally. Sukuks have emerged as a great Sharia compliant alternative to traditional interest based bonds.

Sukuks offer Muslim investors the opportunity to invest in bonds and subscribe to certificates that represent the right to actually receive a share of profits that are generated by an asset base. The profits are generated by the asset base being traded on the market.

What do we mean when we refer to fixed income bonds? Sukuks are fixed income bonds. This means that they are fixed income investments and they can provide what is considered to be a more steady stream of income.

Islamic Bonds

Sukuks are considered to be Islamic bonds. They involve asset ownership which is direct, rather than indirect interest based bonds that Western markets tend to offer.

Any income, return, or profits generated from a sukuk cannot be derived from any speculative activity. This would render the return haram under Sharia laws.

So, how do sukuks work? What normally happens is that the issuer of the sukuk certificate will sell an investor a certificate. The proceeds of the sale are then used towards the purchase of an actual asset. The investor then has a partial interest in the asset based on their respective investment.

Another element of sukuk that is important to note is that the issuer of the certificate must promise that they will buy back the sukuk at a future date.

When it comes to sukuks, compliance with Sharia law means that any profits that are derived from the investment must be totally free of speculative activity and interest.

Sukuk Versus Traditional Bonds

As Islamic finance rules do not permit interest, this means that the traditional Western debt and loan instruments are not accessible to Muslim investors who want to comply with Sharia rules.

Sukuks have therefore become a great alternative for investors (Muslim and non-Muslims) to use sukuks as a viable alternative method of raising funds.

Sukuks are considered to be an interest in an asset, and not a debt obligation or debt instrument.

Conventional bonds and sukuks do have some similarities:

• Both traditional bonds and sukuks offer investors a stream of income payments. The payments on traditional bonds include interest payments, and the payments from sukuks are based on profits from the assets.
• Both bonds and sukuks are sold initially by issuers of the certificates.
• Sukuks and bonds are viewed as less risky than equity based investments

When it comes to ownership, sukuks allow for partial ownership of the asset, whilst conventional bonds are more of a debt obligation. Sukuks are not debt obligations.

It is also important to note that often, conventional bonds finance businesses or industries that are deemed to be haram under Sharia law principles. These haram industries include the gambling industry, alcohol industry, and porn industry. Sukuk bonds cannot be linked to any form of haram activity or industry.

HOW ARE SUKUK CERTIFICATES ISSUED AND HOW DO THEY WORK?

Sukuks are usually found in the form of certificates, also known as trust certificates. In the United Kingdom, sukuk certificates are regulated by the Financial Services Authority. In other countries and economic landscapes across the world where sukuk certificates are issued, there is similar regulation of them.

There is a very specific process for issuing any form of financial certificate including sukuk certificates/ bonds.

The steps below outline the most common steps that are involved in issuing a sukuk certificate:

1. Normally a company that requires some form of capital will establish a special purpose vehicle that is known as an SPV for short.
2. The company is known as the originator.
3. The special purpose vehicle aims to protect the underlying asset from potential creditors in the event that the originator gets into financial difficulties.
4. The special purpose vehicle issues the sukuk certificates.
5. These sukuk certificates are then sold on to investors for a price.
6. The originator uses the funds raised from the sale of the sukuks to purchase the asset they want.
7. The special purchase vehicle will then purchase the asset from the originator.
8. The special purpose vehicle will then establish a form of lease to lease back the asset to the originator.
9. The originator will make the necessary lease payments to the special purpose vehicle.
10. The special purpose vehicle will then distribute the lease payments to the investors.
11. Once the lease is terminated, the originator will buy back the asset from the special purpose vehicle at nominal value.
12. The proceeds of the sale are then distributed by the special purpose vehicle to the holders of the certificate.

Different Types Of Sukuk

As mentioned above, most sukuk certificates have been presented in the various global markets as trust certificates. It is very common for English common law to govern the law relating to sukuk trust certificates in different countries.

However, the management of sukuks varies from country to country so it is always advisable to do your research about the jurisdiction that regulates your sukuk. Information and transparency are key when it comes to any form of investment, especially sukuks. Where possible, always carry out an analysis of the sukuk product or service before you proceed.

The main types of sukuk are as follows:

1. Trust certificates - in this form of structure the originator of the sukuk will create the special purpose vehicle and issue trust certificates to the investors. The proceeds are then used to build a portfolio of assets which will eventually yield a return.
2. Civil law structures - these types of structures have emerged to enable sukuk transactions to be undertaken in accordance with the local laws of the country where the originator is based. One example of a country that used civil law structures when it comes to sukuks is Turkey. Turkey have passed their own legislation relating to sukuks which has to be complied with.

Sukuk For Investors

As Muslim investors have historically not had the opportunity to invest in bonds without an interest element, sukuk bonds have been welcomed across many global economies.

Sukuks are a great way of enabling investors to link returns with the cash flow of financing assets without the riba of traditional form of debt financing.

However, it is important to point out that sukuks as a form of financing should only be used for identifiable assets. Identifiable assets are those assets whose commercial value can be ascertained at any given point of time. Identifiable assets include things like real estate, equipment, cash, and stock.

In this way, the holder of the sukuk bond /certificate does not own a debt, but as the owner of the sukuk certificate, they own a share of the asset that is purchased using the sukuk funds.

Even though the special purpose vehicles that issue the sukuk certificates are usually brand new, this does not mean that investors will bear exposure to the credit risk of that special purpose vehicle.

Advantages Of Sukuk

Here are some of the main advantages of investing in sukuks:

• For those looking for investment from Islamic economies and markets there is a great marketing benefit to sukuks who will appeal to investors looking for Sharia compliant ways of investing their money
• Sukuks are known to yield similar profit on par with conventional bonds
• More bank and financial institutions are offering sukuk products (always check the website of any organisation offering Sharia compliant products to ensure that you have all the information you need)
• The investor base of Sharia compliant investors is vast and continues to grow
• In addition to the Islamic finance investment market, there is also potential to tap into the ethical investment market which has developed over the last few decades and is always in the news
• Issuers of sukuk certificates are entitled to the same tax arrangements as the equivalent traditional financing arrangements
• Assets that are acquired by the sukuk bonds are jointly owned
• Instead of receiving interest, the holder of the sukuk certificate receives actual profits
• Sukuks offer banks the opportunity and tools to invest their excess liquid assets
• Sukuks can operate for contractual terms that are agreed upon between the parties
• Sukuks continue to grow with success attracting all kinds of high-quality investors including Muslim and non- Muslim investors
• Sukuks have been used across various locations and industries including transport, water, power, education, infrastructure and industrial

WHAT IS ZAKAT?

Zakat is one of the five pillars of Islam. It is an obligatory act of worship and is also a mandatory form of charity for Muslims. It has always been seen as a means by which people can achieve social impact through the redistribution of their wealth. The five pillars of Islam are the absolute fundamentals of Islam and include the following:

• Faith (shahada)
• Prayer
• Zakat
• Fasting
• Hajj

Every Muslim is expected to fulfil these five pillars of Islam which serve as the very fundamental acts of worship prescribed by the Islamic faith.

Paying zakat, sometimes referred to as almsgiving, is an obligation for every Muslim who is able to and serves to bring economic equality, fairness, and to rebalance societal injustice.

The Obligations Of Zakat

Muslims who have the financial means and capability are required to pay zakat. They must donate 2.5% of their wealth (see our zakat calculator to work out how much you need to pay). The 2.5% is calculated on money and assets.

The aim of zakat funds is to ensure that they are used to provide the basic necessities for families and communities in need. These needs can include the provision of food, shelter, clothing, education and healthcare.

One of the most important elements of zakat is that payment of it is seen as a means of purifying your wealth whilst demonstrating empathy and compassion for others. In fact, the word zakat actually means 'cleansing' or 'purifying'.

The whole concept is based on the idea that once an individual donates a percentage of their wealth to charitable causes, they fulfil their moral obligation to serve others and build stronger communities and economies. Zakat is particularly important in times of crisis, as it can be used to alleviate hardship via the distribution of wealth.

Zakat is not the same as sadaqa which is encouraged but not obligatory. Zakat is an annual payment that is worked out in a specific way and spent in a specific way.

The Exemptions From Zakat

There are some important exemptions to be aware of when it comes to zakat.

Firstly, there are exemptions for those people who do not have to pay zakat and these include:

• children
• the mentally ill
• the infirm and elderly
• slaves
• Non-Muslims
• the very poor

WHO CAN RECEIVE ZAKAT?

Islamic finance principles set out clearly who can receive zakat. Those eligible to receive zakat include the following:

• Poor people
• The needy
• Debtors who cannot repay their debts
• Orphans
• Widows
• The stranded and destitute
• Travellers
• Slaves or captives
• New Muslims
• Those fighting a just cause

It is very important that when you pay zakat the recipients meet the eligibility criteria set out in Sharia law. Always make the intention of helping those who are in need and adhering to the principles of Islamic finance.

WHAT ROLE DOES SOCIAL JUSTICE PLAY IN ISLAM?

Social justice is one of the fundamental principles of Islam and Islamic finance. The Islamic framework is centred on social justice in all aspects from individual behaviour, to financial transactions, to how we behave in relationships with others.The teachings of Islam place great significance on ethical and moral behaviour. Islam promotes social justice by emphasizing the importance of the following concepts:

• Anti-discrimination: all humans are seen as equal in Islam and discrimination in any form is prohibited. In fact, the Prophet Mohammad's final sermon reiterated how important it was to treat everyone equally and fairly.
• Economic equity: Islam promotes economic justice by ensuring there are frameworks in place for wealth distribution. Zakat plays a key role in the distribution of wealth. Furthermore, the prohibition on interest further prevents exploitation and inequality.
• Charity: as already mentioned the concept of charitable giving is an essential element of Islam. Charitable giving takes place via zakat and sadaqa (amongst other forms of donation). Muslims are encouraged to consistently donate to the poor.
• Gender equality: as mentioned above, Islam believes that men and women are equal and it actively promotes gender rights (particularly those of women) and equality. The Quran consistently mentions treating people with respect and fairness.
• Legal justice: Sharia rules set out the legal framework within which Muslims operate and these rules focus on justice, fairness, and equity. The legal judicial system in Islam operates to ensure that justice and fairness are implemented.
• Ethical behaviour.

The Potential Of Zakat

The actual potential of zakat is large, and estimated to be valued in the region of $200 billion - $1 trillion (this is according to research from the Institute of Development Studies and the World Bank). It is difficult to estimate the exact amount paid each year, but it is clear that Muslims who pay zakat on an annual basis are some of the biggest and most consistent charity givers in countries across the world.

Whilst the Western world is still learning about the impact and potential of zakat, Muslim economies have harnessed the potential of zakat for many decades by establishing leadership institutions to manage and distribute zakat. In addition, Muslim countries have had discussion and debate with scholars relating to zakat and how best to use it, incorporating it into fiscal policy.

HOW DOES ZAKAT HAVE A SOCIAL IMPACT?

• Empowers individuals and communities
• Alleviates poverty
• Optimisation of social good
• Social cohesion building
• Wealth distribution
• Funding charitable projects (such as climate and environment change programmes, education, and healthcare initiatives and practices)
• Economic development
• Promote social justice

An underlying philosophy of Islamic finance and Zakat is the concept of mobilising finance for the greater good. Islamic finance embodies socially responsible actions whether from companies or individuals.

Zakat And Sustainable Development Goals

As zakat is applicable to all Muslims across the globe, it is one of the largest and most successful forms of philanthropy. It acts as one of the largest methods of wealth transfer from the rich to the poor that takes place consistently and with clear guidelines.

Inspired by the Islamic faith, zakat is taking on relevance in countries throughout the world including the UK, United States, Australia and beyond.

Alleviating poverty, inequality, and hunger are not only central tenets of Islam and Islamic finance, but they are also part of the UN's sustainable development goals. According to the Quran there are 8 categories eligible for zakat (see above) and these all align strongly with sustainable development goals.

Some countries such as Indonesia have started collaborating with zakat donors to achieve partnership working towards sustainable development goals. This is a win-win for Muslims as Islam and Sharia rules relating to financial transactions state that every person should seek to work collaboratively and fairly for the good of society.

Conclusion

The power of zakat to harness social impact through charity is undeniable. When you clearly understand what zakat is and its function in society it becomes clear that zakat has the power and potential to alter lives and bring equity.

Introduction

Progressing at pace, the already flourishing Islamic fintech (financial technology) sector, itself the embodiment of the evolution of existing Islamic financial services, now has a clear opportunity to further embed itself within the world of global finance. Islamic fintech can be defined as an offshoot of financial technology that is built on Sharia principles, prohibiting profiting from debt, interest payments and investing in businesses related to alcohol, tobacco and gambling amongst others.

With the socio-economic upheaval and geo-political changes brought about by the global COVID-19 pandemic and the ongoing war in Ukraine, Islamic fintech currently has the chance to become not only a game changing, disruptive force within global finance, but an influential driver of global financial inclusion.

2020 was a landmark year for Islamic fintech as it was the first time that a standalone Islamic fintech company purchased another, with the New York based ethical investment platform and global robo adviser Wahed acquiring the UK based, Sharia compliant digital banking operator, Niyah.

So if Islamic fintech continues along the same path of rapid growth that it has been travelling along on for some time, the sector will unquestionably emerge as a competitive selection of Sharia compliant alternatives to the wide range of innovative fintech startups and established fintech giants that have been a mainstay of Western, Asian and more recently African economies over the last quarter century.

This article explores the latest in Islamic fintech as well as forecasts of the sector’s huge future potential.

The Development Of Islamic Fintech

Islamic finance is one of the fastest growing sectors of the global finance industry. Catering to the financial needs of the 1.8 billion Muslims across the planet and a broader, international ‘ethical finance’ audience, Islamic fintech’s role holds greater significance now more than ever before, where the need for global investment and financing has never been greater, especially in terms of financing SDGs (Sustainable Development Goals) and ESG (Ethical, Social, and Governance) investments, both of which align closely with the Islamic concepts of social justice and zakat (charity).

(consultancy-me.com, jan2022)

The global fintech revolution is having a similar impact on Islamic finance through the evolution of a progressive, forward-thinking Islamic fintech ecosystem, with many Islamic fintech startups using existing, successful fintechs as loose models upon which to base their own, Sharia compliant fintech organisations on.

With the appropriate modification, many of the hugely successful fintech companies across the world could be used as a blueprint to help spawn their Sharia compliant counterparts.

Statistics On The Islamic Fintech Industry

Standard & Poor’s Head of Islamic finance stated that he believes the market will expand by approximately 10% in 2022-2023 after it expanded with a 10.2% growth in total assets in 2021. In 2020, the total combined asset value of the global Islamic finance market amounted to approximately 2.88 trillion U.S. dollars, with more than 200 million micro, small and medium-sized businesses that still require banking assistance.

Over three quarters of Islamic fintechs are active in more traditional areas related to raising funds, deposits and lending, wealth management, payments and alternative finance, meaning that the digital banking space is somewhat up for grabs.

(Global Islamic Fintech Report 2022)

Based on the 2022 Global Islamic fintech report from Dinar Standard and Elipses, the size of the global Islamic fintech market was $79 billion in 2021, although accounting for just 0.8% of the entire global fintech market. The Islamic fintech market size is expected to reach $179 billion by 2026 at a CAGR of 17.9% relative to the overall global fintech industry, which is expected to grow over the same period at a CAGR of 13.5%. The report also estimated that Saudi Arabia, the world's largest Islamic fintech market, is currently worth around $26bn and is projected to more than double in value in the next five years to $52.3bn.

75% of young Muslims want their banks to make investments that ‘do good in the world’, with 62% opposed to their bank lending to tobacco companies and 69% against their bank lending to gambling institutions. 74% of young Muslims said it’s important they can access their bank’s services via a mobile app and 80% said it’s critical they can access banking services anywhere, at any time.

Islamic Finance is currently estimated to be worth $2 trillion globally, at the very least. This figure is set to hit $3.8 trillion by 2023, as driven by high demand from millennial and Gen Z Muslims, who are confidently expected to account for upwards of 75% of Islamic banking revenue within the coming decade. Furthermore, with data from the ONS (Office of National Statistics) showing that by 2019 more than 90% of 16-24-year-olds were already managing their money online, it looks as if the Islamic fintech space will be a blessing for both consumers and providers.

In the UK, 4 million Muslims make up the second largest religious group in the country and according to the Muslim Council of Britain (MCB) contribute £31 billion to the UK economy and wield a spending power of £20.5 billion.

The UK had the third-largest number of Islamic finance education providers, only trailing behind Islamic finance powerhouses Indonesia and Malaysia. Furthermore, the UK leads the way with 27 Islamic fintechs, predominantly catering to the needs of British Muslims that want to bank with ethical financial institutions, which is more than the United Arab Emirates with its 15 Sharia-compliant fintechs.

(Global Islamic Fintech Report 2022)

Examples Of Leading Islamic Fintech Companies

Below is a selection of the most innovative and successful Islamic Fintechs currently operating around the globe:

• Qardus- The UK’s first ethical and Sharia compliant SME financing marketplace that offers up to £200,000 in working capital financing to eligible small businesses.
• Islamic Finance Guru - An online hub assisting Muslims with their investment, personal finance and entrepreneurial journeys.
• Path Solutions- Provider of Digital Banking, Risk Management/Compliance, and Banking software, serving over 150 Islamic institutions across 40 countries.
• Wahed- Ethical investment platform and the world's first global Islamic finance robo advisor. Launched the first exchange-traded fund in the United States that was compliant with Sharia law in 2019.
• P2P financier Amartha Mikro Fintek & Bank Sumut - Empowering women micro entrepreneurs through inclusive financial services including Islamic facilities to develop women-owned MSMEs in the region.
• Global Sadaqah - Award-winning, Kuala Lumpur based philanthropic fundraising finance platform, featuring CSR, Zakat and Waqf Management services.
• Yielders -UK based Islamic fintech and leading peer-to-peer property investment platform.
• PayHalal
• -
• World's first Sharia compliant e-commerce payments gateway and online ewallet issuance market. Owned by Souqa Fintech, PayHalal launched the world's first Islamic buy-now-pay-later (BNPL) platform in 2021
• MRHB DeFi Network - World’s First online, ethical / Halal DeFi Solutions platform for passive crypto Income, commodity exchange & staking. Blockchain services provider based in Sydney, Australia.
• coinMENA- One of the world’s first Sharia-compliant crypto-assets trading platforms offering non-traditional investment options in the MENA region. Licensed and regulated by the Central Bank of Bahrain (CBB).

Challenges For The Islamic Fintech Industry

• Investment capital for Islamic fintech is for now still typically scarce, and there is a need for a new generation of stakeholders aligned with the principles of Islamic finance. Although these realities are starting to change, many sources of venture capital are still far from Sharia-compliant, making it difficult for the up-and-coming entrepreneurs to fund the development and execution of their ideas.
• The Islamic fintech sector is arguably held back by inherent structural weaknesses within Islamic finance such as the complexity of transactions. This is especially true for those in the general public as well as those within the fintech/finance industry who are acquainted with the form of Islamic financial transactions or the processes involved in carrying them out.
• A barrier to the proliferation of Islamic fintech products comes from regulatory miscommunication. While the regulatory frameworks in the Middle-East and much of Asia manage to provide for Islamic fintech, those in charge of setting the rules (and in some cases, drafting the law) around the rest of the world are often poorly acquainted with Sharia compliant products and services, let alone the principles that underpin them all. Not to mention the fact that those regulatory systems were not designed with such principle-bound products and services in mind. As such, many of these countries have yet to make much effort to accommodate for Islamic fintech. This means that those in charge of building and applying the regulatory frameworks in countries on continents such as Europe and the US will need to implement what is necessary to make their markets both receptive and accommodating to such products and services. Although expert assistance is available through professional financial organisations such as the FCA in the UK, some of the most influential actors within finance such as academics, gatekeepers, and those in authority, frequently lack the necessary knowledge about Sharia compliance.
• A further challenge facing Islamic fintech products and services and another barrier to their more widespread use is a lack of awareness of their existence amongst the non Muslim global general public, along with a lack of the requisite knowledge surrounding the basic principles that are the foundation of Sharia compliant finance. This issue is frequently raised and not just in non-Muslim jurisdictions such as the UK, but also in many majority Muslim countries.
• Performing an unquestionably essential function in musharakah, takaful, and sukuk, the concept of profit and loss sharing looms large in Islamic finance, and is a concept that may be hard to align with traditional western financial and investment philosophy.

(Global Islamic Fintech Report 2022)

Adding Value And Innovation To The Global Finance Industry With Islamic Fintech

With a customer base not far short of 2 billion people, projected to reach around 3 billion people by 2060, Islamic finance and fintech has the opportunity to take the global finance industry beyond the time-honoured bottom line of profit, and offer both ethical and sustainable alternatives in terms of investment methodology and investment products. The increasing focus on sustainable/regenerative financial models and goals, along with the recent progression in financial digitalisation and e-commerce, provides the perfect foundation for Islamic fintech to positively influence the sphere of global finance and investment.

• Global financial inclusion
  
  • Through promoting risk-sharing contracts that provide a viable alternative to conventional debt-based financing, and also through specific instruments of redistribution of the wealth among the society based on Islamic principles such as zakat (charity).
• Addressing financial risk
  
  • The 2008 financial crash was brought about by fund managers and financial speculators making risky investments. Islamic investments by their nature mitigate much of this danger through the prohibition of riba (interest) and ghahar (risk), thereby eliminating any opportunities for short selling or uncertain contracts.
• Offering alternatives to traditional investments
  
  • The fact that Islamic fintech and finance are Sharia compliant does not just mean that they are acceptable to muslims across the globe, but that they offer a different choice in terms of the ethical and moral implications that come with investment choices.
• Reframing the corporate landscape
  
  • Islamic FinTech follows Sharia principles and is hence a type of technology that is ethical and religiously acceptable. Through its very nature, it embraces environmental, social, and corporate governance (ESG) elements. The alignment of certain Islamic financial products and environmental, social, and governance factors along with recent strides in digitalisation may allow Islamic fintech to makes a strong foothold in the market, perhaps even bringing about re-alignment of strict shareholder interest through increased focus on SDGs, ESG investments, and genuine, far reaching programs of CSR.