It’s no secret that it had been historically difficult for Shariah-compliant banking products to compete with traditional and high street financial services, but could Blockchain technology be about to change all of this?
Throughout the last couple of years, we have seen banks and other financial services organisations conduct prototypes and proof of concepts using Blockchain. There have been several consortium-led use cases that have emerged in this time, but we are yet to see many successful production rollouts from these attempts.
While the ICO wave has had a bit of a shock with the recent crypto correction, I still believe most of the smart contract use cases of blockchain – especially the ones within some parts of banking like trade finance, have some legs. In a discussion with a Shariah-compliant Fintech firm, we explored the usage of Blockchain for Shariah products. The more we discussed the topic, the more I became convinced that this is an area where the smart contracts use case of Blockchain could be extremely relevant.
Islamic Fintech is based on the principle of providing completely sustainable banking products. Receiving interest (Riba) is strictly prohibited, while any underwritten customer debt will also need to have an asset (product or a service) to back it.
This has made it tough for Shariah-compliant banking products to compete with the banking products that the rest of the world is able to offer.
A standard banking loan is essentially just a contract between the bank and the borrower on a loan where interest is charged, which makes the paperwork involved significantly more straightforward. With Shariah-compliant banking products, things aren’t as simple, with multiple contracts in place including Profit Sharing agreements, Agency arrangements and partnerships.
What this means is that, in the Shariah banking system, the customer and the bank need to go through three different contracts, as opposed to just one when using a conventional banking system.
And when you are trying to sell a product within a competitive landscape, this becomes much more than just another overhead; it adds to operational inefficiencies, creates extra administrative costs. Regrettably, for Shariah-compliant banking setups, all of this is necessary to avoid interest.
This is a space where the smart contract use case of Blockchain can add immense value. A digital contracts engine that can scale functionally (looking at multiple product lines), and non-functionally (performance, throughput), would solve a lot of contractual overheads in Shariah banking. Smart contracts are verifiable, immutable and secure, and near real-time settlements mitigate counterparty risks.
The Islamic Development Bank (IDB) of Saudi Arabia is currently researching the use of Blockchain in Shariah-compliant products. Since Q4 last year, the Islamic Research and Training Institute has been working with two startups – Ateon and SettleMint, to understand the feasibility of the technology for Islamic banking products.
In many ways then, Blockchain could be the perfect fit for Islamic finance. From an operational perspective, it should be able to deliver the efficiencies needed to make Shariah-based products more competitive, but Blockchain’s core values of transparency, trust and the fairness also run parallel to the core principles of Shariah. I was going to say I will monitor any potential partnership between the two with great interest, but maybe we should keep that to a minimum.