Funding faltered. Licenses pulled. Companies shut down. The global fintech scene, including within the Shariah fintech realm, over the last 12 months seemed grim. Yet, there are a few bright spots reminding us that the prospects for digital financial services which respect Muslim sensitivities are still strong.
Islamic fintech start-ups have not been insulated from the macroeconomic shocks which have shaken the global fintech community. Funding has plunged significantly to a nine-quarter low to US$74.5 billion in the third quarter of 2022, a 34% drop quarter-on-quarter, according to CB Insights.
While one may rationalize the decline as a readjustment of the markets following record-high investments in 2021, none can deny the fact that the threat of a global recession exacerbated by surging interest rates, ballooning inflation and the ongoing Russian invasion of Ukraine have spooked investors.
Data from CB Insights suggests that the pressure has forced more fintech start-ups to bow out in the July–August 2022 period than any other quarter over the last 12 months. A handful of fintech start-ups operating in accordance with Shariah principles also fell victim to harsh economic conditions including some in the UK, Central Asia as well as Southeast Asia including MuslimPay in Malaysia and Berkah Finteck Syariah in Indonesia.
Driving the early demise of these start-ups is mostly the lack of funding, an essential lifeline.
“Several have closed down or are in the process of exiting the market which perhaps reflects the very challenging market conditions. Yet, this is also a show of consolidation where companies without strong fundamentals are weeded out. Start-up failure rates are high, up to 90%, and Islamic fintech is no different,” one Halal fintech start-up CEO explained to IFN Fintech.
Yet, investor reticence should not be automatically construed as a lack of demand for Halal digital financial services. Demand is plentiful, and it is growing year-on-year based on the increasing number of enquiries received, Islamic fintech start-ups tell IFN Fintech.
In fact, while unforgiving market conditions have pushed some players out, the commercial opportunities of Shariah fintech are nonetheless luring new players into the market. The IFN Islamic Fintech Landscape has identified 338 start-ups across 12 verticals globally, as at the 15th October 2022, up from 262 a year ago. The 29% growth is supported by new entrants such as in Malaysia where the number of Islamic P2P providers (including on a window basis) have grown eightfold and where its central bank also licensed two Islamic digital banks. In Saudi Arabia, more fintech start-ups are seeking official Shariah compliance assurance including Buy Now Pay Later (BNPL) platform LDUN and supply chain finance platform Lamaa while the Saudi Central Bank licensed at least 10 payment fintech companies.
Concurrently, existing players are steadily expanding their geographical footprint to capture opportunities in new markets. For example, Saudi-based Islamic BNPL platform Tamara forayed into the UAE; payment fintech Cashew, headquartered in the UAE, has begun putting in place building blocks to expand into Saudi Arabia; Southeast Asia’s Islamic crowdfunding platform Ethis opened its doors in Oman; while Bahraini Islamic cryptocurrency trading platform CoinMENA secured licenses to operate in Egypt, the UAE and the EU.
And although investors have become more selective in whom they invest in, the funding pipeline has not dried up. Investors, particularly venture capital (VC) firms which are agnostic in their investments, are more comfortable writing bigger cheques to back promising Islamic fintech start-ups.
We see this in crypto trading platform Rain raising US$110 million in Series B funding; Islamic robo-advisor Wahed landing a US$50 million Series B deal; Pakistan-based Abhi raising US$17 million in Series A funding; Jordan’s liwwa securing US$18.5 million in pre-Series B funding; Uzbek Islamic fintech start-up IMAN closing a US$1 million seed round, and launching its US$3 million post-seed round; Indonesia’s ALAMI concluding its pre-Series B round for an undisclosed amount, building its confidence to tap the market again next year for up to US$80 million; while Canada’s Manzil attracting CA$2.44 million (US$1.95 million) in seed funding.
Investors willing to put (more of) their money into Islamic fintech start-ups are a huge win for the industry as it signals rising familiarity, and confidence, of conventional investors in Islamic fintech.
“We need Islamic fintech champions; successful start-ups who can demand the attention of investors and clients at a regional or international level because this will help the sector as a whole and shine the spotlight on Halal fintech and on what it can do. This then would ease the path for all of us when it comes to seeking funding or penetrating the market,” said one founder.
Another sign of a maturing sector is the fact that more Islamic fintech start-ups are assuming a broader mandate than what they initially set out to do. Across different markets, we are seeing fintech start-ups offering Halal products pivoting to become providers of more comprehensive services. For some, this is a growth strategy; for others, it is a survival strategy.
UK-based Kestrl, for example, started out as a Halal personal finance money app, and has added software-as-a-service (SaaS) provider to its repertoire. In August, the consumer app signed a deal with Malaysia’s Bank Islam to develop and implement personal finance management features for the bank’s new digital bank. By taking on SaaS, Kestrl has essentially expanded its target market base from retail consumers to include institutions.
Household names such as Wahed from the US and ALAMI from Indonesia on the other hand are priming themselves to become full-suite Islamic fintech platforms.
Wahed in September this year launched an equity crowdfunding platform, another step toward the Islamic robo-advisor’s ultimate ambition to become a one-stop shop for digital Islamic financial services following its acquisition of Islamic digital banking start-up Niyah in December 2020. P2P platform ALAMI early this year obtained a digital mobile banking license for the Islamic rural bank it acquired in 2021; fueled by its latest funding, the start-up will focus on building its digital banking capabilities. Conventional SME digital financing platform Funding Societies, which began offering Islamic trade finance in Malaysia, is also laying the blocks for a digital banking proposition — in June, it acquired CardUp, marking its entry into the payments and remittance space; in April, its Indonesian arm invested in an Indonesian bank and it is also working on making a stronger Islamic fintech play.
Digital bank rush
Fintech start-ups are not the only ones gunning for digital banking glamor. Incumbent banks, from Asia to the Middle East, are also scrambling to have skin in the game as they feel the heat from customers demanding for more sophisticated digital services.
In Malaysia, Bank Islam shed its image of digital inertia as the country’s oldest Islamic bank with the rollout of the country’s first cloud-native digital bank, Be U, after constant engagement with the regulator, paving the way for others to follow suit. Al Rajhi Bank Malaysia is close to launching its stand-alone digital bank as well — IFN Fintech learned that the Islamic bank has completed building the architecture (in an impressive 10 months) and is waiting for clearance before officially launching sometime this year.
These new digital outfits materialized in the backdrop of Bank Negara Malaysia (BNM) granting five digital bank licenses, including two for fully-fledged Islamic digital banks. While the jury is still out on how these challenger banks will fare, industry observers agree that the entry of these licensed virtual banks has pushed incumbents out of their comfort zone and compelled them to take digital banking seriously.
In Saudi Arabia, the government in February approved its third digital bank, D360 Bank, a fully-fledged Islamic bank backed by the Saudi sovereign wealth fund. D360 Bank will join Saudi Digital Bank to serve the Muslim market with Halal products. Kuwait is closer to welcoming its first Islamic digital bank as Bahrain-based Ahli United Bank (AUB) will convert its Kuwaiti subsidiary into a fully digital bank as requested by the Central Bank of Kuwait as Kuwait Finance House has completed its acquisition of AUB in October.
Robust regulation rollout
Another theme for 2022 is regulations.
Islamic fintech CEOs and founders consistently ranked the lack of enabling regulations as their biggest barrier to scale up, after funding, as per the annual IFN Islamic Fintech CEO & Founder survey. Policymakers in key Islamic financial jurisdictions are trying to change that.
In Malaysia, BNM released a discussion paper on licensing digital insurers and Takaful operators (DITO) as well as an exposure draft on cloud technology risk assessment. The DITO framework is the central bank’s effort to complement its digital bank initiative. Securities Commission Malaysia on the other hand proposed a regulatory framework on managing technology risks by capital market entities.
As part of its efforts to clamp down on illegal digital investments and online lending, the Indonesian Financial Services Authority or Otoritas Jasa Keuangan (OJK) issued anti-money laundering and terrorism financing prevention guidelines for crowdfunding platforms after releasing new crowdfunding rules (which accommodate Islamic platforms) to support its existing regulations. Year-to-date, OJK has shut down at least 494 illegal online lending sites and 50 digital investment platforms.
State Bank of Pakistan began formally regulating digital banks with the release of a new digital bank framework, under which it received 20 applications. Securities and Exchange Commission of Pakistan (SECP) confirmed it is amending its regulations on non-banking finance companies to provide a framework for P2P financing and it is developing rules for micro and digital-only insurers. SECP also published a concept note on digital asset management companies as part of its push for a “completely digital asset management ecosystem” comprising mutual fund distribution platforms, digital investment advisors and digital asset management firms.
The Saudi Central Bank has updated its rules for debt crowdfunding activities to be more comprehensive. This comes as the government unveiled a new fintech strategy to more than double the size of its fintech community by 2025 and to raise the share of digital payment transactions to 70%.
Capital Market Authority of Oman revealed to IFN Fintech that is working on a framework for digital assets, which it hopes to launch before the end of the year.
Kuwait’s central bank formulated new digital bank guidelines, with a view of licensing its first digital bank before the end of 2022. AUB could very well be it, but telecommunications company Zain in 2019 also entered into a partnership with Boubyan Bank to build an Islamic digital bank.
Central Bank of Bahrain, one of the most progressive advocates for digital financial services in the region, expanded the scope of financing models in its rulebook to include “new and innovative” consumer financing business models, paving the way for technology-mediated solutions including BNPL platforms.
Meanwhile, in Iran, the central bank inaugurated its regulatory sandbox as part of its plans to overhaul the islamic Republic’s fully Islamic banking industry.
The UK, one of the largest Islamic fintech markets in the world by number of start-ups, engineered the Alternative Finance Order 2022, which adopted changes to recognize fintech businesses while taking into consideration the unique challenges Islamic fintech start-ups face, particularly for P2P platforms and home purchase plan providers.
Rainbow after the storm
It has been a turbulent year to say the least.
Around this time last year, the industry was fairly optimistic about the sector’s growth as the world adjusted to the COVID-19 pandemic, which has catalyzed digital innovations in the global financial industry. 2021 became the ground for unprecedented digital transformations and this has set the scene for investors and regulators to pump in more resources to develop the right start-ups and infrastructure.
Barely into the first quarter of 2022, however, Russia invaded Ukraine and this set off a domino chain of reactions on the global economy compounded by ongoing local geopolitical developments. With hardly any time to breathe after being strangled by the pandemic, global supply chains were squeezed yet again sending food and energy prices soaring. Inflation continued to spike, and many lamented the cost-of-living crisis as a global recession looms.
And while Islamic fintech start-ups find it harder to court funding as investors are more careful with how they spend their dollar due to the economic conditions, start-up founders find solace in knowing that there are meaningful positive changes in the industry. They are reassured by the regulators’ efforts to create a conducive environment for fintech activities; they are hopeful that investors are warming up to the idea of Islamic fintech; they are delighted by the increasing demand for Halal digital financial services; and they are thankful for the challenges thrown at them which allowed them to test their ideas, products and strategies under pressure to devise a better game plan. In our survey of Islamic fintech CEOs and founders, most are, surprisingly, optimistic about the growth projection of the industry, despite being battered by market conditions.
After all, in the words of German philosopher Friedrich Nietzsche: “What doesn’t kill you, makes you stronger.”