The Islamic Economy Needs To Find Routes To Connect Innovation With Financing
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The Islamic finance industry reached a milestone with US$2 trillion in assets at the end of 2015, up 10% on the previous year. But for many entrepreneurs, the growth of the Islamic finance industry has not reached them and financing remains difficult to access. The asset-based structure of many Islamic banking products can make it difficult to finance the needs of SMEs, particularly those with tangible asset-light balance sheets.
However, the Islamic banking industry does not alone face such criticism; banks in emerging markets and developed markets alike are having difficulty channeling financing to the entrepreneurs working on developing the next new thing. On fundamental grounds, the approach for Islamic finance with a focus on the real (non-financial) economy and balanced sharing of risk and reward should be a solid fit.
In many cases, it is not just the real economy that needs disruption from new technology-based companies but also the financial system itself. There has been some development in this area from rewards-based crowdfunding, which is now being complemented with equity and debt crowdfunding, but often, the new developments continue the pattern of repeating what has been applied in the conventional finance industry, but doing so in a way that is Shariah-compliant.
Finding a new way to connect financing with innovation that has a unique approach for the Islamic economy has been a challenge, even as the growth in the Islamic economy has been better quantified. Underlying the potential of the Islamic economy is a strong driver of future growth. Muslims account for 1.7 billion people -about one-quarter of the world’s population- with demographic trends that indicate rising economic importance.
Yet today, Muslims’ total food and lifestyle spending represents just 11% of global spending on food and lifestyle sectors. Two trends are behind this discrepancy. First, because Muslims are younger on average than the population, they are still at a point where their current earnings are still rising. In addition, many Muslims live in emerging markets where growth rates have been and are expected to be sustainable higher than the rate in developed markets where an aging population has, on average, less growth potential.
The financial sector is supposed to be the intermediation function between the current sources of wealth and the future growth opportunities, but it has not been working as expected. Some of this is due to a large focus on financing tangible assets in Islamic finance, but much more of it is driven by the stagnation of the business model of banking and added regulations that are accentuating the preference for lower return investments.
One example where this trend is being pushed to the side is Malaysia. There, several Islamic banks and the Central Bank, Bank Negara, have come together to develop the Investment Account Platform (IAP) which connects the banks’ ability to evaluate clients and their deep network with risk capital from investors in search of higher returns. The investors give up a guarantee of their principal in exchange for potentially higher return through a funding portal that, unlike most crowdfunding platforms, retains participation by the banks.
This type of innovation -bringing crowdfunding into the banking systemreinvigorates the purpose of finance and opens up SMEs to new sources of funding. Other innovations in finance that can support growth towards the Islamic economy’s potential start earlier like Skolafund, which was a finalist for the Innovation4Impact Competition at the Global Islamic Economy Summit 2015 in Dubai, and helps students more effectively crowdfund the cost of their education.
As innovative as these products are, they are still limited in scope and cannot transform the financial sector alone. In order to keep entrepreneurial growth going, the financial sector has to be pushed to resist the inertia that funds the safest project, and not the ones that have the most long-term potential. This is the type of innovation that needs to be recognized and supported, not just to make the Islamic economy’s potential a reality, but also to make the financial sector work better for society.