International Shariah Research Academy for Islamic Finance (ISRA)
Shariah compliance is the raison d’etre for the existence of the Islamic banking and finance industry. Shariah compliance is achieved by meeting not only the prerequisites of the pillars and conditions of the Shariah contract used, but ensuring that the underlying asset as well as the underlying purpose of entering into such a contract is in compliance with the Shariah. Compliance with Shariah ensures that the rights of the contractual parties are protected and contractual obligations are met out in a responsible and lawful manner.
The advent of financial technology (fintech) introduces important innovative infrastructure into the realm of Islamic finance. The recent Ernst & Young report on Banking in Emerging Markets (2017) acknowledged the importance and need for the Islamic banking and finance industry to adapt and embrace the Fintech revolution. The report noted that the impact of Fintech could potentially draw an additional 150 million customers to the Islamic banking sector by 2021.
Though fintech innovations promise to enhance market access and profitability to the industry, the industry still lacks the zeal and motivation to fully accept and adopt the fintech revolution. Having said that, many discussions and writings have been taking place on and offline on how Islamic banking and finance could leverage fintech innovations, particularly blockchain technology and smart contract application. Some suggested that Shariah-compliant foreign exchange swap products, profit rate swap products and Islamic liquidity management products can be better implemented through smart contracts. This short article highlights how blockchain and smart contract can be used in Islamic credit card product.
Blockchain and Smart Contract
Historically, the concept of smart contracts was first introduced in 1994. However, smart contracts went through a long gestation period of inactivity and disinterest due to the non-availability of platform to enforce them. This changed when blockchain technology was introduced in 2009. Smart contracts then began to gain traction, which are now becoming a basic tenet of overall blockchain’s power.
The blockchain concept originates from the need for record-keeping in the most intuitive manner. This technology tracks and records data across a digital ledger network made up of participating parties that will independently verify and store each instance of transaction or contract as it originates and changes. Simply put, it is a shared electronic ledger and all participants within the network can see all the transactions recorded within it.
Smart contract is a term used to describe a computer program code that is capable of facilitating, executing, and enforcing the negotiation or performance of an agreement (i.e. a contract) using blockchain technology. The entire process is automated and can act as a complement or substitute for legal contracts where the terms of the smart contract are recorded in a computer language as a set of instructions.
Islamic Credit Card
The choice to apply these fintech tools to an Islamic credit card lies in the fact that it is one of the popular Islamic financial products. In Malaysia, payment through credit cards is still the most popular method, compared with charge cards and debit cards. Therefore, advanced technology integrated within blockchain and smart contract would ensure more robust and effective Shariah compliance while using an Islamic credit card.
In general, there are three groups of Shariah-compliant credit card arrangements:
- A bank provides a line of credit to the cardholder and charges a monthly or yearly usage fee tied to the outstanding balance of the line of credit.
- A customer is allowed to buy an item with a card, but the instant the card goes through, the bank purchases the item before selling it to the cardholder at a higher price.
- A lease-purchase agreement is where the bank holds title to the purchased item until the cardholder makes the final payment.
The more critical arrangement that distinguishes conventional credit card users from Islamic credit card users is the Shariah restriction in the card usage. Islamic credit card users are not allowed to use them for the purchase of non-Shariah compliant products such as alcohol, pornography, gambling or pork. Having said this, there is a loophole. According to a Sharjah Islamic Bank spokesperson, “As long as the place is registered as a bar or liquor store, clients cannot use our cards. But customers can still use our cards in restaurants and lounges that serve alcohol.” (Some Islamic banks allow tobacco purchase now Source: Nada Al-Taher Gulf News, 2014).
This loophole can be addressed: Blockchain technology through the use of smart contract can assist in implementing the right processes and procedures by ensuring that Islamic credit cards are barred in toto from being used to purchase the prohibited items in places that have not registered themselves as fully compliant stores/vendors or are known to be not compliant (casinos, bars, etc.) or stores that sell mixed items of halal and non-halal products. A data repository (maybe a separate blockchain) for tracking products can be established to inform on stores and their halal products for identification to the smart contract platform. Maintaining the right Shariah image is important; therefore, Islamic credit cards should not be allowed to purchase items that are clearly prohibited.
Acceptance of such an innovative idea into the Islamic banking industry requires a push from the regulator. The aim is to build stronger and responsible end-to-end Shariah compliance that drives greater stability and higher growth for the industry. The use of blockchain and smart contract as envisaged above should facilitate this, reducing the incidence of Shariah non-compliance and reputation risk to the Islamic banking and finance industry in future.