Personal Finance

Are Digital Challenger Banks Halal?

The traditional banks have a bad reputation amongst Muslims. The question we’re asking in this article is: are these challenger banks any more Islamic than their older, larger counterparts?

The digital challenger banks have mushroomed in popularity over the last five years. They are now very much in the mainstream and growing faster than conventional banks. They’re an example of how disruptors really can challenge the incumbents. 1 in 4 18-21-year-olds now have a challenger bank account [1] which is quite phenomenal when you consider the strength of the traditional banks.

The traditional banks have a bad reputation amongst Muslims. The question we’re asking in this article is: are these challenger banks any more Islamic than their older, larger counterparts?

We also explore what a sharia-compliant challenger bank would look like. We certainly need one – after all, there is a 1.2 billion Muslim market ready to be tapped!

Who are the big players?

Here’s a list of the key digital challenger banks out there today, the business models of whom we looked at for this article.

  1. Monzo
  2. Revolut
  3. Starling
  4. N26
  5. Metro
  6. Tide

How do challenger banks make money?

To answer that, let’s first understand how conventional retail banks make money.

As a rough rule of thumb, about 35% comes through fees (late payment, international transfer, overdraft, service fees, transaction fees etc) and about 65% comes through interest charged on money loaned out in the form of overdrafts, term loans, mortgages and other products.

Let’s say you deposit a thousand pounds in a current account. The bank will lend that out at ~6% and keep the profit (allowing for a bit of cost associated with default risk etc).

A good bankingtech article [2] summarises the digital challenger bank model as one (or more) of three (but see my fourth category below):

  1. The financial control centre (“Control Centre”)
  2. Banking-as-a-service (“Service”); and/or
  3. The niche bank (“Niche”)

Control Centre model

In the Control Centre model, the hypothesis is that the current account sits at the heart of a person’s financial life, and other financial products fit in and alongside the current account. So the likes of Monzo want to create a platform on their app to enable people to access a whole bunch of other services through Monzo – but provided by others. Monzo will take a cut every time such a service is used.

Service model

In the Service model, either:

  1. Challenger banks provide a stripped back simple banking service that you pay for (as opposed to making their money through lending your money out etc). Generally, these are digital business bank account providers like Tide or Coconut as opposed to retail current accounts which are generally free due to the increased competition; or
  2. Challenger fintechs seek to provide the various bits of plumbing of the financial system as a plug-and-play solution to challenger banks and other fintechs. For example Gocardless provides a plug-and-play direct debit solutions for companies that don’t have that functionality themselves.

Niche model

In the Niche model, a challenger bank will target a specific niche and provide its customers with specific products and features they’re particularly interested in. So, for example, Coconut is an online business account where the whole setup is designed to take out the headache of accounting for expenses.

I want to add in a further category: the New Traditional Bank.

New Traditional model

Increasingly, challenger banks have turned to lending out money as a key way to achieve profitability. Some have had to turn to this as a stop-gap way to make ends meet, while others have unashamedly sought to do this from day one. They make money through overdrafts, credit cards and, soon I am sure, mortgages and other products. To my mind, the economics of this approach are more or less the economics of your larger bank (albeit without all the additional costs of bricks-and-mortar and a far slicker interface).

Is the challenger bank business model halal?

Let’s look at each revenue model in turn and assess it for sharia-compliance.

In the Financial Control Centre model, the challenger bank gets its fees from affiliate commission each time a sale is made. The sharia-compliance of this model depends on the types of services being sold. Given that this is a mainstream financial platform, the likelihood is that a big chunk of the services will be interest-based and not sharia-compliant.

As an aside, one could model a Monzo-style Marketplace as simply a digital venue – and so if Monzo were to only charge a fixed “rental” fee for setting up shop in this digital Marketplace, that might be seen as permissible as Monzo would then not be profiting from the sale of the actual products, but simply from the hosting. However, this is very much in the darker end of the grey area given how likely it is that any company wishing to list on such a Marketplace will be haram. It would be akin to buying up property in the red-light district of Amsterdam and charging rent from all the businesses who occupy your properties. Not ideal.

The Service model is far more promising from a sharia-compliance perspective. But from the mainstream challenger banks I couldn’t really find any offering an account where they guarantee that the money in that account will not be lent out and where they will simply make their money from charging either a monthly account fee or a per-transaction fee. A bare-bones no-frills bank like that would be perfectly sharia-compliant.

The Niche model is itself neither haram or halal – that will depend on the underlying business model of the bank itself. Business accounts like Tide get quite close to the pure service model, but they too have now teamed up with Iwoca to offer business loans and I am sure will be shortly bringing out overdraft facilities and other interest-based products. They’ll also be able to lend out the money you give them and make a return on that. Alas.

The New Traditional Bank model profits from interest. So definitely haram.

What challenger banks should Muslims use?

Sadly, there isn’t really any challenger bank right now that offers a sharia-compliant current account. That said, it is likely that your money in a traditional bank will be more effectively utilised by such banks in giving out interest-bearing loans, as opposed to when you leave it with challenger banks. This is not for want to trying, but rather as challenger banks do not yet have as developed back-end systems which can effectively take their deposits and churn out interest-bearing loans using established products.

And generally, challenger banks do have an ethos of being more transparent and fairer with fees and other charges. So, this is certainly more ethical from an Islamic perspective and to be encouraged.

So if it were a straight toss-up between your average mainstream account like Santander, and your average challenger bank like Monzo, the challenger bank is probably the lesser of two evils (right now).

What does a truly sharia-compliant challenger bank look like?

A sharia-compliant challenger bank could be any of the above challenger bank models, as long as it does not make money from interest, gharar (uncertainty), and gambling.

So a Financial Control Centre model could work by hosting only sharia-compliant service providers as “tenants” on the digital marketplace; the Services model could work, as I described above, by charging for a no-frills current account; and the New Traditional Bank model could work by utilising the deposits that the sharia-compliant bank has only for sharia-compliant financing (such as ijarah, Islamic mortgages, and sukuk).

A current mainstream non-sharia-compliant digital bank could quite easily offer a no-frills paid current account right now. Lloyds had one known as the Islamic Current Account – that’s still open for existing customers, but is no longer available for new customers. We’ve asked them for a comment as to why they dropped it and we’ll let you know when we hear back.

The other, more full-service solutions (e.g. a marketplace or sharia-compliant financing solutions), will require a purpose-built challenger bank. At IFG we have our ears to the ground on all things Islamic fintech and we’re aware of at least 5 such Islamic challenger banks working away in stealth mode at the moment. We’re very excited to see how these guys progress and to support them however we can.

Conclusion

To summarise then, digital challenger banks are not a fundamental shift from their larger predecessors when it comes to sharia-compliance, though they are in all probability the lesser of two “evils” in that they are (a) more transparent on fees; and (b) less effective at earning interest on their deposits at this moment in time. As time goes on though and they start to move towards a more traditional bank model, maybe they’ll find the need to start opening branches. Sounds familiar.

Not enough of a reason for me to shift personally, but if a no-frills current account like the one I outlined in the Services model ever came into existence (or if it already exists – link me to it in the comments!) then I’d be transferring over for sure.

[1] https://www.financederivative.com/1-in-4-millennials-and-gen-zs-are-using-challenger-banks-with-monzo-the-most-popular/

[2] https://www.bankingtech.com/2019/03/the-new-business-models-of-banking/

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2 Comments. Leave new

  • Thaqib Moosa
    July 15, 2019 8:58 am

    As usual, an excellent article summarising the key points. I had a couple of questions on this front.

    Firstly, many of the challenger banks offer overseas transactions with no non-sterling transaction fee (usually 2.5% from a high street bank) and also offer the latest up to date and very competitive exchange rates. They also allow withdrawals of usually circa £200 a day (I think it’s £250 for Monzo?) for free. How can they afford to do this? Why don’t high street banks offer this?

    Secondly, what would the set-up costs of a challenger bank be like? I am assuming investment is significantly lower than with a conventional bank so does this open up an opportunity for Muslim entrepreneurs to work on building a challenger bank that is truly Islamic and hence offer a current account with Shariah compliant current accounts and other products?

    Reply
  • BrandeurStudios.com
    July 18, 2019 12:13 pm

    Great article Ibrahim.

    Thaqib…

    For a fast-track route to market without the regulatory requirements there’s now Banking as a Service (BaaS) where regulated banks with licenses will ‘white-label’ their digital bank platforms and manage all KYC, compliance, back and front end tech. You simply focus on customer acquisition, branding, marketing, and customer service. Some BaaS providers charge monthly flat fees so capital requirements are very low. Europe is currently leading the way with BaaS (Germany, UK).

    There’s never been a more accessible time (lowest barriers to entry) in the history of banking to start your own (niche) bank.

    Reply

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