Small and medium enterprises (SMEs) play a pivotal role in economic development and innovation in Islamic countries. However, access to adequate financial resources remains a major challenge for these enterprises to advance technological innovations. In this context, Islamic finance, with its Sharia-compliant principles, serves as an effective alternative model. This study examines the impact of Islamic finance on the innovation capacity of SMEs in Islamic countries, focusing on process, product, and marketing innovations. Data for this research was collected from 1,700 SMEs in Iran, the UAE, Malaysia, Indonesia, Saudi Arabia, Turkey, and Qatar, spanning the years 2000 to 2023. The analysis was conducted using the Panel Multivariate Probit Model (PMVP). The results indicate that Islamic finance has a positive and significant impact on the innovation capacity of SMEs. This type of financing is particularly effective in fostering process innovations, designing new products, and optimizing production processes. Additionally, the findings reveal that Islamic finance indirectly contributes to improving marketing strategies and the sale of new products. However, its impact on organizational innovation was not statistically significant, with its influence primarily limited to technological innovations. This research highlights the substantial potential of Islamic finance in supporting technological innovations and demonstrates that Islamic financial instruments can significantly enhance the competitiveness of SMEs. Moreover, the expansion of Islamic financial tools can create more opportunities for the development of new technologies and improvements in production processes. Based on these findings, it is recommended that financial institutions and policymakers in Islamic countries devise targeted programs to promote Islamic finance and leverage the innovative capacities of SMEs more effectively.