Chancellor Gordon Brown last week called for Britain to become the international centre of Islamic finance. Why?
What makes Islamic finance different?
There are three broad rules of the Islamic legal code, the sharia, that set Islamic finance apart from Western finance. Most straightforwardly, devout Muslims must not get involved with industries that are considered haram (sinful) such as alcohol, gambling, and pig meat. Second, there is an injunction to avoid gharar – excessive risk-taking or uncertainty. And third, while Islamic teaching encourages trading, invest¬ment and charitable giving, it bans the creation of money by money. Thus the central Koranic concept driving the Islamic finance industry is riba – interest or usury – which is considered sinful. The injunction against giving or receiving interest makes it hard for Muslims to use conventional banking products, such as savings accounts, loans and mortgages.
What is allowed?
Although the Koran bans interest and usury, it does allow money to be used for trading or investing for profit. Islamic finance uses this freedom to create sharia-compliant credit arrangements on the basis of ‘partnerships’ in which risk and profit are shared between the two parties. For instance, people who put money into accounts in Islamic banks do not earn interest, but instead earn a profit share in the business activities that the bank carries out (rather like a unit trust). Similarly, an Islamic finance firm does not provide a ‘loan’ for a car or a washing-machine; instead, the firm buys the goods on behalf of the customer and then sells it on to him at an agreed mark-up. This might seem like hair-splitting to Westerners, but for devout Muslims the need to avoid riba is a religious imperative which in the past prevented British Muslim families from buying property.
How do Islamic mortgages work?
Islamic mortgages work in broadly the same way as a smaller loan, with built in mark-ups that are deemed to be rent rather than interest. Often, the profit margins on all these transactions are based on market interest rates. Currently, there are two kinds of sharia-compliant home finance deals available to British Muslims. The first, used by banks including HSBC’s global Islamic banking arm HSBC Amanah, is based on the Islamic principle of ijarah, similar to Western-style lease financing. Under this scheme, the bank avoids charging interest by instead buying a property outright, then renting it to the customer, and selling it on to him once the fixed-term contract ends – usually after 25 years. The second kind of home finance deal is based on the principle of murabaha – an exchange of tangible goods for profit. Here, the bank buys the property and sells it to the customer at a fixed mark-up price, in much the same way as a smaller loan. For a house purchase, a significant deposit is required (for example, the Ahli United Bank normally requires 20%) and the remainder of the price is repaid in monthly instalments. As the bank receives capital payments from the homebuyer, its ownership stake reduces.
How big is the market?
Analysts estimate that the worldwide market is worth between £200bn and £300bn a year. However, in the past couple of years, there has been an upsurge of interest in Islamic finance. On a global level, that’s largely due to the huge well of excess liquidity flooding the oil-producing states of the Middle East and the Gulf as a result of spiralling oil prices. At the domestic level, demand for Islamic banking is growing fast, perhaps due in part to the perceived growth in religious consciousness among many British Muslims in recent years. Meanwhile, the Government, concerned with issues of social inclusion and integration, is actively encouraging banks to offer sharia-compliant financial products. In a speech last week, Gordon Brown drew an explicit link between ‘financial exclusion’ and political/religious extremism, and called for the UK to become the international centre for Islamic finance.
Who offers suitable products?
Middle Eastern banks began to develop sharia-compliant financial services in the 1970s, and Islamic mortgages have been available in Britain since 1997 (from the Ahli United Bank). But it is only in the past couple of years that the big mainstream banks have begun to tap into the huge potential market of around 1.8 million British Muslims. HSBC was the first to launch a sharia-compliant mortgage in 2003 under the Amanah brand, and it now offers a range of products including a pension fund and current account (call 0800-587 7786; HSBCamanah. com). Lloyds TSB is the first bank to offer sharia-compliant products through all its branches. Its home purchase plan currently costs the equivalent of a 5.18% interest rate. It, too, offers a current and savings account and is working on a student account for launch this autumn (0845-600 7786; Lloydstsb.com). Other providers are Bristol & West, West Bromwich Building Society and the specialist Islamic Bank of Britain (0845-606 0786; Islamic-bank.com) – founded in 2004.
The market for fatwas
One group making large sums from the boom in Islamic finance are the small number of religious scholars who are qualified to decide whether a financial product is Islamic. A product is only considered sharia-compliant if authorised by a fatwa – religious edict – from a recognised scholar. But there are so few scholars that speak good English, understand global capital markets, and command enough religious respect to issue a fatwa, that there is heated competition among investment banks for sharia advice, sending fees soaring. Some banks say they have paid up to $500,000 for advice on large capital markets transactions – exponentially higher than a few years ago – though much of this reportedly goes to charity.