By Irfan Jalil
Islamic finance is a system of monetary trade based on the Islamic principles and jurisprudence. It seeks to create wealth based on partnership and fairness with risks and profits being shared.
Islamic finance, believe it or not, is worth £250bn worldwide. So, clearly, there's a buck to be made. And it's not just about mortgages – multi-million pound global businesses based in Muslim countries increasingly want to base their trade on Islamic principles. Recently, two Kuwaiti companies bought Aston Martin using Sharia-compliant finance.
Five years ago there was only one bank offering you an Islamic account, now it's 10 banks offering you everything from Islamic mortgages, Islamic current accounts, Islamic investment packages and even Islamic student accounts.
The government has even passed laws recently to make it easier for Islamic finance to operate in the UK. Not only that, but London is set to become the largest centre of Islamic financial activity outside of the Muslim world.
It used to be that things like Islamic mortgages were for Muslims who had struck it lucky in, I don't know, oil, but now even you – with your job in a call centre – can get an Islamic mortgage.
Why no ‘interest’ dude?
Interest (Riba) is not allowed in Islam because Allah (swt) says in the Quran:
"The riba that is practiced to increase some people's wealth, does not gain anything at God. But if people give to charity, seeking God's pleasure, these are the ones who receive their reward many fold." [Qur'an 30:39]
So, whereas normally someone could make a profit just because they have money, Islam requires that people work for the money that they earn. Instead of putting money in a bank and living off the interest, you have to invest in, say, a business and work at making that business profitable.
It's against Islamic law to borrow or lend at a rate of interest. But living in Western countries where interest is as common as well… er the flu, it's difficult to avoid it. Scholars recommend that you stay away from interest as much as possible. If the bank gives you interest on your savings you should give it away. It is recommended that you give it to an Islamic charity, a poor Muslim or build toilets in a mosque. And because interest is not legitimate money you should not expect to get rewarded for giving it away. So don’t go thinking this counts as a good deed.
Under Sharia you are not allowed to invest in things like pork, gambling, alcohol and pornography. So Sharia-compliant investment packages steer clear of such things and try to ensure that whatever you invest in is Halal.
Sharia-compliant financing also prevents you from getting caught up in complicated contracts written in legal and financial mumbo jumbo. Everything is kept above board and everyone knows where they stand.
So how does it work... I don’t get it?!
Islamic finance is based on risk-sharing. This means you only lose what you put in. And you gain only according to how much you put in. For example, a customer and a bank share the risk of any investment on agreed terms and they divide any profits between them. All banks which offer Shari-compliant financial products have a Sharia supervisory board. This is a committee made up of Islamic scholars and experts who approve the Halal-ness of a financial product.
Islamic Mortgages: what’s different?
Normally, when buying house you take out a mortgage. The bank buys the house for you and you pay the bank back over what may seem like hundreds of years. The bank also charges you interest. So, if you want a house for £200,000 and you take out a mortgage you could end up paying £250,000 by the time the mortgage finishes.
So, how can you buy a house without feeling icky about it? Well, say your wife's got her heart set on a semi-detached 10 miles away from your mom, you've got a few options as to which type of Islamic mortgage you can take out.
Under an Ijara mortgage you choose a house and then the bank buys it. You then live in the house but pay the bank rent. But you also agree to a set time after which you can buy the house from the bank. The rent is quite high because it also goes towards buying the bank's share in the house. After the agreed period of time, and once all of the bank's share in the house has been paid for, you take legal ownership of the house.
Under a Murabaha mortgage you select the property, the bank buys it and you pay rent at the market rate. You also agree to a date at which you will buy the house from the bank. But this time the bank sells the house to you at a higher price.
In a Diminishing Musharaka mortgage the transfer of ownership of the property is gradual. As you make payments to the bank you get more and more of the bank's equity in the property until you have, over time, bought all the banks stake in the house.
The 'rent' in each of these cases is not a charge for borrowing money, which is what a conventional bank adds on when someone takes out a loan. It acts as a fair payment for the use of a property.
Bear in mind, in Sharia banking it is the bank who 'owns' the house (and you rent it and then buy it off them a small bit at a time). So, if you can't keep up payments (which may very well be much higher than the interest rate) then the bank can take the house from you much more easily than if you used a conventional mortgage.
That's mortgages done. But if your too young to buy a house or too rich to bother with mortgages and can get a house with some loose change, you might want to know about Sharia-compliant current accounts.
Islamic Current Accounts
The money that you pay into an Islamic current account is handled according to Islamic law and isn't used to generate interest. In a normal current account when you put money in the bank, the bank then lends the money to other people. The bank charges interest to borrowers and it also invests money in other products and businesses. These other products and businesses sometimes involve arms dealing, gambling, Haram food and other un-Islamic stuff.
Islamic banking uses the concept of Qard in current accounts. A Qard acts as a loan to the bank, and the bank uses that money to invest in Islamic legitimate businesses. If you want the money back it's paid back to you in full, at least in this country anyway. As all banks operating in the UK, including Islamic banks, are regulated by the government they have to give savers their money back whenever they want it. However, a traditional Islamic bank is not obligated to give you the full amount back.
Islamic banking on your high street
Many High Street banks offer Islamic finance products. Below are a few:
Lloyds TSB's Islamic finance package has current accounts, home financing, student accounts and baby bonds.
HSBC offers personal accounts, home finance and insurance. Most of its Islamic finance packages are available in Malaysia, Saudi Arabia and United Arab Emirates.
NatWest as yet offers only Sharia-compliant business loans.
Islamic Bank of Britain is the UK's first Islamic bank. It offers Sharia-compliant products for individuals and businesses, including online banking.
The small print
Remember banks which offer Islamic finance are not doing it out of the kindness of their hearts but because they see this as another way of making "loadsa monei".
Islamic finance as it's offered on your High Street and in financial markets around the world tries to do something Islamic but it still operates within the confines of a non-Islamic system. But it's a small step towards creating fairness and simplicity in financial dealings throughout the world.
The actual monetary results that emerge out of an Islamic financial transaction may very often be the same as the ones that emerge from a conventional transaction. But Islamic finance opens up what is often an unfair conventional system to allow consumers more choice in their financial dealings.
Here are some more terms you won't remember:
Ijara – based on leasing of an asset
Musharaka – profit and loss sharing
Istisna – production/construction financing
Salam – forward financing
Sukuk – bond based on an underlying asset