The government has announced plans for Britain to issue a £200m Islamic bond in a bid to attract new money to London. The bond will be aimed at institutions, but there are Islamic finance products available to regular savers, investors and homebuyers. Here us a guide to how sharia-compliant funds and mortgages work.
Why aren’t regular accounts sharia-compliant?
Central to Islamic finance is the fact that money itself has no intrinsic value; it is simply a medium of exchange. Each unit is 100% equal in value to another unit of the same denomination and you are not allowed to make a profit by exchanging cash with another person. A Muslim is not allowed to benefit from lending money or receiving money from someone.
This means that earning interest (riba) is not allowed – whether you are an individual or a bank. To comply with these rules, interest is not paid on Islamic savings or current accounts, or charged on Islamic mortgages.
How do sharia-complaint banking products work?
There are several ways that banks can structure accounts so that they are sharia-compliant.
Ijara works as a leasing arrangement: the bank buys something for a customer and then leases it back to them. Different forms of leasing are permissible, including those where part of the instalment payment goes toward the final purchase. This might be used to help you buy a car or other item, or to help a business buy equipment.
Murabaha works by the bank supplying goods for resale to the customer at a price that includes a margin above the costs, and allows them to repay in installments. This might be used to provide a mortgage on a property. The property is registered to the buyer from the start.
Musharaka is a joint venture in which the customer and bank contribute funding to an investment or purchase and agree to share the returns (as well as the risks) in proportions agreed in advance.
Wakala is an agreement that the bank will work as the individual’s agent. If a saver enters into this type of agreement, the bank can use their cash to invest in sharia-compliant trading activities to generate a target profit for them.
How do the banks make money?
Banks can profit from the buying and selling of approved goods and services. The principal means of Islamic finance are based on trading, and it is essential that risk be involved in any trading activity, so banks and financial institutions will trade in sharia-compliant investments with the money deposited by customers, sharing the risks and the profits between them.
Islamic banks are structured so that they retain a clearly differentiated status between shareholders’ capital and clients’ deposits in order to make sure profits are shared correctly.
Although they cannot charge interest, the banks can profit from helping customers to purchase a property using a ijara or murabaha scheme. With an ijara scheme the bank makes money by charging the customer rent; with a murabaha scheme, a price is agreed at the outset which is more than the market value. This profit is deemed to be a reward for the risk that is assumed by the bank.
There are firm laws governing the types of businesses with which the banks can trade. There should be absolutely no investment in unsuitable businesses, including those involved with armaments, pork, tobacco, drugs, alcohol or pornography.
It’s similar to ethical banking, then?
There is some common ground. Some of the tenets of Islamic banking will appeal to anyone, Muslim or otherwise, who agrees with the underlying principles of equitable distribution for everyone, the ideals of fair trading, spending of wealth judiciously, and the well-being of the community as a whole. In the wake of the banking crisis, savers may also be drawn by Islamic banking’s approach to investment: they can only invest in real assets, not financial instruments that are based on speculation.
The Move Your Money campaign rates one bank, the Islamic Bank of Britain, highly for ethics and customer service, but its overall score is diminished by a lack of women on its board and high directors’ pay, among other things.
How does it work if I take out a mortgage?
Islamic mortgages, or house purchase plans (HPPs) can involve ijara, where you are technically leasing the property from the bank, or diminishing Musharaka, where you buy in partnership with the bank and your monthly repayments gradually buy it out. As with a standard mortgage you will usually need a deposit, and you will need to have the house valued before you enter into the arrangement.
You will also be able to fix the amount you pay each month if you wish – for example, the Islamic Bank of Britain offers a fixed rental rate of 3.79% to homebuyers with at least 35% to put down as a deposit, and 4.19% for those with a 20% deposit – both rates are fixed until 31 December 2015.
The bank also offers a buy-to-let house purchase plan.
How does it work if I open a savings account?
Instead of being offered an interest rate you will be offered a target profit, which the bank will try and make for you by investing your money in compliants investments (this might include homes bought through the bank’s Islamic mortgage scheme). The profit is subject to tax, just like interest on standard savings and current accounts. Because there is an element of risk you need to agree that you are happy to make a loss.
As with standard savings accounts, you can choose for a fixed-term deal or an easy-access account. The target rates on offer are along the lines of those elsewhere in the savings market, and sometimes better – currently, the Islamic Bank of Britain is offering a table-topping 2.32% on a two-year savings bond, according to Moneyfacts.
Is my money safe?
If the bank is covered by the Financial Services Compensation Scheme (FSCS), up to £85,000 held on deposit with it will be protected if things go wrong. Check that it is before you hand over any money.