Beginners’ Guide to Islamic Finance
Islamic Finance is a method of financing and banking operations that abides by Sharia Law. With the help of Bank of London and Middle East we outline the rules that all sharia-compliant financial products have to adhere to.
What are the main rules for Islamic finance?Bank of London and the Middle East (BLME), a Sharia compliant bank, says the main principles of Islamic Finance is the avoidance of all haram (harmful) activities such as charging interest. In addition to the prohibition on charging interest, Islamic financial institutions must ensure that ambiguity (gharar) or gambling/speculation (maysair) is minimised in transactions and contracts. Complying with Sharia law also means that Islamic Financial Institutions are not permitted to invest in alcohol, pork, pornography or gambling.
How does Islamic finance work?The overarching principle of Islamic finance is that all forms of interest are forbidden.
The Islamic financial model works on the basis of risk sharing. The customer and the bank share the risk of any investment on agreed terms, and divide any profits between them.
The main categories within Islamic finance are: Ijara, Ijara-wa-iqtina, Mudaraba, Murabaha and Musharaka.
* Ijara is a leasing agreement whereby the bank buys an item for a customer and then leases it back over a specific period.
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Ijara-wa-Iqtina is a similar arrangement, except that the customer is able to buy the item at the end of the contract.
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Mudaraba offers specialist investment by a financial expert in which the bank and the customer shares any profits. Customers risks losing their money if the investment is unsuccessful, although the bank will not charge a handling fee unless it turns a profit.
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Murabaha is a form of credit which enables customers to make a purchase without having to take out an interest bearing loan. The bank buys an item and then sells it on to the customer on a deferred basis.
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Musharaka is a investment partnership in which profit sharing terms are agreed in advance, and losses are pegged to the amount invested.
How long have these products been on offer?Savings and deposit banks that complied with Sharia were launched in the 1960s, says BLME. However, it was not until the mid 70s that commercial banks began to emerge. The last 20 years has seen the expansion both geographically and across financial services of Islamic Banking. In 2004 the first UK Islamic Bank was authorised by the Financial Services Authority. Conventional banks also identified the potential of Islamic Banking and many have opened Islamic ‘windows’ over the last ten years.
Humphrey Percy, CEO of BLME, says: “Since its establishement in 2007, BLME has witnessed a growing demand among medium to high net worth individuals for a banking option that incorporates the transparent and ethical principles inherent in Islamic finance with competitive returns. With the financial climate improving, individuals are looking to diversify their investments that were previously solely held by UK high street banks.”
Who offers them?There are over 500 financial institutions offering Islamic Finance in over 80 different countries, these range from retails banks to investment banks and asset managers. A recent estimate puts the Islamic Finance industry $1 trillion worth of assets and predicts that it will grow at between 10-15 per cent per annum.
Lloyds TSB offers a current account together with a home-financing scheme. The Islamic Bank of Britain offers a Sharia compliant current account, mortgage and also a personal loan. HSBC offers a Islamic current account and mortgage.
Bank of London and the Middle East offers a premier deposit account for investors with a minimum deposit of £50,000.
A handful of other banks also offer financial products in the UK tailored for Muslims.
Can anyone else benefit from these products?Both Muslims and non-Muslims can benefit from Islamic Finance as, by principle, it aims to be a more transparent and fairer system of finance. Many of the instruments or investment methods that have contributed to the financial crisis are not permitted by Sharia, such as short selling or non-asset backed derivatives.
BLME makes the point that there is no difference between how an individual or business would approach identifying an Islamic Bank or financial institution compared to a conventional one. Individuals should check that the Islamic Bank is authorised and regulated by the FSA to ensure they receive the same protection as they would with a conventional bank. It is important that individuals and business ask what benefits and terms they would receive and ensure that they select their provider on how they can meet these.
How do the banks make any money?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.
Source:
https://www.ft.com/content/8c9bc2fc-8845-11df-a4e7-00144feabdc0
