Relevance of Islamic finance in Britain
By Iqbal Khan,
Managing Director Head of Global Islamic Finance, HSBC Amanah Finance,
Foundation and Core Concepts
is an ethical, indigenous and equitable mode of finance, which derives
its principles from the Quran (The revealed book of Muslims) and
tradition of the Prophet Muhammad (pbuh). Shariah law (Islamic law),
which is based on the Quran and Sunnah, governs Islamic finance.
It is a trend
which is broadening the ownership base, creating more stakeholders
and thereby bringing the hope of stability to more than 1.3 billion
Muslims spread across the world.
as a concept is based on themes of Community Banking, Ethical and
Socially Responsible Investments and Affinity Marketing. These themes
themselves are based on core ideas, which include individual responsibility,
reliance on market mechanism, commitment to economic and social
justice and mandatory care for the environment. These guidelines
also include prohibitions from investing in areas such as Defence
and Armaments, Casinos, Breweries - areas which are considered to
be value destroyers.
In Islamic Finance
Scholars say that everything is allowed except that which has been
specifically forbidden. In essence the believing Muslims view of
economics is based on Man's obligation to organise his affairs in
accordance to the will of God as his representative and vice regent
on Earth. The goal is not equality but an avoidance of gross inequality
along with an injunction that wealth should not become "a commodity
between the rich among you". Islamic Finance is firmly embedded
in the commercial, real, value-producing economy.
The desire of
enlightened Muslims to seek the moral equivalent of Modern Capitalism
goes back to Egypt in the early 1960s. The pioneering effort, in
Egypt, took the form of a savings bank based on profit-sharing in
the town of Mit Ghamr. The Islamic Development Bank (IDB) was established
in l975 by the Organisation of Islamic Conference (OIC), but it
was primarily an intergovernmental bank aimed at providing funds
for development projects in member countries. The IDB now also extends
to private sector corporates for project and trade finance facilities.
In the mid-seventies,
Islamic banks came into existence in Saudi Arabia and the United
Arab Emirates. Since then, Islamic financial institutions have emerged
in a large number of Muslim countries including Kuwait, Bahrain,
Qatar, Turkey, Pakistan, Indonesia and a belt of other IDB member
countries. These institutions have taken the form of commercial
banks, investment banks, investment and finance companies, insurance
today is an industry that is still evolving. The industry manages
approximately $180 Billion dollars today, growing at approximately
15% per annum. The growth of Islamic banking is a result of economic
growth in the Islamic world, fuelled primarily by oil wealth. This
growth created a growing middle-wealth segment and hence made banking
a necessary service to the larger segment of the population rather
than a service for the few, as had been the case some 10 to 15 years
Evolution of Islamic Finance
In the 1970s
and 1980s, Islamic banking was characterised by a large number of
commercial banks serving retail Muslim customers in their respective
countries. However, since the late 1980s a shift towards investment
banking has taken place. No where is this better witnessed than
in Bahrain, which has the largest number of offshore Islamic investment
banks in the Muslim world.
In the early
years, investments and products used by most Islamic financial institutions
were driven by the concept of Mudaraba (referred to as Trust Financing)
and focused on short-term investments. During this period, Murabaha
(cost-plus finance) emerged as the most widely used instruments
by Islamic banks, accounting for over 80 per cent of a portfolio
of an Islamic bank.
During the 1990s
Islamic financial institutions have become increasingly more innovative,
developing more complex instruments and structures to meet the demands
of modern day business. The use of instruments such as leasing and
construction finance have become far more widespread. Islamic finance
tranches have also been structured into big-ticket syndication.
only recently opened up as an asset class to Islamic investors,
following approval from the Islamic Fiqh (Islamic jurisprudence)
Academy in Jeddah, one of the major legal bodies in the Muslim world.
Islamic investors are now able to invest in equities subject to
certain criteria. Over 100 Islamic equity funds have now been launched
since 1995 with Assets under management in excess of $7 billion.
Some of these funds are being sold in UK and it would be useful
to make their ISA compatible.
and the Players
More than 2/3rd's
of Islamic finance business is currently originated in the Middle
East. The GCC countries, with the exception of Oman, are all major
markets for Islamic finance. Bahrain is regarded as the hub for
Islamic finance. Other major non-GCC markets for Islamic finance
include Egypt, Malaysia, Turkey, Indonesia, and Pakistan.
a dual banking system promoted by the government. This allows conventional
financial institutions, investment banks, commercial banks and finance
companies to launch separate Islamic banking divisions, competing
alongside two Islamic banks, Bank Islam Malaysia and Bank Muamalat
Malaysia. Bank Negara Malaysia (the central bank) has its own Shariah
Advisory Board, which sets the rules for the entire Islamic banking
sector, ensuring uniformity of products and services.
Over 150 Islamic
financial institutions now operate in over 40 countries around the
world, from commercial banks, investment banks, investment companies
to leasing, and insurance companies.
around the world have devised many financial products based on the
risk-sharing, profit-sharing principles of Islamic banking. For
day to day banking activities, a number of financial instruments
have been developed that satisfy the Islamic doctrine and provide
acceptable financial returns for investors. Broadly speaking, the
areas in which Islamic banks are most active are in trade and commodity
finance, property and leasing. Almost every Islamic bank has a committee
of religious advisers whose opinion is sought on the acceptability
of new instruments and services and who have to provide a religious
opinion of the bank's activities for year-end accounts.
Muslims in Britain
and throughout the world aspire to carry out their financial matters
in accordance with the principles of Islamic law. Muslims are forbidden
from obtaining the various conventional banking and insurance products
and services in the forms currently offered due to their incompatibility
with the principles of Islamic law.
It is estimated
by various surveys that over 2 million Muslims are permanently residing
in the UK. The community is predominantly composed of people from
the Indian sub continent who have settled in Britain during the
1950s. Beside them, there are also Muslims of Middle Eastern and
North African origins. Additionally there is a growing population
of indigenous Muslims.
The UK Muslim
community has now reached the "Second-Generation" stage.
The first wave of immigrants having settled down, the second-generation
Muslims are now slowly penetrating the different strata of the British
society. It is not uncommon to find successful Muslim lawyers, chartered
accountants, bankers, businessmen and even Members of Parliament,
both at the House of Lords and the House of Commons.
The third generation
of Muslims are also emerging from the educational system and is
projected to increase the Muslims' presence in all strata of British
society, especially, the educated middle class.
The vast majority
of Muslims either is living in rented houses or has taken conventional
interest-based mortgages. The total number of Muslim households
as estimated by the Muslim Council of Britain is around 500,000.
Of the 500,000 households, it is estimated by various market researches
that approximately 40,000 families seek financing for home purchases
We have regularly
received enquiries regarding the availability of Islamic finance
products, in particular Islamically compatible finance to purchase
both residential and commercial properties. It is believed that
a large number of Muslims have abstained from taking the conventional
mortgage because of its incompatibility with the Islamic principles.
The needs of these Muslims need to be served immediately.
Beside the market
represented by Muslims living in Britain, there is potential for
overseas investors to be introduced by HSBC. We understand that
a considerable number of Muslims living abroad (mainly in the Middle
East) had expressed their desire to own properties in Britain (mainly
as a holiday residence) but have been reluctant to embark into an
interest bearing financing facility. For these investors an Islamic
home financing scheme will offer the opportunity to own a property
customer, having identified the property, will approach the Bank
to finance the purchase of the property. The transaction structure
will be as follows:
- The customer
chooses the property for purchase and agrees the purchase price
with the owner of the property ("Seller"). The bank
buys the property from the Seller at the agreed price. The customer
will be requested to provide a deposit against the purchase price,
but the Bank will remain the sole registered owner.
- The customer
signs a lease agreement with the Bank. The lease will be for a
period of up to 25 years with the lease rentals to be reviewed
annually to reflect the capital repayment. The terms of the lease
agreement will stipulate that in the event of a default the Bank
will have the right to repossess and sell the property.
- The customer/lessee
will give an undertaking that in the event of a default under
the lease agreement, the Bank/lessor will have the right to compel
the customer to purchase the property for the purchase price (which
shall equal the amount of principal outstanding).
- There will
also be an undertaking whereby the Bank/lessor promises to sell
the property to the customer/lessee at the end of the agreed lease
period (i.e., when the whole of the principal portion has been
repaid). There will also be a provision for certain other specified
instances including when the customer desires to sell the property.
The above structure
would allow British Muslims to get access to home financing without
forcing them to choose between their religion and home ownership.
It allows British Muslims to purchase homes without violating Islamic
prescriptions on borrowing money on which interest is charged. Further,
this initiative will be consistent with the well-established public
policy of encouraging home ownership and making Muslim stakeholders
Home Financing: Current Impediments
A key element,
which will impact the pricing, is the FSA's approach to risk weighting
for this product. FSA has provisionally ruled that the product is
to be 100% risk weighted. This is essentially because the transaction
is equivalent to a lease and leases are weighted 100%. This assumes
that the house remains the property of the Bank throughout the term
of the transaction and is treated as a fixed asset on its balance
sheet. If we are obliged to weigh at 100% then pricing will be significantly
higher than the conventional mortgage rate. Good Muslims should
not be penalised for being good Muslims. The Muslims in the United
States have approached the Comptroller of the Currency Administration
of National Banks ("OCC") to seek the approval for Islamic
home finance based on the above leasing structure. The OCC had in
1997 approved the Islamic home financing based on the above leasing
structure and ruled, inter alia, that the banks' risks under the
Islamic leasing structure are similar to the risks on traditional
mortgage loans (see OCC's Interpretive Letter #806). We hope that
a similar approval would be granted in Britain.
of ownership from vendor to bank at the commencement of the lease
and from bank to customer at the end of the lease, may attract the
payment of two sets of stamp duty. The second set would arise at
the end of the term of the lease at the rate of stamp duty then
applicable. The second set of stamp duty needs to be exempted because
the true effect of the transfer is similar to the redemption of
a conventional mortgage or charge: when the property finally vests
with the customer without any encumbrance. If the second set of
stamp duty is not exempted, the uncertain cost of the second stamp
duty would make the Islamic home financing unattractive and cost
Unlike the conventional
mortgage the proposed product would require the appointment of two
sets of Solicitors, thereby making the product more expensive. It
is suggested that the Law Society should consider giving a general
exemption as is done for the mortgage product.
always been a major trading partner of the Muslim world. Trade volumes
became increasing significant in some parts of the Muslim world
in the 1970s following the oil driven economic boom.
The oil boom
during this period brought about growth in the domestic economies
of the oil producing countries. This brought opportunities for British
firms to play a role in building the infrastructure of these countries.
Surplus funds from the Muslim world found their way into the safe
and stable environments in Britain to be managed by London-based
have also been channelled into direct investments. Good examples
here are Kuwait Investment Office's acquisition of a 20% stake in
BP stands out, the acquisition of Lotus the car manufacturers by
Proton, the Malaysian car company and purchase of the Hartwell Group
by a prominent trading family from Saudi Arabia.
in the London property market by the investors from the Muslim world
has historically been very important. Real estate analysts believe
that in 1998 alone well over 20% of all such investments came from
the Muslim world. In addition, a significant number of Muslim businesses
in Britain are also seeking Islamically compatible finance to purchase
commercial properties in Britain.
We are witnessing
an increasing desire from Muslim investors that these funds be managed
and corporate acquisitions be structured under Islamic financial
principles. Here UK regulators can play an important role in facilitating
the flows of funds and investments into Britain from the Muslim
world through the introduction of "Islamic finance friendly"
too, trading with their counterparties in the Muslim world need
to be cognisant of the growth of this indigenous and ethical mode
of financing and be aware of the characteristics, qualities and
benefits of Islamic finance.
Many of the
Muslim countries throughout the world would be classified as developing
markets. Consequently, cross-border funding for these countries
from western financial markets may be either restricted or limited,
thus hindering trade and investment flows between the UK and the
Muslim world. Here Islamic financial institutions, who have a greater
knowledge and understanding of these markets and consequently the
risks, can play key role by providing financing in instances where
western commercial financiers would be unwilling to lend.
and British export credit agencies would benefit tremendously by
using this indigenous form of finance to gain access to precious
cross-border lines in the 54 Islamic Development Bank Member Countries,
These cross-border lines could become a tremendous source of competitive
advantage for British exporters.
finance is a trend, which is broadening the ownership base, and
creating more stakeholders. It offers a viable financial alternative
that may run parallel to conventional finance. Regulators, bankers,
asset managers and users of capital in Britain may capitalise on
the opportunities afforded by this market and play a proactive role.
supports this form of finance by offering products and services
through its financial institutions and through leading law firms.
The regulatory authorities should come out proactively to introduce
regulations which will allow these instruments to be established
as an ethical alternative to other instruments which are available
in the London financial markets, meeting the needs of Islamic fund
This will require
an understanding and appreciation of the roles which these ethical
indigenous instruments play in keeping the commercial economy as
close as possible to the financial economy. British exporters to
the Muslim countries would be in a very favourable position if they
could provide not only the exports but also export financing that
meets the importers' religious requirements. HSBC is working together
with the Export Credits Guarantee Department and other Export Credit
Agencies in the EEC to provide Islamically compatible financing
and guarantee for exports to Muslim countries. The proactive role
of the ECGD is providing Islamically acceptable financing is essential
to ensure that British exporters to the Muslim countries have an
edge over others. This would lead to more trades between Britain
and the Muslim countries, which could lead to a positive contribution
to the British economy.
has mainstream relevance for British Muslims, British Business and
British Exporters. It is therefore important that relevant Government
Institutions such as ECGD, FSA and DTI should pay attention to this
corporate and social responsibility movement, which is becoming
increasingly important for both Muslims in Britain and abroad.
important is the demonstration effect which such an effort may have
for all of humanity.
Dr. Martin Luther
King Jr. described the challenge, which we face:
our scientific genius we have made the world a neighbourhood,
now through our moral and spiritual genius we must make of it
It is in this
domain and in bringing the financial economy close to the commercial
economy that Islamic Finance can make a real and lasting difference.
Britain with its history and culture of trade, commence and community
banking is well positioned to benefit from this growing trend of