Keep the Faith

The watchword for lenders at the moment is undoubtedly risk. The sub-prime crisis that imploded to become a full-scale credit crunch has been blamed on lenders' inability to identify risk. Now, as lenders, brokers and consumers await an increase in liquidity in the market, there is at least one thing everyone can agree on - the new dawn of lending, whenever it might come, must be more astute at managing risk than the previous era.

Lenders simply cannot lend in the way they did before, when credit was easy and any man on the street could get a mortgage. And consumers should not expect easy credit like they got before, with their next holiday, car or home being just a quick application away. The new lending culture must be more conservative, less dangerous and more ethical. It is because of this that the spotlight has fallen on Islamic finance.  As early as last September industry experts were saying that mainstream lenders should take heed of the principles of Islamic finance. At the time accountant and financial adviser BDO Stoy Hayward predicted that more individuals and corporations would invest in Islamic banking and Sharia-compliant products than ever before.

It claimed Islamic banks were some of the few financial institutions to still have significant sums of money available to finance individuals and corporations, "unlike their western banking counterparts which will continue to constrict their lending policies in light of the current economic crisis".

"As the risk profile of Islamic banks is generally lower than that of more conventional banks, this presents a more solid option for both retail and institutional investors and suggests that dealings with Islamic financial institutions will grow dramatically as people switch to more secure products," Dan Taylor, head of banking at BDO Stoy Hayward, said at the time.  "Further growth of Islamic banking in the UK will also be attributed to their more conservative approach to financing, as risks are shared with investors, much like the private equity model. Also, it is more difficult for Islamic financial institutions to use leverage so their risk profile is naturally lower."

"In light of the prevailing market turmoil we could expect the number of standalone Islamic financial institutions present in the UK to double in the next three years, further reaffirming London's position as the centre of choice for the provision of Islamic finance," adds Taylor.   Islamic finance has its roots in Sharia law, under which making money from money is forbidden and money should only be made through legitimate investments.   This means there are two main differentiators between Islamic banking and conventional lending. First, Islamic banking is ethical. Investing in businesses that are considered unethical is prohibited. This includes companies that deal in arms, gambling, pornography, tobacco or any other commodities contrary to Islamic values.  And second, interest is forbidden.

"Islamic banking is structured on the principles of risk-sharing and entrepreneurship," says Steven Amos, head of marketing at the Islamic Bank of Britain. "Rather than paying interest Islamic banks share profits according to a ratio agreed in advance with their customers. The main difference between Islamic and conventional banking is that Islamic teaching maintains that money itself has no intrinsic value.

"To make money from money is prohibited - wealth can only be generated through legitimate trade and investment. Any gains relating to this trading are shared between the person providing the capital and the person providing the expertise."

IBB generates all its profit through Sharia-compliant trading and investment activities. It then shares any profits with its customers at a pre-agreed ratio. To share in the profits customers must hold one of IBB's savings or investment accounts.   The idea of sharing risk ethically - as opposed to breaking it up and hoping it will go away as with the securitisation model - is something lenders may look at adopting in the future.   At the moment the Islamic finance market is relatively small. According to a recent Datamonitor report entitled Islamic Banking Core Systems: The Western European Opportunity the Islamic mortgage market was worth around £500m in 2008.

IBB is the UK's only standalone Islamic retail bank. Its annual report published in March detailed a rise in customer numbers of more than 10% compared with the previous year to 47,000, illustrating the growing popularity of Islamic finance products.   Amos says Islamic finance is a niche market brokers should be tapping into.   "According to a report by Mintel in July 2008, the UK is home to two million Muslims, of whom 1.3 million are of working age," he says.   "With the market largely untapped the potential for providers of Islamic finance products is huge. The main area that has generated interest among British Muslims so far has been the Sharia-compliant home finance market. They are also interested in Sharia-compliant savings accounts."

But while the market may be ripe for the taking, how easy is it for brokers to get involved in? Diversification is the word on everyone's lips as the intermediary market fights for survival but is Islamic finance too specialist a sector for brokers to work in without extensive training?  "It is a difficult market to get in to because of a couple of factors," says Fahim Antoniades, partner at Quantum Money. "First, there are cultural differences in the way personal information is exchanged by individuals here and in the Islamic world. In my experience if you get to know a Muslim person well they will give you an insight into their personal situation and financial standing whereas in Western culture it's almost the opposite - individuals prefer not to let even friends or neighbours in on their personal situation."  So in Antoniades' view if you are an adviser looking to get into Islamic mortgages it would be a big help to be Muslim and have connections in that community.

"Also, Islamic finance doesn't offer access to financial planning products such as life and critical illness cover for mortgages or income protection as these sorts of products would be considered un-Islamic," he adds. "So aside from buildings insurance it offers a limited revenue-making opportunity."   And Antoniades says brokers should not expect much by way of proc fees from Islamic lenders either, as they prefer to deal directly with applicants. He says it could be for these reasons that the sector is largely unexplored by brokers and in the main, mortgages are handled directly by banks which use them as a way of delivering other banking products and services to the community.

Kevin Friend, strategic partnerships director at Mortgages.co. uk, agrees.  "Islamic finance is popular with those who embrace the Islamic principles of Sharia law," he says. "The Home Purchase Plan is not easy to understand and advice must be given by an expert who can advise applicants in strict accordance with the appropriate compliant and legal process. The products are quite different from mainstream mortgages."

Amos disagrees. He says IBB has launched a website intended to make working with the bank and Islamic finance products more straightforward.

"Our website allows registered brokers to submit leads and applications, track the progress of deals and have unlimited access to printable copies of our product literature," he says.

"Registration is free and subject to compliance checks. Only agents who are regulated by the Financial Services Authority to sell Home Purchase Plans are able to use the full application and tracking service."

A Home Purchase Plan is the Sharia-compliant mortgage alternative. It is based on the Islamic financial principles of Ijara (leasing) and diminishing Musharaka (partnership). Under such an arrangement the customer and the bank each contribute towards the purchase of the home and become partners.

Over the period of the agreement, the customer makes monthly purchase instalments through which they buy the bank's share of the property. With each instalment paid, the bank's share in the property diminishes while the customer's share correspondingly rises.

Aside from the Home Purchase Plan there are a wide range of Islamic finance products available including current accounts, savings accounts, treasury deposit accounts, business banking accounts and options including commercial property and personal finance.   Of course, few are exempt from the credit crunch. The wave of destruction caused by the crisis has been on a scale nobody could have imagined, but how has Islamic finance fared given the big differences between it and conventional finance?

According to Amos, it has been relatively unscathed.  "With UK banks in troubled waters and consumers facing a big credit crunch Islamic banking is considered by many to be a stable and sensible alternative," he says.   "This is demonstrated by IBB's financial results in March which showed strong growth in customer numbers, deposits and financing during 2008. Deposits increased by 15% to £158m and customer financing went up by 48% to £23.5m."   Amos says the reason IBB has remained relatively insulated from the credit crunch is because it was not affected by its root cause - toxic assets.

This is because it does not lend money for home purchasing in a conventional way and instead enters into a partnership with customers to share ownership of properties. As a result it is more prudent in its approach and manages the risks of assets it takes on with care.  "As a faith-based bank many see our approach as an ethical one," adds Amos. "We offer transparency, fairness and competitive products and our Sharia-based structure means everything we do and all the products we offer are regulated by our Sharia Supervisory Committee. This committee has been put in place to oversee all our activities."

While the products may be deemed safer, Friend says his firm has not noticed an increase in interest in Islamic finance since the crunch hit.  "We have seen no significant change to the level of enquiries for Islamic mortgages resulting from the adverse market conditions," says Friend. "What we have noticed is a continuing lack of understanding when it comes to Islamic mortgages. I believe there will be little growth in this often misunderstood niche area of lending in the next few years. It's interesting that following the withdrawal of funding from lenders such as Bristol & West, Middle Eastern banks are keen to offer funding, along with some larger brands."

While everyone will agree the level of lending we saw in the boom time cannot and probably will not return, clearly there is no cause for all lending in the UK to be governed by Sharia law.   But some may argue that lending that is not driven as much by profit and that sees customers and lenders sharing risk could be worth looking at.   One thing is for sure - to some degree, conservatism is going to play a part in any new form of lending that might emerge.

Meanwhile, those in the Islamic finance industry unsurprisingly believe there is much that conventional institutions could learn from an ethical and traditional method of lending.  "Islamic finance is a growing industry in the UK and around the world," says Amos.   "As an alternative system it has been attracting a considerable amount of interest due to the global financial crisis. Many consider Islamic banking to be a more stable alternative to the conventional system and there have been numerous debates and discussions urging conventional bankers to emulate the asset-based structure that Islamic banking follows.

"There is a need for conventional banking to return to traditional values," he adds. "And although Islamic banking is an alternative system it has a lot to offer customers, especially those looking for an ethical and stable system."Islamic finance has a big future''.

Nusrat Janjua, marketing director , Islamicmortgages.co.uk.  ‘The Islamic mortgage market has decreased in size by about 35% since last August and I envisage that it will continue to fall and mirror what is happening in the conventional market, certainly for most of this year.  The biggest reason for this decline has been the limited availability of mortgage products for first-time buyers and those looking to remortgage.

The Islamic mortgage market does not offer any real alternatives for customers unless they have a large amount of equity in a property or a substantial deposit.  Islamic lenders recently increased their deposit requirements - alburaq to 35% and HSBC Amanah to 40%. Both these organisations are leaders in the market, with many innovative products.   Nevertheless, the Islamic mortgage market remains positive, with all lenders investing in marketing initiatives to drum up business.  The Islamic Bank of Britain remains competitive and continues to develop its product portfolio, recently expanding into the Scottish market. But the average Islamic mortgage customer will still struggle to get a mortgage, with a minimum property value requirement of £150,000.

Islamic mortgages provide an alternative to conventional interest-based mortgages, enabling the purchase of property in accordance with the Islamic faith. Under Sharia law making money from money, such as charging interest, is usury and therefore not permitted. For devout Muslims this had made it difficult to participate in a range of financial activities that many individuals take for granted including pensions, credit cards, current accounts and mortgages.

The history of Islamic finance is surprisingly short, stretching back globally only 35 years or so. But two years ago economists predicted the Islamic mortgage market would soon be worth billions in the UK alone.  Ever since Muslims arrived in the UK they have been unable to finance their homes without compromising their religious belief. There was a marked lack of Sharia-compliant finance solutions and this prevented many from owning homes.

In the past five years this situation has changed, and we now have several lenders providing Islamic mortgages to UK Muslims, with an array of product offerings. In the future I forsee further expansion of the industry, with many more Sharia-compliant products and investments being offered, and more commercial institutions operating in the UK.   We aim to provide a no-nonsense approach to the UK Islamic mortgage and finance market and our focus remains on providing quality information without comprising our ethos.   The government wants the UK to be a global hub of Islamic finance''.

Rashid Khaliq , director , Islamic Financial SolutionsThe principles behind Islamic finance have to be in line with Sharia law. The fact that interest is completely forbidden means Islamic Institutions have avoided the money markets that have caused the recent turmoil. Instead, these institutions raise funds from depositors and shareholders, providing them with liquidity while other banks are struggling.  A balanced approach is also taken by Islamic firms, with ethical and moral behaviour at its foundation. Ethical institutions by nature implement a screening process. In Islamic banking this is largely subjective, often depending on individual conscience.

The types of firms that are excluded by Islamic financial institutions include those that are involved in the gambling, alcohol, arms manufacturing, tobacco or pornography industries.  All this means the onus in Islamic finance is on tangible assets and a back-to-basics ethos - a far cry from the complicated financial structures that have resulted in our current unhappy predicament.   We specialise in Islamic and ethical products, catering for Muslims wishing to abide by their faith and for non-Muslims who wish to take a a more ethical approach to their finances.

Our products range from residential, commercial finance to Islamic banking and insurance. Our Islamic Home Purchase Plan is particularly attractive, with rental rates starting at 3.79% along with a low application fee of £299 and no tie-in period or early repayment penalties. This proposition is widely regarded as attractive not only in the Islamic world but across the market, attracting attention from individuals of all faiths, creeds and cultures.

Islamic mortgages avoid interest by using a method based on the principles of Ijara (leasing) and diminishing Musharaka (partnership). Instead of lending money the bank owns a share in the property which it leases to the customer.   The customer then makes rental and acquisition payments in order to own the property outright at the end of the term. The client is able to sell the property at any time and can pay in lump sums twice a year without incurring any penalties.

The Musharaka structure requires the legalities to be different from a conventional mortgage. For example, the legal contract shows the bank's share in the property and ownership rights within the transaction.
Of course, any lawyers involved have to be familiar with the process. That's why we have a panel of vetted solicitors, creating a smooth transition for clients wishing to take the ethical path.

The government has come up with initiatives designed to make the UK a global hub of Islamic finance, and the balanced principles that underpin the industry could make this an ethical solution to some of the problems in this country's traditional banking structure.   Although knowledge of Islamic finance can be attained fairly readily it is hard for brokers to explain the differences between conventional and Islamic financial products -especially what makes them Sharia-compliant.  This is mainly because the structures, Arabic terms and legalities involved have to be understood well enough that they can be explained to clients in a clear and simple way.

Customers may already be confused after trawling through a minefield of information on the internet, and be looking for a simple explanation Islamic methods, and more importantly what makes these products compliant with their faith or ethics.   It's hardly surprising that many brokers do not see the extra work involved in learning about Islamic financial products as representing a viable business.   I believe a specialist approach is key to delivering Islamic financial advice to the masses. This has two main benefits. First, clients see a company not deriving its income from interest-based conventional banks while explaining to them why they should avoid these firms - I'm often asked if I deal with conventional banks. Second, by specialising in this market the principles and structures of it become second nature, and clients can see this.

Reference
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