The UK is bidding to become a global hub for Islamic finance with plans to launch the first Islamic bond provided by a western country.
The £200m bond, or sukuk, has been in the planning stages for years and the government hopes that it will encourage Islamic investment into all sorts of British enterprises. There are also plans for a new Islamic index at the London Stock Exchange so that investors can track companies that engage in Islamic-compliant activities.
Islamic finance is still a relatively new sector but it is growing fast and is now estimated to be worth $1tn globally. Providers say that Islamic finance, which promotes itself as more ethical and transparent than the mainstream, is an area that should be of interest to both Muslims and non-Muslims alike.
What is Islamic finance?
The main difference between a high street bank product or investment and an Islamic one is that Islam prohibits investors from making money from simply lending it.
This means that customers with an Islamic savings or current account are not paid interest on their deposits and borrowers with an Islamic mortgage do not pay interest on their debt.
Instead, homebuyers have the option of an ijara scheme in which the bank buys a property and then leases it to the customer. Alternatively the murabaha scheme means that the bank buys the property and sells it to the customer for a profit. The consumer pays off the profit through fixed repayments.
As with a standard home loan, buyers need a deposit and the rates are relatively competitive. Islamic Bank of Britain offers a fixed rental rate of 3.99 per cent to homebuyers with at least 20 per cent to put down as a deposit.
Savers are offered a targeted profit instead of interest – a system that used to be employed by credit unionsbefore the rules were changed last year.
Islamic banks, or banks offering sharia-compliant savings accounts, use the money deposited to invest in trading activities that generate a target profit. The money is kept apart from other funds.
Like other savings accounts, customers choose either a fixed target profit over time or an easy access account.
The Bank of London and the Middle East offers 3 per cent in its five-year fixed term account for savers who deposit £25,000 or more. The Islamic Bank of Britain is offering a table-topping 2.3 per cent on a two-year bond, the best-two year rate available from any provider.
Deposits of up to £85,000 in both banks are protected by the Financial Services Compensation Scheme.
Who decides if a product is sharia-compliant?
There is no kitemark from the UK regulator to identify a sharia-compliant bank product and Omar Shaikh, a board member of the Islamic Finance Council UK, says that the challenge in helping consumers identify compliant products is something that the council is thinking about.
“It’s not a huge problem, we just need to educate people,” he said. “The system of finance based on debt and interest is very widespread so we just need to explain how Islamic finance differs.”
Banks that offer Islamic financial products must ensure that a scholar or board of scholars has agreed that the products meet the criteria. “The board of scholars actually adds another layer of governance, which is good for customers,” said Mr Shaikh.
Where can I find an Islamic financial product?
Sharia-compliant savings accounts, home loans and credit cards have been available to retail customers in the UK for more than a decade but it is possible you may not have come across one yet.
The entrance of HSBC into Islamic finance was supposed to herald the moment the sector went mainstream, but the sector has not yet taken off and HSBC chose to close its Amanah Finance servicein the UK last year.
Lloyds offers a sharia-compliant current account which pays and charges no interest but, so far, other high street banks have not entered the market.
Bank of London and the Middle East offers sharia-compliant accounts to wealthy customers and Pakistan’s United National Bank (also FSCS covered) has both sharia-compliant and interest-paying accounts.
The Islamic Bank of Britain offers a variety of sharia-compliant products, including a personal and premier bank account and fixed-term savings accounts. It also provides home finance deals and buy-to-let finance plans based on co-ownership and leasing agreements. These can be purchased with a 25 per cent deposit and rents start at 4.49 per cent.
Investors can use the bank’s discretionary portfolio service which will help them to find a sharia-compliant and ethical source of profit. There is also a self-invested personal pension (Sipp) administered by Pointon York.
Parents can save for their child in a sharia-compliant child trust fund from The Children’s Mutual or a junior Isa from Scottish Widows, which also has an Islamic Global Equity Fund investing in global stocks that adhere to Islamic principles. Year to date the fund has returned just over 13 per cent to investors.
Should I buy one?
Anyone can purchase a sharia-compliant product, and the rates on offer in Islamic savings accounts and home purchase plans look competitive compared with the rest of the market.
Islamic current accounts do not offer overdrafts, so users need to make sure they have enough money to meet their monthly payments, but one of the main attractions of Islamic financial products is the ethical business practice.
Banks cannot use money invested to back businesses which fund haram (harmful) activities such as arms, tobacco, alcohol or pornography.
And on wider customer service, the Move Your Money UK campaign gives The Islamic Bank of Britain a score of 74 out of 100 for honesty, customer service, culture and ethics.
Why don’t more people buy them?
The sector is growing. According to Sultan Choudhury, managing director of Islamic Bank of Britain, retail deposits increased by 22 per cent last year.
But it remains at the fringe of the UK’s financial services industry and hopes that many of Britain’s 2m Muslims would switch to Islamic products look forlorn. Qatar had to bail out the Islamic Bank of Britain a few years ago, and now that HSBC has withdrawn from the sector it seems unlikely that other large banks will choose to develop the area. The UK’s banking sector is so notoriously sticky that existing providers are going to need to step up their marketing if they want to encourage customers to move their money.
Buying a house
When Abul fled Pakistan in 1970, he left behind a mudbrick mansion in Habiganj for a concrete flat in Tower Hamlets. He rented a property in London for 37 years, unwilling to buy a house because no mortgage complied with the sharia ban on interest.
When HSBC and other UK retail banks launched sharia-compliant banking services they enticed many devout Muslims like Abul into their branches. With an Islamic bank account, Abul stopped having to donate the interest on his account to charity. An Islamic mortgage enabled him to buy a house.
But not all Muslims have been as keen to opt into Sharia-compliant financial products.
Stricter Muslims spurn Islamic banking because they consider its technique of paying a fee to “investors” (account holders) to be simply the rebranding of interest payments, which are forbidden to prevent exploitation of the poor.
And while many others admire the spirit of the law banning “riba”, or interest, they do not follow the sharia to the letter, opting instead to use mainstream bank accounts.