Do any of the following statements apply to you?
• I’ve been affected by the credit crunch
• I’m fed up with excessive bank charges
• I think my bank makes unethical investment choices.
If so, Islamic banking may appeal to you.
Bear in mind, though, that you may obtain a greater return from conventional accounts. The market for Islamic finance is thriving, according to a recent study by the IMF. It’s estimated to be worth more than £250 billion worldwide – and is growing at 15% a year. Some 25% of the world is now Muslim, with demand for Islamic banking in the UK and Europe being fuelled by the growing number of middle-class Muslims in the West.
The UK Treasury has already expressed the desire ‘to entrench London as a global gateway for Islamic finance’. Consultation is currently underway on the potential for the government to become an issuer of Islam-compliant investment certificates (sukuk – often referred to as Islamic bonds).
And the country’s mainstream banking heavyweights have also become increasingly keen to involve themselves in Islamic financial services. HSBC has introduced Amanah, a range of Islam-compliant services which include a current account and home financing facilities. Lloyds TSB operates a similar set of services.
So what’s it all about?
Before you decide whether it’s right for you, here’s a guide to the basic principles of Islamic banking. It differs from ‘mainstream’ British banking in several fundamental ways. Islamic finance is governed by the principles of Sharia’a (Islamic law). Key Sharia’a tenets include the following:
• The collection and payment of interest (usury – commonly known as riba in Islamic discourse) is prohibited. Earning money – without having to do any work for it – is against Sharia’a principles.
• Instead, one of the mainstays of Islamic banking is the sharing of profit, and loss (for example, between the financial institution and the entrepreneur). Profits made are shared between the bank and the entrepreneur according to predetermined ratio.
For example, let’s say a customer has £1000 in a savings account. The bank invests this in one or more Sharia’a-compliant activities. A profit of £60 is made. The bank keeps £24 (40 per cent of the profit) and the customer gets £36 (the remaining 60 per cent).
• Investing in businesses that are considered unlawful, or haraam, is also prohibited. This includes companies that sell alcohol and pork, as well as those that deal in gambling, pornography, and other commodities contrary to Islamic values. Ethical investing is the only acceptable form of investment.
Will I make more money banking this way?
Not necessarily. The Islamic Bank of Britain was the first Sharia’a compliant, stand-alone high street bank to open in Britain. Profit rates on its savings accounts typically range between two and 3.75% (no profits are made on money in current accounts). In purely financial terms, this compares unfavourably with a ‘profit’, in the form of interest, of over 6% offered by many of the savings accounts operated by mainstream UK lenders.
Of course, if you choose to buy a house using Islamic financial services, you won’t have to pay any interest on a mortgage. Sharia’a compliant home finance is based on the principles of ijara (leasing) and musharaka (partnership).
Here’s an example of how it works: Say the bank contributes 90% and the customer 10% of the purchase price. Over an agreed period (up to 25 years), the customer then pays monthly purchase instalments, through which the bank sells its share of the home to him or her.
However, during this time the bank will make a profit on the transaction. Often, this is through the customer paying the bank rent to live in the property. So, although Islamic home financing aims to be market competitive, you’re unlikely to save much money buying a property this way.
So if I’m not Muslim, why would I choose Islamic banking?
• These banks have largely been protected from the credit crunch and sub-prime mortgage trouble.
That’s because Islamic banks only lend to borrowers who can offer security or collateral for the loan (such as a home.) This means that Islamic banks are unlikely to lend to sub-prime borrowers and shouldn’t be hit by a large number of defaulting borrowers.
• You might prefer their attitude towards bank charges. Simply put, Islamic banks can’t profit from these charges.
Overdraft facilities are not offered, and if an account does go overdrawn, no penalty interest is charged. Administrative fees are charged – for items like returned cheques and letters of notification – but in keeping with Sharia’a principles, the charges should only reflect expenses incurred.
Many Islamic banks even choose not to keep the money from bank charges. For example, the Islamic Bank of Britain donates its charges, to the penny, to charity.
Something for Britain’s other banks to think about?
• Islamic banking might be more in line with your ethical choices.
If you’re not Muslim, you may not object to your current bank investing in pork products or alcohol. But what about armaments, or the tobacco industry? Though both of these are ‘grey areas’ where Sharia’a is concerned, many Islamic banks make the choice not to get involved with them at all. So if you want to protect your money and not worry about the ethical implications, it’s worth thinking about.
If you do decide that Islamic banking is for you, you’ll find you can make the switch with relative ease, and it needn’t affect other areas of your life. You don’t need to be Muslim to take part in Sharia’a compliant banking in the UK. Your religion, behaviour and ethical choices in everyday life won’t be scrutinised.
Obviously this approach won’t be for everyone. Islamic banking may not make you rich, and it certainly isn’t a financial panacea. However, it does seem the banking mainstream could learn a thing or two by taking a look at the principles behind it.
By Serena Cowdy – Fool.co.uk, 9 January 2008