Islamic Financing - a Model for the Banking Industry?
By Aijaz Hussain
Chicago , IL
“The ethical principles on which Islamic Finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service” – Vatican March 2009
It took the demise of a global economy to wake up the world to the sensibility of looking at Islamic Finance. Greed, corruption, over-leveraging and lack of Government regulation have cost us more than fair value for our goods, services, and properties. This disruption in global economics has created a golden opportunity for Islamic Finance.
Presenting at the 5th International Shariah Scholars Forum, Mahathir Mohammed, the respected former Prime Minister of Malaysia, stated, “Collapse of conventional banking, finance and the monetary system has exposed their weakness and the ease with which they can be abused.” The time has come for people to make a choice, but education and communication are imperatives for Halal Finance companies to convey their value and benefits to consumers.
Islamic financing is conservative by nature. By definition there is no leveraging and risk is prudently analyzed. Even in the go-go days of “easy” financing, Islamic financial institutions evaluated customers based on common sense metrics like income, down payment and credit. These actions led to lower delinquency and foreclosure rates than the industry in general. This has garnered some degree of popularity and press coverage recently with Muslims and non-Muslims who are taking an interest in exploring these financial solutions.
The key distinction between Islamic financing and conventional lending is the process and methodology. Islamic finance is based on the concept of trade, two parties engage in a buy sell business transaction. In a conventional lending transaction money is lent and the profit for the financier is derived from the use of money in the form of interest. Islam is very clear that this type of an arrangement involves Riba and is strictly prohibited.
There are three Islamic financing models available in the US today. Each of these models has been approved by some of the top scholars in the field of Islamic finance.
Ijara Model : An Ijara transaction is very simply a ‘lease to own’ contract. A trust purchases the property and leases it back to the customer for a certain length of time. At the end of the term the customer buys the property from the trust at an agreed upon price.
Murabaha Model : A Murabaha transaction is an ‘installment sale’ contract. The financing company purchases the property and then resells it to the end user at an agreed upon markup price.
Musharaka Model : A Musharaka transaction is a ‘Rent to Own’ contract. The customer and the financing company buy the property jointly in a partnership structure. The customer then buys out the partnership share from the financing company over a period of time. Along the way the customer pays the financing company rent for using the property share not owned by the customer.
In each of these cases since a ‘product’ is changing hands it is an acceptable model of financing from a Shariah perspective. Qualification for Islamic Financing is based on three factors: income, credit scores and down payment. As long as the deal makes sense closing can take place within 30 days. Customers with good credit scores can also qualify for low down payment programs.
As far as pricing is concerned, the popular notion that Islamic Financing is more expensive is simply not true. While it is true that 10-15 years ago halal financing alternatives were more expensive, these days companies like UIF offer products at or below conventional lender rates.
Investors looking to avoid interest based savings accounts can utilize Shariah Compliant deposit accounts that are being offered through University Bank. The funds invested here are used to finance commercial real estate and masjid construction projects.
Bottom line: as our communities grow and prosper we need our own Islamic financing institutions. We can no longer depend on conventional lenders to fulfill our needs.
