Islamic finance expert Afsor Ullah provides a brief introduction to Islamic finance and some of the key concepts underpinning the fast-growing means of financial support.
Global assets in Islamic finance grew to $3.374 trillion in 2020 and are anticipated to grow at 8% annually until 2025 (to $4.95 trillion). The Bank of England reported in December 2020 that UK assets held by the four exclusive Islamic banks were worth over £5 billion and there were now more than a dozen conventional banks offering sharia compliant services, investment firms and a thriving advisory sector. With the launch of the Bank of England’s Alternative Liquidity Fund aimed at supporting Islamic banks, it is apparent that Islamic finance (also known as sharia finance) is clearly playing an important role in banking, real estate and financial services sectors.
What is Islamic finance
Islamic finance is essentially finance which is compliant with the Sharia, Islamic Law. This is derived from two primary sources: (1) the Qur’an: this is considered by Muslims to be the final revelation from Allah (God) to mankind for its salvation and contains stories of past prophets, historical events, and numerous rulings to abide by; and (2) the Sunnah: these are sayings and teachings of the Prophet (peace be upon him).
Often when we speak about Islamic finance, we immediately begin to speak about the various structures being used and various rulings. Al-Ghazali, an historic Islamic scholar, reports that ‘the obligation of the Sharia is to provide the wellbeing of all humankind, which lies in safeguarding their faith, their human self (nafs), their intellect (’aql), their progeny (nasl) and their wealth (mal)’. The grander objective of Islamic finance is therefore more than just structures which are sharia compliant, but is actually about improving socio-economics through alleviating poverty, protecting wealth and generally enhancing wellbeing.
At the heart of Islamic finance is the concept that money itself should not have an intrinsic value and therefore making money from money is strictly prohibited. There are number of key principles and concepts that usually feature or inform most Islamic finance arrangements:
- Riba’ – also known as usury or interest. Strictly prohibited in Islam and void under sharia law.
- Gharrar – uncertainty in contracts – far more stringent than English law. Modern day insurance for example is prohibited for that reason, as it is uncertain if the insured event will occur.
- Maisir – speculation. This is beyond general commercial speculation but prohibits forms of speculation which are akin to gambling.
- Zulum – Unjust enrichment/unfair exploitation – unjust enrichment at the expense and exploitation of another through undue influence or duress. This needs to be looked at on case-by-case basis.
- Haram – things that are forbidden through divine intervention. Anything haram is considered by Muslims to be harmful and so Islamic investments or assets must not be in anything haram (eg alcohol, pornography, gambling industries).
- Halal – the general rule in sharia is that generally everything that is of benefit is halal or allowed so long as there is no evidence to indicate that it is prohibited.
Modern Islamic finance structures used in real estate transactions
Taking into the account the various principles and concepts (as listed above), a variety of different structures were created under the watchful eyes of Islamic scholars. Islamic financial institutions typically employ sharia boards and advisers who approved these arrangements and continue to maintain them.
- Diminishing Musharakah (co-ownership) – the customer who wishes to purchase an asset enters into a partnership with the bank whereby the bank will fund a portion (for example 80%) and the customer will fund the remainder (for example 20%). As part of the agreement, the bank will lease its share of the property to the customer, who will make monthly rental repayments and make acquisition payments to gradual increase their share over the course of the finance term. Once the customer has increased their share to acquire 100% (ie redemption of their Islamic mortgage), the bank is obligated to transfer the asset to the customer. Where the customer is selling the asset, the bank is usually obligated, upon receipt of the redemption funds, to transfer the asset to the new purchaser.
- Commodity Murabaha – the customer who wishes to purchase an asset will enter into a Murabaha Agreement. This involves the bank purchasing a precious commodity on behalf of the customer (usually a metal such as palladium) and agreeing to sell this for a fixed rate profit on a deferred basis. The bank will then purchase the commodity and sell it on the same day, releasing the sale proceeds to the customer who will use the money to purchase property. The customer will then pay the bank for the purchase plus the agreed profit.
- Ijarah leasing – the financial institution owns the asset and agrees to lease the asset back to the customer who will pay rent and an agreed profit. The bank will agree to sell the asset to the customer with the final balloon payment which is usually the final rental amount plus agreed profit. After making the last payment, the asset is transferred to the customer. This structure is very similar to conventional car financing arrangements.
Islamic finance is growing and adapting to the needs of the market and its consumers. At the same time, the modern structures created and used in the UK have had to be created using the UK legal and regulatory framework. Before entering any Islamic finance arrangement, it is important to fully understand the various documents which are often part of an Islamic finance deal. Similarly, when choosing a structure, it is also important to consider its compatibility with the asset being purchased and the wider commercial objectives. The documents used in Islamic finance in the UK are usually governed by English law but usually created to comply with sharia law; this concept often confuses consumers and lawyers alike!
Hill Dickinson’s Real Estate team include experienced Islamic finance solicitors who can navigate, advise and negotiate on the raft of documents used various Islamic finance arrangements in a real estate transaction.
For further information, please contact:
Afsor Ullah, Hill Dickinson