Islamic banking reaches the UK - The Independent

Esther Shaw reports. Her exposition is to be admired.

UK financial institutions creating Islamic products

Over the past four weeks, Lloyds TSB has launched both a current account and mortgage that comply with Sharia law. The account pays no interest and charges no interest because there is no overdraft on offer. With the mortgage - a five-month pilot project in five branches in London, Birmingham and Luton - the bank buys the home for the customer, who in turn pays for it with a fixed monthly sum plus rent.

Other deals include a Bristol & West mortgage in a tie-up with the Arab Banking Corporation, launched last May, and a pension fund available from HSBC's Amanah finance division. This tracks an index of the top 100 companies engaged in Sharia-compliant activities - avoiding shares in areas such as conventional finance (including Western banks), tobacco, pornography and gambling.

And the Islamic Bank of Britain opened its first branch in London last year and now offers a current and savings account as well as a personal loan that makes an arrangement charge instead of piling up interest.

UK regulators leveling the playing field

The Chancellor, Gordon Brown, has been busy too. His recent Budget brought tax on Islamic financial products into line with their conventional Western counterparts by scaling down the number of different tax charges. In 2003, in an effort to create a more level playing field for all customers, he also abolished "double stamp duty" for Muslims who were either buying or selling a property. Before, under Islamic financial schemes, they had to pay the tax twice both at the time of purchase and again when they came to sell up.

Complex or just different? (Or, more provocatively, economically equivalent?)

Trying to operate Islamic banking in the UK is a difficult task for providers, which have to comply with both Sharia law and the UK's regulatory requirements for the financial services industry.

One of the problems has been the complexity and extra cost of specialist products that require UK banks to take steps to avoid earning interest. To tackle this issue, Lloyds TSB's new mortgage uses a finance deal called Ijara which operates using Diminishing Musharaka - joint ownership by the lender and the customer. The bank must first buy the property outright and can contribute up to 90 per cent of the overall purchase price. The customer then gives the outstanding amount upfront to the bank - at least 10 per cent - and repays the balance over an agreed term together with a rental payment.

This reminds me of the U.S. regulations that require lenders to disclose to borrowers what the simple sum of their payments ("total of payments") will be over the life of the loan. (The point of the regulation is help naive borrowers understand what it means to pay back a loan with interest.) The simple sum is greater than the present value which is the size of the loan. With the Ijara described above the simple sum is also greater than the size of the loan, yet it is said there is no interest.

Return on savings accounts

The problem of interest earned on money is particularly complex for savings products. The Islamic Bank of Britain offers savings accounts run on a principle known as Modaraba, where a profit-sharing agreement is struck between the bank and the customer. Rather than earn interest on their deposits, savers rely on the bank to use their funds to trade in Sharia-compliant investments and then share out the profits.

Is it unquestioning reliance? What is the extent of the saver's responsibility to ensure that the bank is investing as promised?

(Bold added. Thanks to The Eclectic Econoclast for the pointer.)