Advisors.ie

This article first appeared in the Sun on Sunday on the 28th of July 2013

As it is the month of Ramadan I thought it would be worth talking about Islam, and to make it relevant the way that Islamic Finance or ‘Sharia compliant finance’ works.

It may seem strange at first (and this may be the first time you have even heard of it) to hear that a religious belief has a certain financial system bolted on to it, but if you look to the current financial system you can see that it too had religious roots in its history.

In the middle ages Jews were pushed into money lending by Christians, because Christians, like Muslims forbade ‘usury’ or ‘charging interest’. Jews couldn’t charge interest to other Jews, but they could charge it to those outside of the faith because through the interpretations of the Talmud they could be seen as ‘investments’.

But back to Islam, in Islam usury or ‘Riba’ is still ‘Haram’ or ‘forbidden’. There are two types of it, the first is called ‘Riba al Naseeyah’ and that’s common ‘interest’ on a loan. In Islam you are not meant to make money from money, it should be from labour or investment.

The other lesser known forbidden action is called ‘Riba al Fadl’ and it comes about when somebody charges an excessive amount for something beyond the economic cost to them to provide it. If you had a well in the desert and sold glasses of water you could charge and make a profit but if you charged €100 a glass to a dehydrated passer by when it only cost you a few cent to provide it then you’d also be morally and ethically conflicted.

The modern system started in the early 1960’s and had two main objectives, the first was local development the other was to help people save to go on pilgrimages or ‘Hajj’.

What the history books don’t often mention is that early Muslims were astute and reliable business people and traders. Some historians even believe that part of the popularity of the religion came from the way in which traders behaved themselves and dealt with others in an honest and forthright manner.

How it all works is generally by attempting to get the same result as you might with a normal financial product but by doing so in a lawful or ‘Halal’ manner.

So take a mortgage for example, an Islamic mortgage wouldn’t have an interest payment in it because that is forbidden. Instead the loan is at 0% (sounds attractive!), but instead the person would rent the property and buy equity stakes in the home.

Rather than have a €1,200 per month mortgage payment they might pay €800 per month in rent and the other €400 of the payment goes towards the 0% loan. In doing so they abide by the rules and achieve home ownership. That these loans are not available in Ireland is a pity as we have a thriving Muslim community, about 50,000 strong, who are instead forced to either rent for life or break their own rules.

Other products like Insurance (Takaful) or Bonds (Sukuk) are a little more tricky, but when you have a financial system growing as fast as the Islamic Finance one which is thought to be growing at over 15% a year and worth in excess of $1.4 trillion dollars finding a morally acceptable solution is a big incentive.

Ireland already has about 20% of the non Middle East domiciled Islamic Funds and it is something we have been addressing with legislation which started in 2009 with the 2010 Finance Act, and which was strengthened by the 2012  and 2013 Acts.

A general concept is that in Islamic Finance you are more like ‘co-investors’ rather than having a ‘lender/debtor’ relationship. The idea of taking a stake in the things you invest in (because for banks their loans for houses are their investments or assets) is a central and ongoing theme in Islamic finance, and one that we would do well to learn from.

Why would this be good for all of us? Because it would mean that start up businesses would have ‘investors’ not ‘lenders’, and while it may mean that the role of banks reduces or changes, it may not be such a bad thing because greater competition creates greater efficiency, competition and ultimately better prices.

Could we one day have a new lender who operates this way? Not any time soon I suspect, but one day it will probably happen. If you strip out the religious aspects of Islamic Finance what you are left with is a blueprint for a financial system that is actually ethical and more centred on both profit and loss sharing with the people who interact with it.

The status quo might not be ideal, but we do know it’s viable due to the fact that it exists. That makes any call for an Islamic Finance system less appealing because it is based upon ‘what if’s’, but that certainly doesn’t mean we can’t learn all we can from it, and in time that learning will turn into products that will serve the market and make things better for all of us.