Understanding Shariah-compliant banking
This editorial was featured in the Financial Reporter.
Charles Haresnape, Chief Executive Officer
Shariah-compliant finance is one of the fasting growing areas in financial services. Worth just $200bn in 2003, the global sector is now expected to top $4 trillion in assets by 2030. Its growth in recent years has been aided by its increasingly broad appeal, which, due to a natural alignment with ethical practices, is popular amongst Muslim and non-Muslim citizens alike.
Shariah-compliant banking in the UK
In recent years, the UK has aspired to play a key role in Shariah-compliant banking, with the first Islamic bank launching in 1982. Following further growth of Islamic finance in the early 2000s, the government established a work programme to make the UK’s financial service regulations compatible with the market and changed tax treatment to ensure that equivalent conventional and Islamic finance transactions were served equivalent tax bills. The UK also became the first nation outside the Islamic world to issue a sovereign Islamic bond (sukuk) in 2014, with a second sovereign sukuk issued in 2021.
In 2021, the Bank of England announced that it would take deposits from UK-based Islamic banks to its Alternative Liquidity Facility for the first time. As the first of its kind offered by a Western central bank, the non-interest-based deposit facility was created to allow Islamic banks to place funds at the Bank of England in the same way conventional banks do. As the Bank’s Executive Director for Markets, Andrew Hauser, outlined when launching the facility, this aimed to help “further strengthen the United Kingdom’s role as the leading international financial centre for Islamic finance outside the Muslim world”.
Undoubtedly, using the facility will mean that the UK is better positioned to serve its citizens of the Islamic faith, which the ONS reports to have increased by 25% from 2011 to 2017 alone. However, a piece of research commissioned by Gatehouse Bank in 2019 found that only around two-fifths (40%) of Muslim consumers use Shariah-compliant financial products. Of those who had, four in five (85%) of Muslim consumers stated that the experience exceeded their expectations.
In a market of heightened risks, and where environmental, social, and governance concerns are being integrated across financial products, Shariah-compliant finance has the potential to respond to these challenges. As Mr Hauser noted in his speech, the “core principles of Islamic finance are strikingly well-suited to responding to some of the biggest challenges”, such as by “prioritising equity-like risk-sharing over debt, factoring ethical and environmental considerations into investment decisions, and embracing innovative financial solutions beyond traditional banking.”
For many, Shariah-compliant finance is also perceived to be more ethical than traditional banking, as there is a natural alignment with the Shariah principles of promoting, preserving, and protecting the human race, and sustainable development frameworks. For example, Shariah-compliant banks do not invest in sectors such as alcohol, gambling, tobacco, adult entertainment, or the arms industry. At Gatehouse Bank, we aim to provide fair, transparent, and socially responsible services, and have formalised our commitment to do good for the environment by becoming a founding signatory to the UN Principles for Responsible Banking, where we have committed to strategically aligning our business with the UN Sustainable Development Goals and the Paris Climate Agreement. We have also been certified as an operationally carbon neutral business for two consecutive years.
These values resonate with many of Gatehouse Bank’s customers, which we see through the success of our Woodland Saver Accounts, for which we plant a tree for every account opened or renewed, enabling us to plant over 20,000 trees since the product’s launch last year.
Learning the language
To treat customers fairly, it’s essential the industry explains Shariah-compliant products clearly – whether it’s to homebuyers or socially-conscious savers looking for a better return on their deposits. Fortunately, explaining a couple of key terms can go a long way to demystifying Shariah-compliant finance.
When it comes to savings, the key difference between conventional and Shariah-compliant banking is that the latter does not pay interest. This is because Shariah principles state that money should be put to work to produce the return rather than generating it in and of itself. Instead, Shariah-compliant banks offer an “expected profit rate” or EPR. The bank generates this by investing deposits in a portfolio of assets that comply with Shariah principles, and savers receive the profits as returns.
Similarly, home purchase plans (HPP), which are sometimes referred to as “Islamic mortgages”, require further explanation. Home purchase plans are a partnership, where the customer and bank purchase the property together, and the customer pays the bank rent on the proportion of the home they don’t yet own.
In essence, this is not very different to a conventional mortgage, where the customer pays interest only on the money it still owes to the bank. Just like mortgages, which come with repayment and interest-only options, HPP customers have a choice. One option is a rent and acquisition product, where the portion of the property the bank owns reduces over time with each monthly payment, including a sum to acquire a portion of the bank’s share. Another is rent-only, where the customer must pay for the bank’s share as a lump sum at the end of the finance term. Most importantly, the outcome of a HPP and a mortgage is the same, with the customer becoming a homeowner at the end.
Crucially, at the heart of Shariah-compliant finance is the value of being fair to the consumer, which is becoming an increasingly attractive proposition for people of all faiths, and none.