LONDON, 21 July 2003 — In the hallowed headquarters of the self-styled “the world’s local bank” in London’s Canary Wharf last week, some 170 specially invited guests were privileged to witness the launch of HSBC’s first Islamic mortgage product in the UK market. The guests — a selective mixture of Muslim community leaders and Muslims with existing HSBC conventional mortgages — were treated to the usual marketing hospitality of a banking major, away from the prying eyes of the media. On hand were HSBC’s Shariah Advisory Board.
The launch comes on the back of the decision by UK Chancellor of the Exchequer Gordon Brown delivered in the April budget to waive the double stamp duty (property tax) imposed on the Ijara mortgage contract, and to give relief on one set of stamp duty, to bring the Islamic mortgage on par with its conventional counterpart. The measure officially comes into effect in December this year. So one must assume that all three banks currently offering Ijara mortgages in the UK would be inculcating this in their mortgage formulas.
Earlier this month, the United National Bank, (UNB) a largely Pakistani-owned but UK registered bank, beat HSBC to the draw with the launch of its Islamic mortgage product, UNG IslamicMortgage, which became available to Muslims in the UK from July 7. “UNB has taken a proactive approach to its product development program. This is the first Ijara (leasing) based product to be launched in the United Kingdom that complies with the Shariah concept of diminishing ownership but which also retains the same level of risks as a standard Ijara mortgage. The approach taken is far more acceptable from a Shariah perspective and avoids breaching rules of amanah (trust),” explains Mohammed Paracha, an associate at Norton Rose, the City-based international law firm. The UNB product will be available through the bank’s seven branches, located in the major cities of Britain. HSBC, however, being a major high street lender, has a much wider distribution network, and will also initially focus in selling the produce in areas with largish Muslim populations including London, Cardiff, Birmingham, Bradford, Leicester and Manchester.
One other Gulf-owned bank, Ahli United Bank (formerly United Bank of Kuwait) through its London subsidiary has been offering Islamic mortgages for more than a decade under its Manzil Program.
Of course Saudis and other investors from the Gulf who wish to purchase a property in the UK, now have the option of choosing a Shariah-compliant mortgage as an alternative to a conventional one. In fact, all three banks confirm that there has been interest for the Islamic mortgage not only from Muslims in the UK but also from the Gulf and from the EU. All three Islamic mortgage providers are basing their product under the Islamic contract of Ijara (leasing). Under this arrangement, the bank providing the financing takes title to the property, and immediately leases the property to the customer in return for monthly payments of an agreed rental (which diminishes over the time period of the mortgage) and toward the sale price of the property (capital repayment). Legal title is transferred to the customer once all payments have been made. In other countries such as Malaysia and Kuwait, other Islamic contracts are used such as Murabaha (mark-up) and Al Bai Bithamn Ajil (deferred payment). However, although these are legal Islamic contracts, they are deemed by most Shariah scholars as not the ideal contracts suited to mortgages. The above two are similar in effect to a fixed-rate conventional mortgage. Scholars prefer the Ijara or the Mushraka (equity participation) contracts for mortgages.
The irony is that Islamic mortgages are now available in a non-Muslim country, whereas they are not available at all in several Muslim countries.
While more detailed information has to emerge from the three Islamic mortgage providers, it seems that they lenders are pitching their products at about 0.5 percent to 1.5 percent more expensive than conventional products. For a start, conventional products do not have the added cost of Shariah compliance, and the cost of hiring Shariah advisories are escalating. On the other hand, documentation costs for Islamic contracts are usually less expensive, given the fact the contracts very often can be less complex.
There are those who strongly believe that Muslims should not pay a premium to have financial products based on their faith.
These products should be competitive in the market to other alternatives. The cost of capital and pricing of the current mortgages may well see downward pressure over the next few years as other major high street lenders enter the Islamic mortgage market. Already Woolwich Building Society (owned by Barclays Bank), West Bromwich, Nationwide, and Yorkshire all doing studies on Islamic mortgages. Other banks such as Abbey National, National Westminster, Halifax, are also looking at the sector.
But behind the hype surrounding the mortgage launches, there are some questions that need to be clarified to the ordinary Muslim customer. How, for instance, is the rental value calculated? UNB says that it bases its rental value on the Bank of England base rate plus a profit margin. This is rather unfortunate, for it would be possible to base the rental value on the market value for rent at a particular given time and for a particular type of property. But then the entire transaction should be benchmarked against the market value of the rent or the property. Other areas where clarity and transparency is needed include fees, late payments, defaults, early redemption, and exit options.
Risks of both the financier and the customer are well defined in an Ijara contract. However, no bank, especially a Western bank, would want to take the mortgage and property risk on its books. Some cynics stress that even the Ijara mortgage is in net effect similar to a conventional mortgage because the risk characteristics are basically the same.
In the UK too there is hardly any mortgage securitization as in the US, where Freddie Mac and Fannie Mae are some of the largest mortgage securitizers in the West. Securitizarion allows banks to offload exposures to mortgages and other property finance contracts by selling on these facilities in the market, where they are traded, and thus creating liquidity in the market. Securitization which is asset backed is in theory a classic Islamic financial instrument, but it is conspicuous with its absence in global Islamic finance. Why? Because Muslim investors, the drivers of the global Islamic finance sector, tend to risk-averse and therefore are short-term in their outlook.
The shorter the term of investment the less risky the transaction, and therefore the smaller the reward or return. Yet some 70 percent of Islamic finance funds are invested in short-term low-risk Murabaha transactions.
This even in some cases where investors have a negative yield if zakah subtractions are taken into account. Not surprisingly, real estate and commercial property as an asset class, has gained in momentum over the last two years, with the launch of several Islamic property funds both in the US, UK, and the Gulf states.