LONDON — Following the latest meeting in London last week between the UK Treasury and the Islamic Finance Advisory Group chaired by Andrew Buxton, senior adviser, Barclays Bank, it seems that the British government is edging closer to facilitating the introduction of competitive Shariah-compliant mortgages (housing finance) in the UK.
Such mortgage products are clearly lacking in the UK because they are currently not competitive compared to conventional mortgages. The reasons for making such products available to the two million-or-so Muslim population of the UK and other ethical investors are manifold.
Under the "Social Investment Taskforce" launched in February 2000 by UK Chancellor of the Exchequer Gordon Brown, the Labor government is keen on promoting social and financial inclusion, and community development finance.
Several surveys, including one done by Barclays Bank, have also suggested that demand for Islamic mortgages, which by-pass the interest mechanism, is sufficient to make them an economically-viable niche product. Another report published earlier this year by independent UK market analyst, Datamonitor, suggests that Muslims are set to be one of the key customer target groups in the UK over the next few years.
However, the structure of an Islamic mortgage has various impediments under current UK tax laws and regulation. There are currently two types of Islamic mortgage contracts – Murabaha (cost-plus or mark-up financing) and Ijara (lease financing).
The Murabaha is not regarded as an ideal Islamic mortgage contract because it is likened to a fixed-rate conventional mortgage, although in the Murabaha contract, the mark-up is technically subject to negotiation between the bank (the financier) and the house purchaser, and not according to the prevailing base interest rate. The United Bank of Kuwait (UBK) was the first to introduce an Islamic mortgage based on Murabaha under its Al-Manzil brand. But following the closure of its Islamic banking unit some two years ago, UBK has downgraded its Islamic finance activities and is merely servicing its existing Al-Manzil mortgages. As such, it is no longer a major player in the field.
The Ijara is an ideal contract but it involves the bank purchasing the property on behalf of the client, which constitutes one contract, and then renting it out to the client who also pays an additional capital repayment component in the monthly installment, until such time the entire capital is repayed and the title to the property then passes to the client, which under the UK tax laws constitutes a second contract. As such, under current Inland Revenue rules, the Ijara contract would be subject to double stamp duty (the house purchase tax) because it involves the two contracts stipulated above. This makes the Ijara contract uncompetitive because these taxes have to be paid by the house purchaser.
In addition, the risk weighting for both the Murabaha and the Ijara is 100 percent compared to 50 percent for conventional mortgages. According to the rules established by the Basel Committee of the Bank of International Settlements, the supreme body which sets the standards for global banking and which is run by the central bank governors of the Group of Ten Industrialized Countries (G-10), every bank requires capital against every lending that it does. This is called risk weighting.
An ordinary loan carries a 100 percent risk weighting. But a conventional mortgage because of its relative stability and length, and its core position in Western consumer finance in that it is predominantly the single largest purchase by the household in their lifetime, carries only a 50 percent weighting. This means that for an Islamic mortgage, the bank has to set aside twice the amount than for a conventional mortgage, which makes the Islamic product less competitive.
The Islamic Finance Advisory Group, which includes representatives from Barclays, HSBC, I-Hilal (the Dubai-based Islamic financial platform), and United Bank of Kuwait, with the active support of Sir Eddie George, governor of Bank of England, have been lobbying the UK Treasury to create a level-playing field for Islamic mortgages in Britain. The Treasury, according to Buxton, has responded sympathetically to a report prepared by the Group on Islamic mortgages, and has indicated its willingness to investigate how such a level playing field can be created and over what time scale.
Banking sources suggest that following last week’s meeting with the Treasury held at the Bank of England, the provision to remove the double stamp duty requirements for Ijara-based mortgages will be included in the UK Finance Bill 2003, although there has been no official confirmation of this as yet. The changes relating to the risk-weighting will take longer because they have to be initiated through the Basel Committee. It is not clear whether this would come under Basel II, the revised set of banking regulations and standards imminently set to be introduced by the BIS.
Muslims in the United States, of course, have successfully lobbied the Comptroller of the Currency Administration of National Banks (OCC) and other US agencies, who in 1997 approved the Islamic mortgage financing structure based on the Ijara, and ruled that a bank’s risks under the said structure are similar to the risks for traditional mortgage loans. As such Islamic mortgages in the US are subject to the same stamp duty and risk weighting as conventional mortgages. Earlier this year, HSBC launched its first Islamic mortgage finance product in New York, which was structured by its specialist Dubai-based Islamic finance division, HSBC Amanah Finance, headed by Iqbal Khan.
While the US market for Islamic mortgages is driven by its potential size and an above-average income Muslim population, the UK market demographics has also improved and is proving particularly attractive in a post-9/11 environment, and especially as a platform for the wider European market, with an estimated 15 million-20 million Muslim population.
According to Datamonitor, the number of Muslims resident in the UK in 2001 was around 1,750,000 (or 2.9 percent of the National Statistics Office’s estimate of the mid 2000 UK population at 59,755,700). "The market for Islamic finance products is estimated at about a third of this figure, based on the number of people registered at UK mosques. This therefore suggests a possible figure of about 5,400 high net worth individuals, with potential liquid assets of 3.6 billion pounds," stressed the report.
However, using the number of Muslims registered at UK mosques as a criteria is highly flawed, because most Muslims attending mosques are not registered and there is no legal requirement to do so. Religion is also not a compulsory identification category of the UK census, the latest of which was completed last year.
But Nicholas Stephens, Datamonitor Global Wealth analyst who wrote report earlier this year, maintains that "the market for Islamic (Sharia-compliant) finance in the UK is set to grow hugely. A huge gap in the market exists for Sharia-compliant equity and mortgage products. Muslims have historically been underserved by UK financial institutions, but this is set to change."
This is so because Muslims are showing increasing readiness to invest in the stock market; they are an easy group to target (they are located in well-defined regions in the South, Midlands and the Pennine region, in cohesive communities); and there is a huge well of UK Muslim money waiting in cash to be pumped into Islamic equities and other products once they become available.
The number of Muslim high networth investors in the UK is also set to rise significantly, and research shows that high networths increasingly prefer to keep their money onshore because of "a relatively benign tax regime in the UK, and the constraints of tying up money offshore, which for many may actually harm performance."
A US-led fight against money laundering have also forced offshore havens to tighten up regulations. At the same time, high networths are being catered for by an ever-increasing list of wealth managers onshore, from high street banks to investment banks, offering ever more services and products.
– 21 October 2002
