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Islamic Finance Heads Down Under: Australia Launches its First Islamic Finance E-Learning Program
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UPDATE: Islamic Finance Heads Down Under: Australia Launches its First Islamic Finance E-Learning Program
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FACTBOX-Key political risks to watch in Bahrain
MANAMA, March 1 (Reuters) – Mass protests by Bahrainis, mainly from the majority Shi’ite community, have shaken the stability of the Gulf Arab kingdom that is home to the U.S. Fifth Fleet, since uprisings toppled veteran rulers in Tunisia and Egypt.

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KPMG Named Best Islamic Finance Adviser By Euromoney
KUALA LUMPUR, Feb 24 (Bernama) — KPMG has been named “Best Islamic Assurance and Advisory Services Provider” in the 2011 Euromoney Islamic Finance Awards.

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“Islamic finance can also reduce the problem of subprime borrowers by providing them loans at affordable terms. This will save billions of dollars that are spent to bail out the rich bankers,” said Chapra, who at present works as adviser at the Islamic Research and Training Institute of the Islamic Development Bank.

Chapra estimated the derivatives market at $600 trillion, more than 10 times the size of the world economy.

“No wonder George Soros described derivatives as hydrogen bombs while Warren Buffett called them financial weapons of mass destruction,” he pointed out. The derivatives include credit default swaps (CDS) worth $54.6 trillion.

The Islamic economist described the present global financial crisis as the worst in four decades. “There is a lurking fear that this might be only the tip of the iceberg. A lot more may come if the crisis spreads further and leads to a failure of credit card institutions, corporations, and derivatives dealers,” he warned.

Chapra urged Muslims to establish a genuine Islamic finance system with proper checks and controls, adding that such a move would encourage others to embrace it.

The Islamic system does not allow the creation of debt through direct lending and borrowing. It rather requires the creation of debt through the sale or lease of real assets by means of its sales- and lease-based modes of financing such as murabaha, ijara, salam, istisna and sukuk.

Spelling out the regulatory regimes in the Islamic system, Chapra said: “The asset which is being sold or leased must be real, and not imaginary or notional; the seller must own and possess the goods being sold or leased; the transaction must be genuine with the full intention of giving and taking delivery; and the debt cannot be sold and thus the risk associated with it cannot be transferred to someone else.”

He said the conditions set by the Islamic system would help eliminate most of speculative transactions. “Financing extended through the Islamic products can expand only in step with the rise of the real economy and thereby help curb excessive credit expansion,” he said.

Chapra emphasized the significance of the condition that prevents a creditor from transferring the risk to someone else by selling the debt. “This will help eliminate a great deal of speculative and derivative transactions where there is no intention of giving or taking delivery. It will also help prevent an unnecessary explosion in the volume and value of transactions and the debt from rising far above the size of the real economy,” he added.

It will also release a greater volume of financial resources for the real economic sectors and, thereby, help expand employment and self-employment opportunities and the production of need-fulfilling goods and services.

The discipline that Islam wishes to introduce in the financial system may not materialize unless the governments reduce their borrowing from the central bank to a level that is in harmony with the goal of price and financial stability, Chapra said.

“In the Islamic system, credit is primarily for the purchase of real goods and services which the seller owns and possesses and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully,” he explained.

He said excessive and imprudent lending by banks was the main cause of the current global crisis.

“There are three factors that make this possible: inadequate market discipline in the financial system resulting from the absence of profit and loss sharing (PLS); the mind-boggling expansion in the size of derivatives, particularly CDSs; and too big to fail concept of banks who believe that the central bank would come for their rescue.”

The false sense of immunity from losses introduces a fault line in the system as banks do not undertake a careful evaluation of their loan projects. This leads to an unhealthy expansion in the overall volume of credit, to excessive leverage, and to an unsustainable rise in asset prices, living beyond means, and speculative investment. Unwinding later on gives rise to a steep decline in asset prices, and to financial frangibility and debt crisis, particularly if there is overindulgence in short sales.

Chapra said the subprime mortgage crisis in the US was also the result of excessive and imprudent lending. “Securitization or the originate-to-distribute model of financing has played a crucial role in this. Mortgage originators collateralized the debt by mixing prime and subprime debt. By selling the collateralized debt obligations (CDOs), they passed the entire risk of default to the ultimate purchaser. They had, therefore, less incentive to undertake careful underwriting.”

Consequently a number of banks have either failed or have had to be bailed out or nationalized by governments in the US, the UK, Europe and a number of other countries.

“This has created uncertainty in the market and led to a credit crunch, which has made it hard for even healthy banks to find financing,” he said.

“When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive urge for resorting to derivatives like CDSs to seek protection against default. The buyer of the swap (creditor) pays a premium to the seller (a hedge fund) for the compensation he will receive in case the debtor defaults,” he added.

A former executive director of the International Monetary Fund, Dr Abbas Mirakhor, says wider Islamic economics relies on God’s guidance, handed down almost 1,400 years ago.

There is a “consciousness of a supreme creator and a system that he has provided”, he says.

What we know as the conventional Western way does not have that, which is “really the major difference between the two”, he adds.

In practical terms, the most significant difference is that charging interest is not allowed in Islamic finance.

Neither are most forms of speculative investment permitted, such as hedging or derivatives trading.

“We don’t recognise the concept of interest… to look for some profit from trading money,” explains Dr Bambang Brodjonegoro from the Islamic Development Bank.

“In the Islamic concept, money is strictly for the purpose of exchange or storing value, but not for the transaction of looking for excessive profit,” he says.

Sharing risks

How then, does an Islamic bank, and a customer who puts money in that bank, make a profit?

The system is asset-based, with tangible assets or commodities at the heart of it. There are buyers and sellers, not borrowers and lenders.

Here is a comparison.

In Los Angeles a customer who wants to borrow money to buy a car would go to a conventional bank and agree a loan. The bank would hand over the money.

There would be regular repayments, which include interest accrued on the loan.

In Lahore a customer could go to an Islamic bank and sign a contract with the bank to buy a car from them.

The bank would not loan the money but buy the car itself. Then it would sell it to the customer at a mark up.

The customer would agree to pay back the cost in instalments over a regular period.

One of the core principles at the heart of Islamic economics is risk sharing. The bank and the people who put their money in it share any profit, or loss, from investments.

“In Islam we appreciate merit, so if someone works harder in a business…they (the bank) will get the sharing benefit,” explains Dr Brodjonegoro.

“The more important thing is that there will be no bank that rules everything. It will be bank and borrowers at the same level and they share the risk and benefit.”

Alternative way

This sense of equality is important. It is one of the defining characteristics which proponents of Islamic economics say make it different from the conventional western way.

Islamic economics also highlights a belief in benefitting the wider Muslim community.

The former IMF Executive Director Dr Mirakhor says that it chimes with “a movement toward becoming more ‘other conscious’…having consciousness about the other fellow, about the general public interest.”

This contrasts with what he described as the “simple narrow basis of self interest which motivates, supposedly, the economic agents in the liberal economic system.”

Some see the Islamic model as an alternative. Others see it as complementary to the system which has dominated the western world.

“I don think that this Islamic banking system is the alternative, that we have one or the other. I think this is a complimentary service, a way of doing service,” says Prof Ekmeleddin Ihsanoglu, Secretary General of the Organization of Islamic Countries.

“It needs to be an option there where people can find different ways of doing the same thing.”

Compromising principles

Islamic economics is not the exclusive preserve of Muslims.

London is emerging as a major financial centre for Islamic finance. Islamic banking products are also widely used by non Muslims in Malaysia.

“This is an alternative system that can be applied to everybody. Everybody can use it regardless of their religion,” says Dr Brodjonegoro from the Islamic Development Bank.

Major banks like Britain’s HSBC and Citi of the US have set up Islamic banking subsidiaries that are flourishing. Some of the champions of the Islamic way want to see business expand beyond the natural market of Muslim countries.

They believe that now, more than ever, there is a market for non Muslims who share in the values espoused in Islamic economics.

But there are some who fear that by expanding the Islamic way is becoming less Islamic.

Time to reflect

“Unfortunately what is happening is that Islamic finance in some ways is moving more and more closely to the conventional finance,” says Prof Habib Ahmed, a world authority on Islamic finance.

“If you look at the development in the past few years, Islamic finance appears to be mimicking most of the products of conventional finance.”

There has never been a better time to champion an economic model which is different to the one laying in shreds on Wall Street, says Prof Ahmed. But he believes that the Islamic concept is being diluted.

“As people after this crisis are looking for solutions…the Islamic finance industry is moving towards that very system,” he says.

“I think it is time for Islamic finance to pause and think of the direction it is taking”.
– By Robin Brant BBC

“The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Vatican’s official newspaper Osservatore Romano said in an article in its latest issue late yesterday.

Author Loretta Napoleoni and Abaxbank Spa fixed income strategist, Claudia Segre, say in the article that “Western banks could use tools such as the Islamic bonds, known as sukuk, as collateral”. Sukuk may be used to fund the “‘car industry or the next Olympic Games in London,” they say.

Pope Benedict XVI in an Oct. 7 speech reflected on crashing financial markets saying that “money vanishes, it is nothing” and concluded that “the only solid reality is the word of God.” The Vatican has been paying attention to the global financial meltdown and ran articles in its official newspaper that criticize the free-market model for having “grown too much and badly in the past two decades.”

The Osservatore’s editor, Giovanni Maria Vian, said that “the great religions have always had a common attention to the human dimension of the economy,” Corriere della Sera reported today.

Risk Analysis Of Islamic & Conventional Banks In Pakistan

Islamic banks are a key source to earn profit without Riba(interest) . According to Islamic law Riba(interest) is prohibited in Islam and in any trading activities. “The funds of the customers are placed in profit sharing investment and also interest is not paid on the customers deposits a/c in Islamic banking” (Archer & Karim, 2006). There are a large number of risks which are involved in commercial banks with Islamic banking and also banks without Islamic fianacing. This paper analyze the two  major risks of the bank, credit risk and liquidity risk. Those convential banks which are using islamic financing have considerable less credit and liquidity risk as comapre to other convential banks which are not using islamic mode of financing  (How, Karim, & Verhoeven, 2005). This article provide the results regarding islamic banks and conventional banks. This paper articulate the risks in islamic banks and conventional banks, also provide the psychoanalysis between these two sector. It also contribute to the vast prose on the determinents of bank risks by the simplification of preceding observed findings with respect to a country  that acquire a dual banking structure. Our results show that conventional banks in pakistan are more risky than the islamic bank, which have low credit risk and liquidity comparativly.

The remnants of this article is consisting the structure and model of the banks. Which tell the numerical figures related to the risks of conventional banks and islamic banks.

“Islamic banks do not pay interest on customers’ deposit accounts. Instead, customers’ funds are placed in profit sharing investment accounts” (Archer & Karim, 2006)

Literature Review

Islamic banks offer financial instruments that are consistent with the religious beliefs and cultural characteristics of Muslim societies. The essential feature of Islamic banking is that it is interest-free. 3 Islam prohibits Muslims from taking or giving interest (riba), defined as any predetermined or fixed return from financial transactions including both deposits and loans, regardless of the purpose for which such loans are made or how low the rate of interest charged is. The prohibition of riba is mentioned in four different revelations in the Qur’an,4 which also declares that those who disregard the prohibition of interest are at war with God and His Prophet. Some scholars have also put forward economic reasons as to why interest is banned

in Islam. The main problem of all these financial institutions is the manipulative character of interest. As the financial system in Islam is based entirely on equity basis i.e. the investor of the capital and the entrepreneur shares in the profit as well as loss, the Islamic banks are also conducting their business on the same pattern. I.e. profit and loss sharing principal (Iqbal,Z. 1999). There are a large number of theories on the determinents of risks in islamic banking and conventional banking.

Even in ancient times, people were well aware of risk factor…while taking financial and monetary decision, they knew that lending their money to a person with good background is much safer investment than lending their money to a bankrupt. However, risk is one of the important tools of decision making and now it can also be measured and different values can be assign (ALi & ALgeri, 2003).

Those who advocates the intrest concept in financing holds that intreset factor encourages and motivate the investors to invest thier capital insted of spending the money on consumption (Rabooy, 1991)

There is very genuine book  (M.Ali)which consist the difference table between conventional financing and islamic financing.

Table 1.1 Differences between conventional financing and Islamic financing

Conventional finance

Islamic finance

Primarily based on Interest rate

Facilitate financial activities

Structured and formalised

Stress on financial efficiency

Restricted moral dimension

Highly systematised in terms of risk

management, accounting and other standards

Existing set of legislations to deal with legal issues

Highly developed banking and financial product market

Existence of conventional money market

Availability of inter-bank funds

Strong and developed

secondary market for securities

Existence of short-term money market

Interest is prohibited

Facilitate social, economic and

financial activities

Unstructured and still informal in

many ways

Stress on social, ethical and financial

efficiency

Strong moral dimension

Standards for risk management, accounting and other activities are still developing

Legal support still in development with several legal areas under doubt

Developing banking and financial product market

Non-existence of significant Islamic money market

Non-availability of inter-bank funds

Non-existing secondary market for securities

Non-existence of short-term money market

Islamic Banking System in Pakistan

Islamic banking system in Pakistan has been established in 1980s.  A large number of products have been introduced by Islamic banks, which facilitate the customers to buy those products with easy conditions. These products are basically having five Islamic financing arrangements: Mudarbah, Murabaha, Al-Ijarah, Musharakah, And Sukuk.

Mr. Muhammad Ali Jinnah emphasized the virtues of Islamic principles, and in his address at the inaugural ceremony of the state bank of Pakistan, he said, “I shall watch keenness the work of your organization in evolving banking practices compatible with Islamic ideas of social and economic life. We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality manhood and social justice. (Azam, 1 july 1948)  “

There are five major Islamic banks in Pakistan AL Baraka Islamic bank, Bank Islamic Pakistan limited, Dubai Islamic bank Pakistan limited, Emirates Global Islamic bank limited, Dawood Islamic bank limited, and Meezan Islamic bank limited.

There are large numbers of commercial banks which provide Islamic and non Islamic finance products and some are the conventional banks which only provide the non Islamic financing.

According to the Islamic Banking Bulletin of state bank of Pakistan, that Islamic financing banks are increasing in number and volume which shows the effective and better response of these banks compare to the conventional banks.

Data analysis and Methodology

Hypothesis

In this article, we build up hypothesis on the relationship between Islamic financing with two most important risks, which are credit risk and liquidity risk. Different aspects of these risks are presented in this article to analyze the impact of these risks and also find the measure regarding these important risks.

Credit quality problems can result in bank insolvency or in a significant drain on bank capital and net worth. We expect Islamic banks to conduct “credit” checks and perform feasibility studies before entering into a new venture. Banks with more dealings in derivative contracts are expected to have higher credit risk. (How, Karim, & Verhoeven, 2005)

H0: There is no difference in risk between islamic financing and non islamic financing banks.

H1: Banks with islamic financing has lower risk than the non islamic financing banks.

Data description

Our sample consists of three banks with Islamic and three banks with non Islamic financing. We surveyed different banks reports of different banks and found their four year data from 2005 _ 2008. To find out the relationship of credit risk and liquidity risk by their assets and Equity, which give us the detail regarding the banks with and without Islamic financing.  Data gathered from the annual reports from the sites of these banks, and also from the site of state bank of Pakistan. Total Assets, Equity are the independent variables and meanwhile credit risk and liquidity risk are dependent variables.

Descriptive statistics on islamic banks in pakistan, 2005-2008

Period

Credit Risk

total assets

Equity

2005

0.4933

21644708

2684223

2006

0.00403

43246940

5311067.7

2007

0.00257

58371715

5956019.7

2008

0.0048

64128099

5888889.3

Descriptive statistics on conventional  banks in pakistan, 2005-2008

year

Credit Risk

total assets

Equity

2005

2.02

268197787

24933457

2006

2.613

436826565

32159341

2007

3.06

537529091

14706172

2008

3.16

535628398

735287038

For Islamic Banks

Y = Bo + B1 X1 + B2 X2 + E

When

X1 is Total Assets

X2 is Equity

Dependent is Credit Risk

After analysis results show that the value of R = 0.995 which shows that there is positive impact of total assets and equity on credit risk.

The results show that the value R2 = 0.991 which shows that 99.1% of the variation in the credit risk is explained by the variation in the total assets and equity.

For Conventional (Non-Islamic) Banks

Y = Bo + B1 X1 + B2 X2 + E

When

X1 is Total Assets

X2 is Equity

Dependent is Credit Risk

In this case results show that the value of R = 0.999 which shows that there is positive impact of total assets and equity on credit risk.

The results show that the value R2 = 0.991 which shows that 99.1% of the variation in the credit risk is explained by the variation in the total assets and equity.

Conclusion

The results of this research show that there is positive relationship between dependent variable and independent variables in both of the cases whether it is in Islamic Banks or Conventional Banks. The results suggest that the degree of correlation is high in Islamic Banks than Conventional Banks.

The pakistani banking system is highly diversified, it has both the conventional and islamic financing system performing their duties side by side. The study examines through the vast literature review of the risk determinants from the previous studies of different researchers.

We used three conventional and three Islamic financing banks for our analysis and take out the data of four years, 2005-2008. To allow for possible interaction between the independent variables, we run different test on the gathered data ,to find out the relationship of risks. The results show that Islamic financing has low credit risk than the non islamic financing banks. They have low credit risk ,that may be the cause of profit sharing principle of Murabaha type financing in Pakistan.

The banks with Islamic financing growing and establishing day by day due to their rules and regulations and also interest free system in niche market. Unique quality can be the competitive edge for any bank but the most important thing is to retain that quality and position in the fast growing market, and have to take precautionary measure to prevent from the heavy risks and losses. They need to analyze their few risks and control those risks.

Typically, under the Islamic Banking system, home loan financing is based on the principle of Profit Mark Up on the cost of the property, by mutual consent of the Bank and the Borrower. This type of financing is usually done under the contract of Murabaha.

It goes like this. Suppose you are interested in buying your dream home (who’s not!). You approach the Islamic Bank with your requirements with regard to the financing. The Bank in turn would assess your requirements as well as evaluate your eligibility for the financing based on your income and repayment capacity. After taking an overall view of your financial standing and credit rating, the Bank would fix a eligible amount of home loan for you. Let us say the Bank fixes a home loan limit of USD 100,000.00 for you.

This amount would include their mark up on the cost of the property. This mark up is fixed by mutual consent. Suppose the mark up is say USD 10,000.00. That means the net amount of your home loan is USD90, 000.00. The next step for you, the borrower, is to identify your dream home in the range of USD90, 000.00. After that you give details of the property thus identified to the Bank, who in turn will negotiate with the owner of the property and make a purchase of the same specifically to sell it to you.

The next step would be to complete the formalities in regard to documentation etc., after which you get the possession of the home, though you are still not the owner of the same. The ownership will vest in you once you repay the stipulated number of installments within the repayment period fixed. Then your dream home becomes really yours!

The main characteristics of the above type of home loan under Islamic Banking are: a proper evaluation and assessment is made of the repaying capacity of the borrower and fixation of the appropriate loan amount. Another notable feature, which is in fact the bedrock of Islamic Banking, is the absence of Interest on the loan amount. Instead the Bank adds up a profit margin to the cost of the asset and divides the total amount into equal installments payable usually monthly.

Ijara and Murabha are considered by religious scholars and Islamic banks to be the most suitable methods of finance for the purchase of property in the United Kingdom.

Ijara – In the Ijara method of finance, the financier purchases the property and sells it to the customer for the same amount of money, with the payment spread over a period of time agreed between them. The customer also has to pay rent to the financier over the repayment term. The installment of the purchase is somewhat like the capital payments under a conventional loan, while the interest in the conventional loan is like the rent in the Ijara.

Murabha – In the Murabha method of finance, the financier purchases the property and immediately sells it to the customer at a higher price. The higher price is settled based on the number of years allowed by the financer to the customer to pay the purchase price. The extra sum can be compared to the interest which is charged on a conventional loan at a certain rate over the whole payment term.

Under Ijara, the bank will buy the asset you want and you will be allowed to use the asset for an agreed period in return for a monthly payment which covers the bank’s capital. It is a kind of leasing.

In Musharaka (meaning partnership), the bank buys the asset and becomes the legal owner. You pay monthly installments, covering part of the rent and part of the cost of the asset, so that after a pre-determined period, you own the asset itself.

If you’re Muslim and are concerned about financial products that comply

with Sharia Law, there are more and more options available to you

today. The first Islamic bank in the UK, the Islamic Bank of Britain,

opened its headquarters in Birmingham in 2004, offering a range of

products and services such as pensions, mortgages and loans.

The main requirement for financial products and services under Sharia

Law is that they neither charge interest nor pay it out, as making

money from money is considered usury, and that they do not invest in

companies that are deemed unethical, such as those connected with

alcohol, tobacco, pornography or gambling.

What often happens when providing loans is that the bank will purchase

an item for the customer at a set price and rent it or sell it to them,

with repayments made in instalments. The bank makes its money by

levying a charge on the customer’s payments.

With investments, Islamic finance works on the basis of sharing the

risk as well as the reward. Both the customer and the bank agree on

terms for sharing the risk of any investment and split any profits

equally between them.

The four main modes of Islamic banking are known as murabaha, where a

purchase is made by the bank and re-sold to the customer without any

interest payments; musharaka, a partnership in which the rewards and

risks – i.e. the profits and losses – are shared by both the bank and

the customer in an investment; mudaraba, where someone places their

investment in the hands of an expert who invests for them and shares

the profit but doesn’t bear the risk of any losses; and ijarah, a

rental agreement made in order for the customer to obtain goods, in

which rental payments are made over a specified period and the bank

reclaims the goods at the end of it.

Many of the high street banks offer Islamic products, and there are

some Middle Eastern banks with branches in the UK that provide

financial products and services suitable for muslims.

Trust funds

The government introduced child trust funds in 2005 to help new parents

to start saving for their child’s future. Upon the birth of a child,

they are given £250 in vouchers to invest on their behalf, and an

additional £250 on the child’s seventh birthday. Additional

contributions of up to £1,200 can be made annually, and the money

can be invested in savings accounts or in stocks and shares, or a

combination of both (a stakeholder account).

A Sharia-compliant child trust fund is also available for the children

of Muslim families, and is provided by the Children’s Mutual. It’s a

stakeholder account, which invests in the stock market until the child

turns 13 and then transfers the funds into a savings account or lower

risk investments such as government bonds. This aims to reduce the

impact of any stock market slumps in the run-up to their 18th birthday.

All investments are made in funds that don’t compromise Islamic

principles, and no interest is paid on the savings.

Mortgages

As mortgages are interest-charging loans, they are not considered

acceptable to the Islamic faith. However, as most people can’t afford

to pay cash to buy a property outright, there is a demand for Sharia-compliant mortgages

among the Muslim community. Many high street banks now offer such

products, as does the Islamic Bank of Britain. An Islamic mortgage

normally works by means of ijara, a leasing agreement in which the bank

purchases the property on behalf of the customer and charges rent to

them (including a handling fee) until the purchase price is repaid, at

which point the customer owns the property outright. As with other

mortgages, the bank retains the rights to the property until this point.

Bank accounts

To comply with the Islamic faith, bank accounts should neither charge

nor pay interest. This normally means that there will be no overdraft

or credit card facilities on current accounts, and that savings

accounts invest money to make a profit rather than receive interest on

it.

Pension schemes

A few financial organisations now offer Islamic pension schemes,

allowing Muslims to invest for their retirement without having to

compromise their beliefs. Such schemes invest only in funds considered

to be ethical under Sharia Law – i.e. no investment in companies

involved in alcohol, tobacco, betting or pornography, or any companies

such as banks that profit from charging interest. If any dividends

arise as a result of business involvement in any of these areas, the

money is ‘purified’ by giving it to charity rather than awarding it to

those investing in the scheme.

Read more on Bloomberg

Sukuk Issuers Shun Bonds Backed by Property: Islamic Finance
Persian Gulf Islamic bond issuers are avoiding collateral based on real estate after Dubai property prices plunged 50 percent.

Read more on BusinessWeek

Sukuk’s Emergence Marked Importance Of Islamic Finance
KUALA LUMPUR, Oct 12 (Bernama) — The importance of Islamic finance in strengthening financial linkages became evident with the emergence of sukuk instruments as an attractive new asset class for investors and a competitive form of financing for businesses.

Read more on Bernama

The main requirement for financial products and services under Sharia Law is that they neither charge interest nor pay it out, as making money from money is considered usury, and that they do not invest in companies that are deemed unethical, such as those connected with alcohol, tobacco, pornography or gambling.

What often happens when providing loans is that the bank will purchase an item for the customer at a set price and rent it or sell it to them, with repayments made in instalments. The bank makes its money by levying a charge on the customer’s payments.

With investments, Islamic finance works on the basis of sharing the risk as well as the reward. Both the customer and the bank agree on terms for sharing the risk of any investment and split any profits equally between them.

The four main modes of Islamic banking are known as murabaha, where a purchase is made by the bank and re-sold to the customer without any interest payments; musharaka, a partnership in which the rewards and risks – i.e. the profits and losses – are shared by both the bank and the customer in an investment; mudaraba, where someone places their investment in the hands of an expert who invests for them and shares the profit but doesn’t bear the risk of any losses; and ijarah, a rental agreement made in order for the customer to obtain goods, in which rental payments are made over a specified period and the bank reclaims the goods at the end of it.

Many of the high street banks offer Islamic products, and there are some Middle Eastern banks with branches in the UK that provide financial products and services suitable for muslims.

Trust funds

The government introduced child trust funds in 2005 to help new parents to start saving for their child’s future. Upon the birth of a child, they are given £250 in vouchers to invest on their behalf, and an additional £250 on the child’s seventh birthday. Additional contributions of up to £1,200 can be made annually, and the money can be invested in savings accounts or in stocks and shares, or a combination of both (a stakeholder account).

A Sharia-compliant child trust fund is also available for the children of Muslim families, and is provided by the Children’s Mutual. It’s a stakeholder account, which invests in the stock market until the child turns 13 and then transfers the funds into a savings account or lower risk investments such as government bonds. This aims to reduce the impact of any stock market slumps in the run-up to their 18th birthday. All investments are made in funds that don’t compromise Islamic principles, and no interest is paid on the savings.

Mortgages

As mortgages are interest-charging loans, they are not considered acceptable to the Islamic faith. However, as most people can’t afford to pay cash to buy a property outright, there is a demand for Sharia-compliant mortgages among the Muslim community. Many high street banks now offer such products, as does the Islamic Bank of Britain. An Islamic mortgage normally works by means of ijara, a leasing agreement in which the bank purchases the property on behalf of the customer and charges rent to them (including a handling fee) until the purchase price is repaid, at which point the customer owns the property outright. As with other mortgages, the bank retains the rights to the property until this point.

Bank accounts

To comply with the Islamic faith, bank accounts should neither charge nor pay interest. This normally means that there will be no overdraft or credit card facilities on current accounts, and that savings accounts invest money to make a profit rather than receive interest on it.

Pension schemes

A few financial organisations now offer Islamic pension schemes, allowing Muslims to invest for their retirement without having to compromise their beliefs. Such schemes invest only in funds considered to be ethical under Sharia Law – i.e. no investment in companies involved in alcohol, tobacco, betting or pornography, or any companies such as banks that profit from charging interest. If any dividends arise as a result of business involvement in any of these areas, the money is ‘purified’ by giving it to charity rather than awarding it to those investing in the scheme.