By Mary Christina Love October 15, 2008

Moody’s Investors Service, a credit rating agency, claims that the global Islamic finance market has grown about 15% each year since 2004 and is now worth about $700 billion worldwide. The heavyweights of global finance took notice: Citigroup, HSBC, Deutsche Bank and others have affiliates devoted to Islamic finance.

Giant mortgage investor Freddie Mac began buying sharia-compliant mortgages in 2001. Freddie Mac buys from four banks that together originate mortgages nationwide. In addition to Devon Bank in Chicago, Freddie Mac bought mortgages from Guidance Residential in Reston, Va.; University Bank in Ann Arbor, Mich.; and American Finance House Lariba in Pasadena, Calif.

Freddie Mac bought more than $250 million in Islamic mortgages in 2007, but volume slipped as the housing market declined.

Sharia financing is mandated in the Quran and involves alms-giving to Islamic charities. Though modern muslims are not always required to use sharia financing they often prefer to, and may indeed claim it as a religious requirement. In business loans, Islamic financing is like an equity investment, with the bank essentially sharing profits with the borrower. Depositors and borrowers at Islamic banks share profits and losses with the bank, in lieu of receiving interest payments. It is an arrangement that U.S. banking regulators do not offer partly because the FDIC does not want to share in a losing investment. However, London based, Devon Bank has a small branch on Chicago’s North Side. According to David Loundy, Devon’s vice president and legal counsel, Devon Bank has transformed itself into a no-interest Islamic financing specialist. Sharia financial loans now account for over 75% of the bank’s mortgage portfolio, and Devon has made sharia compliant mortgages in 36 U.S. states.

Devon Bank caters to Pakistani and Middle Eastern immigrants. They believe Islamic finance is booming worldwide, fueled by high oil prices, and strict interpretation of the holy Quran across the Islamic world.

There’s some dispute about exactly where the Quran comes down on finance and interest.

Scholars at the Al-Azhar Institute in Cairo — influential in Islam’s chief Sunni denomination — declared in 2002 that the Quran did not prohibit all interest payments and charges, just those so exorbitant that they crossed the line into usury. Conventional banking has been widespread for years in the Islamic world, however, a stricter interpretation barring all interest has gained ground over the past decade and driven the growth of no-interest Islamic finance.

An Islamic mortgage is similar to a lease-to-own deal. The bank, not the borrower, buys the house. The borrower makes installment payments to the bank for a number of years, at the end of which he or she closes and obtains title to the house.

The bank’s profit technically comes from renting the house, not lending the money. Islamic mortgages are more costly than traditional mortgages because they involve paperwork for two home sales: the first by the bank, the second by the borrower after the installment payments are finished.

Many questions arise: Are sharia loans also “subprime” loans? Do banks make as much money on sharia loans that are not based on simple interest. Are the monthly fees the same each month, with the equity portion greater than the interest throughout the life of the loan? My concern is that since loans and terms are individual with sharia, terms such as “flexible” may leave room for “discrimination.” What are the actual interest rates on these loans? Are these the “subprime” loans we are talking about in the bailout? Is the recent “bailout” meant to purchase these sharia loans so that the banks can “lease” them to Muslims who received sharia loans? Given that Americans have given the Saudi’s so much financial power in the form of oil money, are American taxpayers and IRA holders in effect actually paying a ransom, a jizya tax, under the guise of a “bailout”? Do banks make as much from a sharia loans? Is a “faith-based” loan the same as a sharia loan?

Are faith-based and/or sharia loans discriminatory to non-muslims who have simple interest loans where the interest portion is much greater initially, and equity payments increase over time.

If the Freddie Mac and Banks are $700 billion in debt because they purchased $700 billion worth of sharia loans for qualifying muslims, we may very well be paying a ransom or a jizya. (A jizya tax is a tax that conquered non-muslims must pay muslim conquerers). 

Types of Sharia loans. There are different types of sharia loans, just as there are different kinds of financing for traditional banks. In the following three types of financing a borrower doew three things initially:

• Identify the property to purchase 
• Negotiate the price of the purchase 
• Make an earnest money payment

Cost plus sale transaction. A cost plus sale transaction is called murabah financing. It is where the bank buys a property and assumes the risk. The bank then sells it to the “borrower” for a fixed price, which is the price the bank paid plus the amount that will be the bank’s profit. The profit, established in advance, is based on the mortgage market rates at the time. The total price is then agreed to be paid to the Bank with an initial down payment and fixed installments by the borrower over an agreed-upon period of time.

Payments, scheduled at the beginning of the transaction, do not change and the borrower gains full ownership and title of the property at the closing. Although a murabaha transaction is a distinctly different legal arrangement than a conventional interest-bearing mortgage, the payments are similar to a conventional fixed-rate mortgage. The murabah loan has few additional costs over those of a conventional mortgage, and is the most readily-available  for borrowers in the U.S. 

Rent to own. Sharia rent to own is called ijara financing. The Bank purchases the property and gives ownership to a separate holding entity. The borrower agrees to purchase the property over time at cost. Title to the property is transferred to the borrower after the full cost of the property is paid over the allotted time. Because the borrower uses the property until it is paid in full, it is like paying rent. The borrower can choose from daily, monthly, or various annual payments.

The ijara loan is flexible, but more complex, with additional costs involved to establish and maintain the loan arrangement. The payments are similar to a conventional adjustable-rate mortgage. If there is sufficient value in the property, the borrower may be able to establish a sharia compliant line of credit.

Though less available than other financing, musharaka financing is another equity based rent to own property loan with the borrower and the financier as co-owners. The Bank purchases the property and the borrower agrees to purchase property over time, and at a cost. The balance of property ownership is transferred to the borrower with each payment as the payments are made to the financier. Again, the borrower can choose between daily, monthly, or various annual rental adjustment periods. In the event of a sale, the profit or loss is based on ownership percentage.It is more complex yet very flexible. It also has additional costs to establish and maintain the arrangement. The payments are similar to a conventional adjustable-rate mortgage. A line of sharia credit can be established with sufficient equity.

Islamic bonds. Islamic bonds are called suku. Nearly $33 billion in Islamic bonds were issued in 2007, up from $5.5 billion in 2001. Islamic bonds work something like Islamic mortgages, where investors technically earn money from rent, not interest. For instance, the German state of Saxony-Anhalt issued its first Islamic bond in 2004, selling government property to bond investors and then leasing it back.

Determining a sharia-compliant transaction can get tricky. HSBC and Citigroup each have sharia advisory boards consisting of Islamic scholars. Devon Bank, which has assets of just $250 million, depends upon advice from the Sharia Supervisory Board of America.

Tax breaks encourage Islamic banking, with Kuala Lumpur, the capital of predominately muslim Malaysia, emerging as an Islamic finance global capital. Besides Saudi Arabian banks, other places that participate in sharia banking are Singapore and Hong Kong.

Devon Bank-Faith Based Financing http://devonbank.com/pf_faithbasedfinancing.html 

Devon Bank Sharia Financing http://www.devonbank.com/Islamic/index.html 

Devon Bank, Freddie Mac Announce Expanded Financing Opportunities For Muslim Homebuyers  http://www.freddiemac.com/news/archives/afford_housing/2005/20050110_devonbank.html

Devon Bank and Freddie Mac Provide Islamic Home Financing http://muslim-investor.com/news/devon-bank-freddie-mac-islamic-house-financing.html

Islamic finance market has grown and is now worth about $700 billion worldwide.http://www.usatoday.com/money/industries/banking/2008-03-26-islamic-finance-sharia_N.htm

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