Future Prospects for Islamic Finance in the UK - Coursework Example

Future Prospects for Islamic Finance in the UK Introduction This paper briefly examines the current state of Islamic finance in the UK, and offers some insights into its prospects for the next decade. Worldwide, the Islamic finance sector is growing at 10%-15% annually, and the UK’s position as a leading financial centre plus the presence of a considerable Muslim population in the UK has made the country one of the leaders of Islamic finance (Ainley, et al., 2007). This essay will first briefly describe the basic characteristics of Islamic finance and how key principles in Shari’ah law define what is allowable for Muslim businesses and consumers. The development of Islamic finance from the point of view of the government’s attention to helping it grow in the UK will then be discussed, followed by an examination of some of the key challenges that must be addressed if Islamic finance is to continue its successful path. Characteristics of Islamic Finance “Islamic finance” describes the principles imposed on financial transactions and products by Shari’ah law, which governs all aspects of Islamic life (Aioanei, 2007: 11). The fundamental philosophy underlying Islamic finance is the concept of shared profit and risk, and the prohibition of riba, or interest (Abdul Rahman, 2007: 123). The theological basis of the concept is that riba serves as an insurance against the lender’s risk, making the risk relationship between lender and borrower unequal; this is not allowed, because it is up to God to grant whether a venture should be successful or not – in other words, one who does not take a risk does not deserve a reward of profit (Abraham, 2009: 42). The specific requirements of Islamic finance can be summarised in a number of key provisions (Aioanei, 2007: 11; Abraham, 2009: 42-43): First, riba is prohibited. Second, investments must be in ethical products, and avoid those which are haram (prohibited), such as gambling businesses, alcohol, prohibited foods such as pork, weapons, and other things considered immoral by Islam. Third, investments must be in “real” products, or be trade-related. For example, a Western financial invention like a credit default swap would not be acceptable in Islamic finance. The idea in this principle seems to be that money is something that should not have a value except as just a medium of exchange; without an underlying product for the money to represent, the money has no definable worth. The fourth principle is avoidance of gharar (excessive risk). This is related to both the provisions against investing in that which is haram, since excessive risk is like gambling, and the prohibition of riba is the sense that any profit to the lender comes to him without his own effort in either case; winning a gamble is simply chance, and collecting riba is a guarantee against fair risk (Abraham, 2009: 43). Finally, one of the most important principles is that a part of the profits must be paid as zakat (charity). Modern banking and financial systems present a number of challenges to Islamic finance, which in its ‘classical’, most theologically-pure form sets a bigger priority on social utility than financial gain (Abdul Rahman, 2007: 127). In order to stay up-to-date and relevant, however, some of the definitions of Islamic finance principles have been interpreted in different ways, which causes some confusion and conflict. For example, riba in its orthodox form means all forms of interest, but it also can be, and has been interpreted as simply meaning “usury,” or unfair interest, so long as what is considered “fair” interest can be defined as a form of profit-sharing (Abraham, 2009: 42). Abraham (43-44) also points out that the definition of what constitutes a “real” product can be bent as well, and has led to the development of sometimes controversial secondary financial products such as the sukuk murabaha, which is the sale of rights to receivables, or a form of bond. Current State of Islamic Finance in the UK Islamic finance in the UK began to develop with commercial transactions in the 1980’s, followed by the introduction of retail murabaha products for home mortgages offered through banks based in the Middle East and South Asia in the early 1990’s (Nizami, 2011). In a murabaha transaction, the bank purchases the asset (a home, in the case of a mortgage) and resells it to the final buyer at a mark-up. In 1995, UK Bank Governor Lord Edward George recognised the potential of the Islamic finance market in Great Britain, and worked to integrate it into the British financial system on the principle that “nobody in the UK is denied access to competitively prices financial products on account of their faith” (HM Treasury, 2008: 5). Because of the UK government’s attentive approach to studying and providing a positive environment for Islamic finance, the sector began to expand rapidly after 2000, and now represents the largest market for Islamic finance outside of the Gulf States and Malaysia (HM Treasury, 2008). Although the government of the UK adopted a positive perspective towards Islamic finance, the success of the sector in the UK has also been tremendously helped by well-organised social action groups such as the Islamic Foundation, which focuses on education and research to promote understanding of Islam in the UK, and the Islamic Finance Council (IFC), which serves as an advocacy group to represent Islamic finance in regulatory concerns (Ahsan, 2008: 115; Islamic Finance Council, 2011). Four laws that have greatly assisted the growth of Islamic finance in the UK are the Finance Acts of 2003, 2005, 2006, and 2007 (Nizami, 2011). The Finance Act of 2003 provided some exemptions for murabaha mortgages to prevent them from being taxed twice, as they were under the old law because they involved two sales – one to the bank, and one from the bank to the homeowner – which made Islamic mortgages more costly than non-Islamic ones. The Finance Act of 2005 treated the taxes on murabaha and profit-sharing arrangements known as mudaraba the same as on loan interest, further reducing extra costs paid by Islamic banking customers. The Finance Act of 2006 legalised musharaka transactions, which are a form of “lease-to-own” arrangement that are often used as an alternative way to purchase a home. Finally, the Finance Act of 2007 clarified regulations regarding sukuks, or investment bonds, allowing businesses financed according to Islamic principles better and more equitable access to capital. The Future of Islamic Finance in the UK The proactive approach by the UK towards Islamic finance is an indication that the government and the financial sector are optimistic about its continued growth, but there are a number of challenges that must be faced. There are some issues to be resolved concerning the relationship of Islamic finance to international accounting standards and practises, and specific issues of regulation within the UK. The problems that arise from Islamic finance with regard to accounting standards is that there is no overall authority in Islam to define what is haram and what is halal (acceptable) in financial transactions and products. There is an Accounting and Auditing Organization for Islamic Financial Institutions (AAOFI), which has 140 members from about 30 countries and which has developed many general and Shari’ah-compliant accounting standards, but a financial institution can get different interpretations from different Islamic religious authorities as to whether or not a particular financial product is allowed; it is important to remember that, as in other religions, differences of opinion on the “rules” and their meaning exist within Islam (Aioanei, 2007: 13; Abraham, 2009: 47-48). This potential inconsistency makes it difficult to apply a single set of standards that effectively covers all possible situations that is still agreeable to everyone. The challenges identified by UK financial regulators are also related to the potential for ambiguity in defining Islamic financial products. First, the definition of products is important so that they can be correctly regulated by the Financial Services Authority. An Islamic finance product may have a similar result as a conventional one, but a very different formula that requires a new regulatory definition, or in some cases, even a change in law in order to make it possible to regulate and be fair to consumers (Ainley, et al., 2007: 13). A good example of this is the murabaha mortgage that required an adjustment to its taxation with the Finance Act of 2003; even though it was a mortgage for all practical purposes, before the change in the law the only way the law had to define it was as two sales, leading to double taxation. A second challenge is in defining the roles of Islamic scholars in advising financial matters. The FSA regulates financial institutions and transactions on a secular, not a religious basis, and has guidelines for the qualifications and the avoidance of conflict of interest for directors and executives of financial institutions. An Islamic scholar advising several competing firms may have a conflict of interest under the rules, or may not meet the qualifications necessary ‘competence and capability’ under the ‘Fit and Proper test for Approved Persons’ standard to exercise directorship in a financial institution (Ainley, et al., 2007: 13). The problem to be overcome is that in the UK at the present time, there is a shortage of people who are both highly-competent in Shari’ah law and finance, and as the sector grows this problem will become more acute (Abraham, 2009: 43). Conclusion Islamic finance in the UK has grown rapidly in the past decade, and its continued success in the coming decade seems very likely because of the government’s support for it, and the UK’s ambition to remain a global financial centre. By working to make the regulations of the financial industry in general apply more fairly to Islamic financial products and transactions, the UK has made ethical financing available to more people and has made the country a more attractive destination for the vast amount of liquid capital available in many parts of the Islamic world, such as the Gulf States (HM Treasury, 2008). In order to maintain the momentum of progress, however, the government and the Islamic financial sector must work together to overcome a couple key challenges. First, conflicts within the Islamic community itself as to the interpretation of the permissibility of particular kinds of financial products and transactions must be avoided, and amicably resolved when they arise. The whole point of the UK developing a single regulator with the creation of the FSA was to improve consistency and efficiency in the financial sector (HM Treasury, 2008); the Islamic community should take this as a cue to maintain a single, clear set of standards agreeable to all concerned to foster the growth of Islamic finance. Along those lines, efforts such as those put forth by the Islamic Foundation and the Islamic Finance Council to educate more people in finance and Islamic law and culture should increase, and this is perhaps an area in which the government can lend greater assistance. There is a danger, of course, that there might be a perception that a particular “religion” is being promoted, but this can be avoided with greater education and understanding of Islam for non-Muslims. Setting aside the religious connection of the principles of Islamic finance, there is much about it that may appeal to a wider market, because at its core it seeks to be ethical, fair, and compassionate, characteristics that are universally beneficial. Perhaps it is better not to think of it as “Islamic finance” as much as an alternative financial philosophy that can work for anyone; Islamic finance is successful in the UK and will continue to grow, but its growth could exceed all expectations if an even more universal perspective was applied to it. References Abdul Rahman, A.R. (2007) “Islamic Banking and Finance: Between Ideals and Reality”. IIUM Journal of Economics and Management, 15(2): 123-141. Abraham, I. (2009) “Riba and Recognition: Religion, Finance and Multiculturalism”. In J. Johnston & K. McPhillips (eds), Essays from the AASR Conference, University Of Auckland, New Zealand July 6-11, 2008. University of Sydney, pp. 39-54. Ahsan, M. (2008) “The Experience of the Islamic Foundation UK in Promoting Islamic Economics”. In: The 7th International Conference in Islamic Economics, 115-122. Jeddah: Islamic Economics Research Centre. Ainley, M., Mashayekhi, A., Hicks, R., Rahman, A., and Ravalia, A. (2007) “Islamic Finance in the UK: Regulation and Challenges,” Financial Services Authority, November 2007. Available from: http://www.fsa.gov.uk. Aioanei, S. (2007) “European Challenges for Islamic Banks”. Romanian Economic Journal, X(25): 7-19. HM Treasury. (2008) “The development of Islamic finance in the UK: the Government's perspective”. December 2008. Available from: http:// hm-treasury.gov.uk. Islamic Finance Council. (2011) “The Islamic Finance Council UK”. Website. Available from: http://www.islamicfinancecounciluk.com/. Nizami, S.M. (2011) “Islamic finance: the United Kingdom's drive to become the global Islamic finance hub and the United States' irrational indifference to Islamic finance”. Suffolk Transnational Law Review, 34(1). Available from: http://www.law.suffolk.edu/highlights/ stuorgs/transnat/documents/Nizami_final.pdf. Read More