Islamic finance: the United Kingdom's drive to become the global Islamic finance hub and the United States' irrational indifference to Islamic finance.

Author:Nizami, Shah M.

    In the wake of September 11, 2001, Islamic finance has become synonymous with the concept of "terror financing" in the United States rather than an alternative approach to financing and banking. (1) The recent economic crash, which was fueled by practices prohibited in Islam, has led many outside of the United States to view Islamic finance as an alternative financing approach. (2) This change in perspective is causing Islamic finance to grow annually at a rate of fifteen to twenty percent since 2002. (3) In 2004, the United Kingdom signaled to the world its commitment to become the western hub of Islamic finance by granting approval to the Islamic Bank of Britain (IBB), the first retail Islamic bank in Europe, to operate in the United Kingdom. (4) The United States lags behind the United Kingdom in cultivating Islamic finance and thereby risks missing an opportunity to be a significant force in a consistently growing market that is estimated to be worth anywhere from $700 billion to $1.5 trillion. (5)

    This note argues that the United States must do more to fuel the growth of the Islamic finance industry by emulating the steps the United Kingdom has taken to nurture the Islamic finance industry. (6) Part II of this note discusses the origins, sources and key concepts of Islamic finance. (7) Part III of this note discusses the history and present state of Islamic finance in the United Kingdom and the United States. (8) Part IV of this note discusses the steps the United States must take to recognize and cultivate Islamic finance as the United Kingdom has done. (9) Finally, this note concludes with recognizing that the United States has great potential to expand the Islamic finance industry if it proactively integrates Islamic finance into its existing tax and regulatory scheme. (10)

  2. Origins, Sources and Core Principles of Islamic Finance Law

    1. Origins of Islamic Finance Law

      1. Shari 'ah--Just Islamic Law or Something More?

        Shari 'ah, the "foundation of Islamic Finance," means the "road to the watering place" or "the path leading to the water," but loosely can be understood to mean Islamic law. (11) The primary source of Shari 'ah is the Holy Qur 'an. (12) In addition to the Holy Qur 'an, the sunnah ("well-trodden path") and hadiths (reports) are primary sources of Shari 'ah. (13)

      2. Fiqh--Islamic Jurisprudence

        Fiqh (Islamic Jurisprudence) is the exercise of "deducing and applying the principles and injunctions of Shari 'ah, and the sum total of the deductions by particular jurists." (14) Fiqh allows legal scholars to draw detailed practical rules from the Holy Qur 'an, sunnah, and hadiths. (15) The majority of legal scholars employ ijma (consensus on judgments). (16) They also use qiyas (analogical reasoning). (17) In drafting detailed practical rules, Shari'ah scholars use both resources to take into account contemporary changes in all aspects of life. (18)

    2. Core Principles Underlying Islamic Finance

      Shari 'ah compliance requires one to engage in an exercise to avoid violating the four major prohibitions of Shari 'ah (19) Shari 'ah prescribes four major prohibitions that all Islamic finance products or transactions must follow to be deemed Shari 'ah-compliant. (20) The four major prohibitions involved are: riba (interest or usury), gharar (uncertainty), maisir (excessive risk or gambling), and haram (investing in products and industries forbidden to Muslims). (21)

      First, riba is the charging or receipt of interest and usury by

      investors and lenders. (22) The two rationales that underlie the prohibition against riba are no intrinsic value in money and unfairness in manipulating "poorer members of society by unscrupulous merchants." (23) Second, gharar is the prohibition against excessive uncertainty or risk. (24) Gharar allows some level of risk but prohibits excessive and disproportionate risk and any speculative trading and transactions. (25) The prohibition against gharar tends to forbid major western financial products such as forward contracts, swap agreements, hedges, options, derivatives, and financial insurance. (26)

      Third, maisir is the prohibition against gambling. (27) In most commercial transactions, there is some component of gambling but maisir prohibits gambling that gives rise to "an effortless gain." (28) Finally, haram is the prohibition against investing in forbidden industries or products. (29) The following industries are examples of haram industries: alcohol, pornography, gambling, weapons/defense, prostitution, and financial services dependent on payment of interest. (30)

    3. Shari 'ah-Compliant Finance Concepts

      There are seven major Islamic finance concepts that are Shari 'ah-compliant. (31) This note will focus on providing a cursory overview of only the following five Shari'ah-compliant finance concepts: ijara, musharaka, mudaraba, murabaha, and sukuk. (32) Ijara is a finance lease in which the bank purchases the asset and subsequently, for a rental fee, leases an asset to the customer. (33) Musharaka is a partnership in which both the customer and financial institution provide capital and share in the profits and losses based on an agreement between the parties before the transaction is finalized. (34)

      Mudaraba is comparable to a venture capital financing or profit-sharing type of financial structure. (35) In a mudaraba financing, the investors provide all capital and the "borrower" manages the venture and puts up sweat equity. (36) Mudaraba and musharaka are similar in regards to splitting profits on a predetermined formula, but only the party providing financial capital in a mudaraba bears all the losses. (37) A murabaha is a mark-up contract and is the most

      "common form of Islamic finance." (38) In a murabaha contract, a bank or other financial institution purchases the asset and sells it to the ultimate buyer at a contractually pre-arranged cost on an installment basis. (39)

      Finally, sukuks are loosely defined as "Islamic bonds" but in reality, they are similar to equipment trust certificates or investment certificates because of their ownership attributes. (40) Sukuks differ from "equity, notes, and bonds" because they are not "debts of the issuer; they are fractional or proportional interests in underlying assets, usufructs, services, projects, or investment activities." (41) Moreover, the underlying assets or activities of sukuks must be Shari'ah-compliant for the sukuks to be considered valid under Shari 'ah law. (42)


    1. Islamic Fiannce in the United Kingdom

      1. History of Islamic Finance in the United Kingdom

        The U.K. Islamic finance market began in the 1980s by providing wholesale Shari 'ah-compliant services and products. (43) Islamic finance in the United Kingdom mainly consisted of commodity murabaha-type transactions and no retail products were available in the 1980s. (44) Retail products, such as home financing, appeared in the United Kingdom in the 1990s through offerings by banks from the Middle East and South Asia. (45) The retail products, however, fell outside the regulatory framework; thus, consumers investing in retail Islamic finance products lacked the protection that consumers investing in conventional finance products enjoyed. (46) Lord Edward George, Governor of the Bank of United Kingdom in 1995, recognized the importance of Islamic banking and "the need to put Islamic banking in the context of London's tradition of competitive innovation." (47) The Islamic finance market grew slowly from the 1990s to the early 2000s, but has grown significantly since the early 2000s because of the United Kingdom's proactive approach in nurturing the Islamic finance market. (48)

        In 2000, the Bank of United Kingdom established a group with Her Majesty's Treasury to investigate the obstacles facing the Islamic finance industry in the United Kingdom. (49) Subsequently, the Bank of United Kingdom recognized the potential value of Islamic finance, marking the beginning of the industry's significant growth within the United Kingdom. (50) Lord George chaired a high-level working group with representatives from the City and national government, the Muslim Community, and the Financial Services Authority (FSA) to examine the barriers to Islamic finance in the United Kingdom. (51) Moreover, while speaking at a conference organized by the Muslim Council of Britain, Chancellor Gordon Brown explicitly stated that the United Kingdom was in a position to become "a gateway for Islamic trade and finance." (52)

      2. Financial Services Authority--Sole Financial Regulator of the United Kingdom

        The FSA, an independent, non-governmental organization, was created in 1997 to regulate the U.K. financial industry. (53) The FSA became the sole regulator of the financial industry in 2000 in accordance with the Financial Services and Markets Act (FSMA). (54) As the sole regulator, the FSA can provide a consistent analysis of Islamic financial institutions and products and their potential to operate within the larger system. (55) FSA has made it clear that all authorized financial institutions operating in the United Kingdom are subject to the FSMA. (56)

      3. Significant Tax & Legislative Changes Geared to Fuel the

        Growth of Islamic Finance.

        The United Kingdom has introduced a series of tax and legislative changes to help transform the United Kingdom into the global hub of Islamic finance. (57) The first major obstacle to Islamic finance in the United Kingdom was the Stamp Duty Land Tax (SDLT) on murabaha-structured mortgages. (58) The United Kingdom charged a SDLT on the sale of every property. (59) Islamic mortgages were double-taxed because murabaha transactions require the property be sold first to the bank and then transferred to the homebuyer upon full payment. (60) In 2003, the United Kingdom passed the Finance Act of 2003, exempting, on a limited basis, "alternative property finance" from the SDLT, thereby...

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