July 2018
By Nada Jarnaz, banking partner and Islamic finance expert at Howard Kennedy LLP
For some time now, there have been a number of banks in the market that provide finance on a Sharia-compliant basis. Sharia-compliant finance is available to anyone, and Islamic banks are able to compete in certain markets with conventional lenders. It would therefore be useful for anyone seeking Islamic finance to have a basic understanding of Islamic principles, both in deciding whether an asset is suitable for Islamic finance and in understanding how that finance works.
There are a number of key principles which underline all Islamic financing models, also known as Sharia-compliant finance models. These include the prohibition of riba which is an unjustified reward or unlawful gain (eg interest); the prohibition of gharrar, which is uncertainty, risk or speculation (insurance can be regarded as falling into this category); and that the underlying asset must be tangible and acceptable in accordance with Islamic principles. A betting shop, for example, could not be funded by Islamic finance.
Typically, Islamic banks are concerned with the Sharia compliance of their financing (as opposed to conventional lenders that provide finance structured in a Sharia-compliant way at the request of their customers), and have an in-house Sharia scholar or committee that provides them with guidance and a final say on the Sharia compliance of the financing models that they use.
In real estate finance, Islamic finance is typically provided under two models: for commercial, the commodity murabaha facility is often used, and in the residential mortgage market, the ijara lease structure is more common.
The commodity murabaha structure is a deferred payment arrangement, where one party sells a commodity to another for a price which is the sum of its costs plus an element of profit. This price is then paid by the buyer to the seller over a period of time. In practical terms, this can look very similar to a term loan facility, with quarterly profit payments and a bullet payment at maturity, underpinned by standard representations, covenants and defaults.
Under the ijara lease structure in the residential mortgage market, the bank buys the property and grants a lease and an option to the "tenant" – its customer. The tenant pays rent to the bank under that lease and then on maturity, under the option, has the ability to buy the underlying property for a price that is the equivalent of the bank's original financing.
As a tangible asset class, real estate is a popular and suitable asset for Islamic banks to provide finance against. Many such banks are able to offer both investment and development facilities, and work with their customers to allow for conventional debt to be integrated into the financing model in some way – whether by way of mezzanine finance or on a parallel debt structure.