BLUE CHIP | Islamic Home Finance
Scaling Up
Islamic mortgage has emerged as a stronghold within the overall
Islamic finance sector and is well equipped to act as a catalyst in
the race of ‘Profit against Interest’, finds out Fareem Chagla
A
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n Islamic home financing in essence
involves the bank buying a property
on behalf of the customer and reselling the same to them at a profit. It is
interesting to see the reasons behind the
popularity of this segment within the field
of Islamic Finance. The advent of freehold
property bought to the fore by markets
in the GCC region has been instrumental
in driving demand in the region. Coupled
is the inherent nature of the mortgage
contract, having an underlying tangible
asset; it becomes an ideal product offering
in the bank’s portfolio allowing little scope
of debate on religious grounds, which
has otherwise proven a grey area, given
varying interpretations.
For the consumer, one of the biggest
factors drawing attraction towards this
method of financing is the removal of
uncertainty around the financing process
and having more transparency around
the same. With the agreement clearly
outlining the profit amount upfront, it
is immensely beneficial for clients who
seek peace of mind. Besides, unlike
conventional finance which invites heavy
penalties, translating into an ‘interest on
interest’ in the event of a delay in paying
an installment, Islamic Finance outlines
a fixed fee charged to the client, which is
then directed towards charitable activities.
However, this does come at a cost.
Some critics have in general underlined
the higher costs associated with
Islamic Financing, given the increased
documentation requirements, which could
lead to higher structuring cost compared
to available traditional conventional
options. Bashar Al Natoor, Global Head
of Islamic Finance, Fitch Ratings, opines
that the basic differentiator of products
between Islamic and conventional
Finance, is their Sharia compliance
nature and requirements, which has
seen increasing customer demand in
Typical contracts centric to Islamic Home
Finance include:
Murabaha, where the bank acquires the
property and sells it back to the buyer with
a mark-up.
Ijarah, involving the bank typically
acquiring the property for the buyer
and then leasing it to them with the rent
income constitutes the repayment.
Diminishing Musharakah, involving the
buyer and the bank acquiring the property
jointly. The buyer’s share represents the
down payment. Subsequently, the bank
leases its share of the property to the
buyer in return for a rental payment.
the past few years. In countries with a
mature Islamic finance sector, banks
have managed to some extent to reduce
such cost, and now there are many
Islamic banks and institutions, and even
conventional banks, Islamic finance
windows, having similar offering, making
the overall quality of servicing a key
competitive factor.
Popular Islamic home financing options
in the UAE are typically based on the ijarah
contract and diminishing musharaka.
While the Islamic Finance domain is
often criticized on the ground of a lack
of standardisation, Natoor believes this
particular segment, i.e. home financing, is
not categorized as very sophisticated bank
offering and thus does not necessarily
require reinventing, mainly due to its
assets backed and based nature.
Current contracts like ijara or
diminishing musharakah, amongst others
fits well for such product offerings. On
the same, Jayesh Soneji, CFA, Member of
CFA Society Emirates, believes the scope
of innovation limits itself to offering
flexibility to the customers. Some areas
he points towards are the possibility of
prepaying and settling the financing
without attracting huge break up cost
as is currently the practice and also the
possibility to have variable profit rates
as part of the options for a customer.
As an end user, the customer continues
to remain in the dilemma of opting for
the Islamic Financing or Conventional
Loan route for his home. Soneji adds that
while liquidity is drying out from the
conventional banking ecosystem, there
has been an upsurge in people parking
their savings and liquid cash in Islamic
Banking channels, which in turn has
seen increased liquidity chasing Sharia
Compliant Institutions.
In summary, the Islamic Home
Financing has within a short period of time
established itself as a strong competitor
within the mind of the potential home
buyer and is well equipped to act as a
strong pillar in the race of ‘Profit against
Interest’.
www.wealth-monitor.com | April 2016