- There has been an increase in Islamic housing finance products across Islamic compliant banks, a move that has prompted conventional banks to offer such products. What is behind this trend?
We are witnessing increased appreciation of Islamic banking, which is based on sharing of profits and losses. This has led to an influx of Islamic banking products, one such being the Islamic mortgage finance, which is quite attractive to potential homebuyers because it is based on Diminishing Musharaka.
- What does Diminishing Musharaka entails and how does it work?
The term Musharaka simply refers to a partnership established under a contract by the mutual consent of the parties for joint ownership of the property where the financier rents out its share to the customer. With each installment paid by the customer under Diminishing Musharaka, the equity of the bank reduces and ultimately the ownership of the asset transfers to the client after an agreed period.
Under the Diminishing Musharaka finance, the bank and the customer jointly purchase a property, which will be used by the customer by paying a certain amount of rent to the bank for using the bank’s share in the Musharaka assets.
- What happens if a person defaults or the property is destroyed by a natural calamity?
As opposed to non-Islamic loan where the client is liable for all costs incurred due to natural disasters or theft, under the Islamic home finance, the loss has to be shared among the co-owners of the asset according to their shares.
- Could you take us through the main highlights of Islamic banking?
A house is owned jointly by the bank and customer under an agreed sharing ratio. Usually, units owned by the bank will be rented out to the customer through Ijarah (Islamic lease) agreement.
This rent is essentially a utilisation cost paid by the customer for using the bank’s share in the property. The customer buys the shares of the bank at pre-agreed price.
- What makes home loans under Diminishing Musharakah stand out in comparison to conventional mortgages?
Under conventional mortgages, the mark-up commences the day the loan is paid by the bank, whether the buyer has taken the asset or not. Diminishing Musharakah, on the other hand, is based on Shariah where rent is charged after the customer has taken over the asset. Under conventional home loans, expenses incurred in the process of the purchase of the asset such as registration charges, insurance and stamp duty fees are paid by the user, while in Diminishing Musharakah, expenses related to ownership are borne by both the bank and the customer proportionate to their ownership.
- What would you say is the major benefit of Islamic home finance?
One of the major benefits of this type of financing model is the concept of partnership in the property. For example, if the bank and the customer jointly purchased a property and the bank subsequently rented its share to customer for, say ten years, and three years later the property is destroyed by a natural disaster, the loss will be borne by both parties on prorata basis. In addition, the contract will stand dissolved, meaning there are no outstanding liability on the customer for the next seven years.
- How do Islamic compliant banks make their profits then from the Islamic home finance?
Islamic Banks can profit from the buying and selling of approved goods and services. The principal means of Islamic finance are based on trading, and it is essential that risk be involved in any trading activity, so banks and financial institutions will trade in Sharia-compliant investments such as Diminishing Musharak, which is true ownership.
Although they cannot charge interest, Islamic banks can also profit from helping customers to purchase a property using an ijara or murabaha scheme. With an Ijara scheme, the bank makes money by charging the customer rent; with a murabaha scheme, a price is agreed from the outset, which is more than the market value. This profit is deemed to be a reward for the risk that is assumed by the bank.
- Do Islamic banks charge penalty on defaulters?
In Dimishing Musharakah model of Islamic finance, the user of the property may be asked to undertake that if he fails to pay rent on due date, he will pay a certain amount for charity through the bank. The bank does not in any way benefit from these penalties and as such, they are not declared as part of income by the bank.
- Are people from other faiths eligible to apply for Islamic mortgage loans?
Certainly. Contrary to what people think, some of our major clients are not from the Muslim faith.
- How would you sum up the potential of Islamic banking?
Islamic banking has proved over time that it is based on firm and sound economic principles, and has a good potential for becoming an alternative system of banking, especially in view of the recent global financial crises.