Is an Islamic loan a loan or a borrowing?

I’m about to have a week in Kuala Lumpur, if anyone wants to meet-up, with a focus on Islamic Finance. I remember twenty years ago talking with Mike Hanlon who was founding the Islamic Bank of Britain (IBB), and he was telling me how UK Gov really did not understand the concept. What is the concept? It’s that you don’t have mortgages, loans, credit cards and interest-based products. It varies by Sharia-law but my simplistic view is that you use the bank as an intermediary to give you a car or a house and, as the intermediary, you pay them a monthly payment for a term which, at the end of the term, you pay a final, closing payment to keep the car or the house.

Sounds like our system? Yes, but different as, until the final closing payment, the bank owns the car and the house. The problem UK Gov had with this is that cars and houses have VAT and stamp duty, but IBB argued that there was no transaction. The bank owned the asset, not the customer who was borrowing the product from them, and so VAT and other taxes did not apply.

It took them ages to argue this case, which they did win, but it shows an interesting difference between the views of us and the views of those who avoid usury – the use of interest to make money. We talk about Revolut, Monzo and others who are making much of their income from interest-income. Interest-income does not exist in Islamic finance or, some would argue, it does but in a different form.

What forms?

Well, there are four main forms that I would cite:

Profit-Sharing (Mudarabah): A bank can act as an investor, and the client as the provider of capital. Both share in the profits or losses of the business or investment.

Trade-Based Financing (Murabaha): A bank purchases a commodity or asset and sells it to the customer at a profit, with the payment made in instalments.

Partnership (Musharakah): Customers and the bank enter into a partnership to jointly purchase and own an asset, with the bank eventually selling its share to the customer over time.

Leasing (Ijarah): Similar to a lease agreement, where the bank owns the asset and the customer pays to use it, often with an option to purchase it later.

There are also Sukuk investments. These are Sharia-compliant financial certificates, often called Islamic bonds, that represent undivided ownership in a tangible asset or investment activity. Unlike conventional bonds which represent a debt obligation and charge interest (riba), sukuk tie investor returns to the profits or rental income generated by the underlying asset. This asset-backed structure provides a Sharia-compliant alternative to interest-based financial instruments.

I guess the biggest difference between all of the above is the semantics of how you define financial instruments that are Sharia-compliant versus the rest. I’m happy to have any of my Islamic colleagues disagree with me, but it just seems that you dress up the core product in a different way. A loan is a loan with interest. You can call it a borrowing that is shared or a dual investment, but it always ends up with a payment to own the asset that resides with the client and often with a balloon payment at the end.

Whether Islamic or Christian or other, financial services breaches many codes of the Bible, Koran and more (as I’ve blogged often). It is the reason why Jesus threw the bankers out of the temple.

Can we trust financial institutions that want to earn interest by burdening us with debt?

Well, we have got used to it. C’est la vie. In fact, this is a question that has been with us for centuries, spotlighted by Shakespeare’s Merchant of Venice where Shylock, the loan shark, demands a pound of flesh from Antonio for the loan outstanding.

“The pound of flesh which I demand of him is dearly bought; 'tis mine, and I will have it”.

It is a demand used to exact revenge, rather than for profit, and is a theme played out in most of our daily lives, movies and games.

Would you give a pound of flesh for a thousand pounds of cash?

Islamic finance dresses this in different terms – there is no interest-income or usury – but I still think a pound of flesh is invested when you get to the end-game.