The Islamic Mortgage: Paradigm Shift or Trojan Horse?
Sheikh Haitham al-Haddad
Tarek El Diwany
25th Shawwal 1427 H
18th November 2006
All praise is due to Allah and may His peace and blessings be upon our Prophet
Muhammad, his family and all his Companions.
During recent years there has been an unprecedented expansion in the range of commercial banking products labeled as “Shari`ah compliant” in many countries of the world. Popular interest among Muslims in the Shari`ah of financial transactions has increased likewise, and in the United Kingdom the permissibility of so-called “Islamic
Mortgages” is among the most frequent topics of enquiry. We therefore thought it appropriate to record here what we see as the main problems associated with this product class from the perspective of Shari`ah, knowing that many of our criticisms can be equally well applied to other types of product that are currently available from the Islamic banking sector. Scholars who have approved the main forms of Islamic mortgage will no doubt disagree with some elements of our criticism. We mean them no harm, and remind the reader that Allah has decreed the existence of differences among people, including Muslims, as one of the tests by which Paradise may be attained.
Although we conduct a purely contractual examination of the issues, it is important not to forget the socio-political context of the discussion. Muslims in the West are attempting to implement certain elements of Shari`ah within an environment that is frequently inhospitable, and the formulation of an appropriate strategy is therefore rather complex.
The question is not limited to whether particular financial products are contractually valid. Wider concerns are also in play. For example, is it permissible to establish an Islamic bank that initially has some dealings with interest if the intention is eventually to become interest-free? Should we be content with a structure in which an essentially un-Islamic industry accommodates some Islamic products? Or should banking as an industry be avoided until a completely interest-free opportunity presents itself? If so, how will Muslims satisfy their banking needs in the meantime? Perhaps most fundamental of all, is the Western model of Islamic banking and finance something that can be ‘Islamized’ in the first place?
When approaching this subject some scholars of Islam may give greater weight to the surrounding context than they do to narrow contractual issues, particularly in Western countries where the institutional and legal framework is rooted in practices that are often prohibited in Islamic law. It is surely unreasonable to expect a wholly Islamic banking paradigm to suddenly sprout from un-Islamic foundations, and some sort of transitionary phase is therefore to be expected when developing Islamic alternatives. Moreover, in many countries of the world, Islamic and non-Islamic, the Muslim community is not in a position to effect the wide ranging institutional changes that would be required if a genuine Islamic financing paradigm is to emerge.
Whatever approach is taken to dealing with the problems that face us, we feel that one
Key rule to be obeyed is that Islamic principles and teachings should not be twisted to fit preconceived solutions. The basic Islamic prescription for success in these matters is, as always, to deal with the causes of a problem and not its symptoms. If we are asked to provide an Islamic solution to the economic problems caused by interest, without eliminating interest, then we say that Islam does not have that solution. To those who argue that “partly Islamic” financial products are an acceptable stepping stone towards an ideal solution, we respond that such products may already be part of the problem. Many of today’s Islamic financial products are neither presented nor perceived among the Muslim population as temporary solutions dictated by force of circumstance. Because of this, the drive towards improvement in the Islamic finance industry is being diminished. If existing products are already “Islamic”, why develop new ones? Now referred to as “home purchase plans” by the UK Treasury and Financial Services Authority, Islamic home financing products usually adopt one of three basic forms of Islamic contract. These are murabahah, `Ijara wa iqtina (sometimes referred to as ijaramuntahia bitamleek) and musharakah mutanaqissa. Murabahah is a sale of an item to a buyer at a disclosed profit margin over cost. In order to implement a murabahah mortgage, a bank will buy from the vendor the property that is desired by its home-buying client for the agreed price, and immediately sell it to the client at an agreed profit margin over cost. The home-buyer will pay the price of the property in installments over several years, and mortgage the property to the bank in order to secure the installments that are due. Banks that offer this form of finance usually borrow (at interest on the money market) the amount of money that they use to purchase the property in the first leg of the murabahah transaction. The installments paid by the client are therefore set at a level that is sufficient to repay the money borrowed by the bank from the money market, and provide the bank with a profit on the deal. The installments paid by the client must be fixed in total (since a contract in which the price is not specified is invalid under Shari`ah) hence a bank often uses the interest rate swap market in order to fix its interest costs. By fixing its own borrowing costs, the bank can fix its client’s installment payments. Rises or falls in interest rates during the term of the murabahah will not then have an effect upon the cash-flows of either the bank or its client.
`Ijara is a rental of an item by its owner to a client, and `Ijara wa iqtina is a rental of an item followed by its sale to the client. In the case of home financing using `Ijara wa iqtina, the bank will buy from the vendor the property desired by the home-buying client at an agreed price, rent it to the client for a period of years, and then sell it to the client at the end of the period at a price agreed between them at the outset of the contract. The client’s monthly payments to the bank will comprise two main payments. One is rent, the other an amount that is held by the bank as an assurance that the client will be able to pay for the purchase of the property when required to do so at the end of the rental period. The “assurance money” is loaned out at interest by the bank to the money market, producing a financial benefit for the bank. The client’s monthly payment under an `Ijara corresponds approximately to the payments under an amortizing interest-based loan in which capital and interest are repaid in changing proportions over the term of the loan.
This similarity allows a bank to easily adapt its interest-based lending processes to the requirements of an `Ijara mortgage. Musharakah mutanaqissa is a diminishing partnership between a financier and a homebuyer.
There are several ways in which this partnership can operate.
In the case of the Al-Buraq scheme in the United Kingdom, the bank purchases the
property desired by the home-buying client using its own funds plus a deposit
provided by the client. Although the property is registered in the name of
Al-Buraq at the Land Registry, the diminishing partnership contract splits the
so called “beneficial interest” in the property between the bank and the client
so as to reflect the relative size of their contributions to the
Ahli United Bank in London offers products that are described
as murabahah and `ijara. United National Bank, HSBC, and
Al-Buraq offer what they call a diminishing
partnership contract. The Al-Buraq contract has
been adopted by Bristol and West, Lloyds TSB and Islamic Bank of Britain. Until
recently, HSBC offered an Islamic
The Islamic principles of financial transactions are found
within a part of Islamic law
Islam defines riba in such a way as to prohibit any
benefit received by a lender for
“… Allah has permitted trading and forbidden riba …“from ayat 275, Surah al-Baqarah
Islamic law also prohibits hila
(legal trickery) that can produce a usurious loan from otherwise permissible
contracts. For example, a usury-free loan, a promise and a gift
“What matters in contracts is substance, not words and structure.”
Speaking of such contracts in a more general sense, the late
Arab scholar ibn Uthaymeen described modern day Islamic banking as the “usury of
“What we are developing now is not fiqh-ul-mu`amalat (the jurisprudence of financial
transactions), but rather fiqh-ul-hiyal (the jurisprudence of legal tricks)”.
Contract combination has become very common in modern Islamic banking. For example, in the murabahah model, Person A (the bank) might buy a property for £100,000 from Person B (the seller of the property) and immediately sell it on to Person C (the home buying client) at a price of £150,000 to be paid in equal installments over 15 years.
Person C must begin the process by promising in writing that
if Person A buys the property from Person B, then Person C will immediately buy
the property from Person A. The few Shari`ah scholars who approve this
transaction say that it is trading (buying
The contractual documentation used in a murabahah to the purchase orderer transaction
Usually includes an offer letter which states that the bank
does not agree to execute
The use of an offer letter may maintain the appearance that
the transactions (property purchase followed by property sale) are independent
and therefore not similar in
“We [UBK] will not buy the Property from the Vendor or sell
it to you [the Client]
“Before the start of each Rent Period, we will send you an
Scholars have argued that setting rental levels in line with
market interest rates is
Summarizes: “… general conditions specify that the sale must
not include any of the
Dr. Wahba al-Zuhayli, Islamic Jurisprudence and Its Proofs, Dar al-Fikr (2003), p. 33“A sale without naming the price is defective and invalid”
Dr. Wahba al-Zuhayli, Islamic Jurisprudence and Its Proofs, Dar al-Fikr (2003), p. 56 If the home-buying client later decides that he can no longer afford the rental, both the
HSBC and Ahli United `Ijara contracts require that he
or she must guarantee to repay the cash sum initially provided by the bank to
fund the purchase of the property. In those cases where the property has to be
sold to achieve this, the possibility arises that,
Clause 6.3 (d) of the United Bank
of Kuwait `Ijara agreement from 1998 provides an example of the way in
which banks seek to protect themselves from capital loss. Here,
From the Shari`ah perspective, it is clear that a client can
only be renting a property
In answer to this question some Shari`ah scholars have argued
that, in a modern `ijara agreement, the bank only buys the property and
rents it to the client because the
Once again, we are not convinced by this argument. The
essence of an ‘Ijara contract
Furthermore, an `Ijara mortgage typically requires
that the client purchases the property from the bank at the end of the `Ijara
term as a means of protecting the bank’s original capital contribution. This
transaction, involving a deferred delivery of both
“Delay from both sides is not permitted by consensus either in corporeal property or in liabilities as it amounts to a proscribed exchange of a debt for a debt.”
Ibn Rushd, Bidayat al-Mujtahid (English translation), Garnet (1996), p. 154 The final issue that we wish to address here is the purchase of shares by a home-buying client under the diminishing partnership form of contract. Here, the price and timing of share purchases is usually fixed at the outset of the contract. We are aware that in one Particular case, the price of share purchases is related to the market value of the underlying property at the time of the purchase, and that in this same case such purchases are not forced upon the client contractually. This case is however an exceptionand the majority of financial institutions adopt the former model. For example, the Al-Buraq contract forces its home-buying client to purchase shares in the partnership at monthly intervals:
“We agree to sell and you agree to buy Our Share of the Property for the Acquisition Colton the terms of this Deed. The Acquisition Cost shall be payable by way of the First Acquisition Payment, which shall be paid on the date of this Deed; and the Acquisition Payments …, which shall be paid on each Payment Date …”
Clause 2, Al-Buraq Diminishing Ownership Agreement, 2006
It is worth noting that the Shari`ah standards of the
Bahrain-based Accounting and Auditing Organisation for Islamic Financial
Institutions (AAOIFI) prohibit the purchase of shares in a diminishing
partnership at a price that is fixed in advance. This is on the basis that
partners in a contractual investment (in this case, a rental property) must
share any losses on their investments in proportion to their capital
contribution. If one partner forces another to buy his shares at a predetermined
price, he may effectively be able toprotect himself against loss, thus breaking
the principle of loss sharing that must apply if an Islamic partnership is to be
valid. For example, if two partners put £50 each into a business partnership,
the partnership capital is £100 in total. If it is further
“It is permissible for one of the partners to give a binding
promise that entitles
AAOIFI Shari`ah Standards 2003 - 2004, section 5. Diminishing Musharakah, p. 214
The diminishing partnership contracts that have come to our
attention protect the bank from capital loss on its share of the partnership by
various means and to varying
In summary, we believe that any Islamic home financing scheme
in which the financing organisation stipulates conditions to protect itself from
a negative return on capitalis equivalent to an interest-bearing loan. Contracts
in which the financier buys a
Given that it is possible to produce genuinely Shari`ah compliant Islamic property financing contracts under English law, we feel that to permit the present range of products on contractual grounds is a flawed strategy for the Muslim community to follow.
The risk is that the benefits possible under a proper
implementation of Islamic finance
Allah knows best and may His peace and blessings be upon our Prophet Muhammad, his family and all his Companions.
The Islamic Mortgage: Paradigm Shift or Trojan Horse?
Thursday, November 23, 2006
Please report any
broken links to
Copyright © 1988-2012 irfi.org. All Rights Reserved. Disclaimer