Islamic Finance

At Palmers Solicitors we are able to advise our clients on all aspects of Islamic Finance including the buying of residential and commercial property.

Islamic Finance explained

The basic framework of an Islamic Financial System is based on elements of Shar'ia, which governs Islamic societies. Shar'ia, the law of Islam, originates from two principal sources: the Quran, the Holy Book of the Muslims and its practices; and Sunnah, the way of life prescribed as normative in Islam, based on the teachings and practices of Prophet Muhammad (peace be upon him).

In essence Shar'ia is an Islamic moral code which forbids investment in or association with certain unethical products and industries, such as pornography, alcohol and tobacco. Shar'ia also prohibits amongst other things, unjust enrichment without commensurate effort. This encompasses the earning or payment of interest, speculation or gambling (maysir), and contractual uncertainty (gharar). Traditional financing techniques fall foul of many of these strictures, so Islamic financing techniques seek to create the same outcomes as traditional products by different means, for example by replacing interest payments with rent, sharing in profits though an equity stake or by the lender buying and reselling an asset at a higher price on a deferred basis.

How does Islamic finance work?

The prohibition or taking or receiving interest at exorbitant rates (Riba), but this does not preclude a rate of return on investment. Risk in any transaction must be shared between at least two parties so that the provider of capital and the entrepreneur share the business risk in return for a share in profit. Money is seen as potential capital and thus only takes the form of actual capital when it is used in a productive capacity.

The overarching principle of Islamic finance is interest free and on the basis of risk sharing.

The customer and the bank share the risk of any investment on agreed terms, and divide any profits between them. The terms of the agreement are laid out in writing between the parties and the buyer's solicitor will advise the buyer on the terms of that agreement.

The main categories within Islamic finance are: Ijara, Ijara-wa-iqtina, Mudaraba, Murabaha and Musharaka.

Ijara (Leasing agreement)

Ijara is a leasing agreement whereby the bank buys an item for a customer and then leases it back over a specific period.

The bank would bear all the risk and a portion of the installment payment goes towards the final purchase of the asset at the time of transfer of asset. This can also be set up as a lease-purchase contract for the term of the assets specified lifetime. The following steps should be taken in purchasing a property with the above product:

1. You find the property and agree a price with the seller.
2. You appoint a specialist solicitor to undertake the conveyancing (this is where Palmers Solicitors can assist)
3. The bank does the survey and buys the property from the seller.
4. The bank's solicitor checks the legal title and draws up the lease document. The property is registered in the bank's name.
5. The bank then sells the property back to you at the same price.
6. You agree to pay rent to the bank for the benefit of living in the property.
7. A lease agreement is drawn up in respect of the rent payments. Your solicitor at Palmers will check the title (deeds), searches etc. and the lease and will comprehensively advise you.
8. In addition to the rent you pay a contribution towards the purchase price each month.
9. The monthly payment is usually fixed in advance on a yearly basis.
10. You can usually pay off more than the agreed monthly payment without incurring a penalty.
11. The amount owed to the bank decreases each month until the total price has been paid and the property is yours.

Ijara-wa-Iqtina

Ijara-wa-Iqtina is a similar arrangement, except that the customer is able to buy the item at the end of the contract.

Mudaraba (Cost-plus sale)

Murabaha is the undertaking of a trade with a mark-up and is used for short-term financing, similar in form to purchase finance. An example would be a bank purchasing a tangible asset of some sort from a supplier with the resale based on the cost plus an agreed mark-up. This is most often used to finance property, since the bank would not be allowed to charge interest on any loan. Once such a debt covenant is in place between a bank and the customer, repayments can begin until a completion point where the asset is transferred to the customer. There is no interest rate risk which is essentially covered within the mark-up percentage, identified at the outset.

Murabaha (Buying/Selling agreement)

Murabaha is a form of credit which enables customers to make a purchase without having to take out an interest bearing loan. The bank buys an item and then sells it on to the customer on a deferred basis.

Musharaka

Musharaka is an investment partnership in which profit sharing terms are agreed in advance, and losses are pegged to the amount invested.

There is very little difference between this and a joint venture agreement. The parties involved contribute in varying degrees of assets, technical expertise etc. and agree to a percentage of the returns as well as the risk. All parties must invest a certain amount of capital. In the case of purchasing a property under this sort of arrangement, it is purchased by both the bank and the customer together, and the repayments made are partly rent and partly a buyback.

The following steps should be taken in purchasing a property with the above product:

1. You find the property and agree the price with the seller.
2. You must arrange the survey
3. You appoint a specialist solicitor to undertake the conveyancing (this is where Palmers Solicitors can assist)
4. The bank then buys the property and then sells it to you at a higher price (which is calculated by taking into account the original price of the property, the repayment period agreed, less the deposit already paid by the buyer).
5. Generally a large deposit of around 20% of the purchase price must be put down by the buyer on the day of the purchase.
6. On completion the property is registered in the name of the buyer.
7. The outstanding balance under the agreement may be paid off at any time.
8. The bank generally offers a fixed repayment period with a fixed monthly payment for the term of the loan.

Shar'ia Conveyancing at Palmers Solicitors

When a property is bought with the aid of Islamic Finance there is a significant amount of additional work involved for the buyer's solicitor as they are required to liaise with the bank's own solicitor, providing details of title, searches and enquiries to the bank's solicitor and dealing with any queries or special conditions raised by the bank. The buyer's solicitor must also check the agreement and any lease provided by the bank's solicitor and advice on the contents of these documents.

At Palmers we do not charge extra for this work you pay the same fee as a conventional property sale/purchase and not penalised for taking out Islamic Finance. You therefore get our specialist advice for no additional cost.