Some Muslims won't accept the standard loans offered in Australia based on Islamic law forbidding interest payments. They've instead taken on a new way of lending aimed to stay within their beliefs. This unique Islamic finance market is growing internationally to the tune of nearly US$1 trillion, and could soon become a force in Australia as well. Kit Kadlec reports.

 "Those who charge riba are in the same position as those controlled by the devil's influence... As for those who persist in riba, they incur Hell, wherein they abide forever" - Qur'an 2:275

This much is clear - the Qur'an has very strong words against "riba," which loosely translates to interest.

This poses a clear difficulty for Muslims in Australia who would want to take out a mortgage while still following Islamic law. There were more than 340,000 Muslims in Australia in 2006, and the population is growing. Many of these residents want to live the Australian dream and own their own home. But in doing so with a local lender, they must pay back interest and thus violate "Sharia" or Islamic law.

"The difference between Islamic and Western banking is the notion of interest rates," says Nail Aykan, marketing manager with the Muslim Community Cooperative of Australia (MCCA). "In the Islamic beliefs, the interest rate is forbidden, hence there must be an alternative."

One way to avoid any interest payments would be to pay entirely in cash for a property, but few could ever afford such a transaction in Australia. Another option would be to borrow from friends, but that also is usually not practical.

In order to get around this challenge, the MCCA has followed the lead of other lenders abroad and offered Islamic finance - essentially a process that avoids interest by entering into a partnership with each homebuyer and sharing the risk of the purchase.

The buyers don't make interest payments, but instead pay rent to the MCCA until a certain point when they are granted full ownership.

Slow start in Australia

Founded in 1989, MCCA is the first and one of the leading providers of Islamic finance in Australia, a small but growing market. There's little competition other than a few others such as Sydney-based Iskan Home Finance. While Islamic finance has taken off in some Western countries such as Britain and the United States, it's still relatively small here. Aykan says there are about 1,500 MCCA members, which is slightly under 2% of the estimated 80,000 Muslim families across the country.

Part of the problem in drawing in customers is that the MCCA does not offer the multitude of services as larger banks do.

"If we had real banking services, I believe we could easily penetrate 20% of the Muslim market," says Aykan, going as far as to say 50% of the Muslim market eventually be committed to Islamic finance eventually in Australia. The MCCA also aims to reach non-Muslim customers as well.

While the Muslim community is growing, it is not completely accurate to describe it as one homogenous group. There are more than 60 countries of birthplace and 55 languages spoken, according to the MCCA.

Another major reason Australia has lagged in growth of its Islamic finance sector is that it doesn't have the connections to the Arab world like the U.S. and U.K., says Bala Shanmugam, a professor and chairman of accounting and finance at Monash University's Malaysian campus.

"Britain and the United States have always viewed themselves as a major destination for petro dollars - a repository for Arab funds," says Shanmugam. "Hence they are taking steps to do what is necessary to maintain their stand. Australia on the other hand is not exactly a centre for such funds, so I do not see a rapid take-off in that direction."

Perhaps the largest issue, however, is the fact many Australian Muslims, while growing in number, see the traditional lending method with banks here to be both easier and cheaper.

"Research shows that Muslims as well as non-Muslims view returns as a more important factor in a financial transaction," says Shanmugam. "This variable outweighs religion in terms of importance for patronising types of banking. Therefore, unless people see actual benefits in terms of returns, the extent of patronisation will be nominal."

Case study

There are some Muslims in Australia who place religion first, however. Mohammad Tabiaat, of Lebanese descent, is one who chose to borrow through MCCA for his first family home.

He bought a three bedroom home in Campbellfield, outside of Melbourne, in December for $270,000, paying a 20% deposit. That part is not unlike anything other Australians would do in purchasing such a home.

The difference is that Tabiaat is not paying interest back. Instead, he's paying about $1,600 per week in rent through "Murabaha." It can be described as a lease-to-own agreement, where the borrower is offered a fair market rent.

Murabaha, an Islamic term, is defined as a transaction where the seller (in this case MCCA) discloses the cost of its commodity, then adds some profit thereon, which is either a lump sum or based on a percentage. This payment must be a fixed amount.

In another option, Ijarah Muntahia Bittamleek, the payments can be either fixed or variable, and the end ownership of the property is transferred to the client with the last instalment. There are another three products as well, and other lenders such as Iskan Home Finance have other offers as well, although all aim to be Sharia compliant.

In his own particular case, Tabiaat will be paying back his rent for 180 weeks, which ultimately equates to $288,000, plus the $54,000 deposit. While not everyone can afford such high weekly rents of $1,600, it is common to have borrowers pay off the amount owed quickly with Islamic finance, says Aykan.

The MCCA has also taken on some of the risk in this transaction, as it essentially has made the purchase on behalf of Tabiaat. According to the MCCA, the mortgage can either be seized by the funder or left with the borrower given that it is registered for full mortgage securities entitlement to the funder. It is also permissible to use a third party property as a security mortgage.

Tabiaat says he realises it would have perhaps been easier to use a traditional bank, but he prefers to follow the Islamic law.

"It's an individual choice," he says. "Some people are really conscious about what rate they are paying, whereas others don't mind paying the extra amount to do it in a compliant way."

How much more is it that one must pay in Islamic finance? Aykan says it often is a very similar bottom line.

"A normal bank and a traditional bank may be offering the same rates, but it's how it's processed that is the difference," he says.

Profit or interest?

The MCCA and other Islamic finance lenders often define the amount of money they take above the purchase price as profit. Since "interest" is forbidden, the word is avoided in most cases, although the Australian government still requires it to be used in the paperwork.

Aykan says while the MCCA aims to offer something under religious guidelines, in the end, they cannot offer loans without making their own profit.

"You have to remember it is a business at the end of the day, it's not a charity," he says. "But it's a more ethically, morally-based banking than just interest-based, where it's just greed. Islamic banking has certain religious values and guidelines."

The word profit is thus often used in describing the amount paid by an MCCA customer. But that's not what they will see on their official paperwork.

"What the MCCA has experienced, because the whole conventional system is based on the understanding of interest, is that our funders, our regulators, and whole heap of other bodies always use the word interest," says Aykan. "They don't know an alternative word."

Yet he says he's hopeful that in the next few years a new term will be allowed on the official forms for Islamic finance.

"We're not engaging in interest, but that term is still there, whether we like it or not," Aykan says.

There is an explanation given to customers, and Aykan says the term is little more a formality.

Shanmugam says he's unsure why there's even an issue at all with the wording.

"I'm not sure why the mere usage of the world 'interest' can cause a conflict between Sharia and Aussie law," he says. "Islamic finance has devised ways and means of not utilising the interest paying or charging mechanism to undertake financial transactions. However, in places such as the U.K. and Singapore, amendments have been made to existing legislation to cater for Islamic finance."

Tabiaat says he'd like to see Australia adopt the changes in language sooner rather than later.

"Why not adopt these changes and open your heart to it," he says. "Look at it as a benefit. If you change the law, it will bring more investment into this country."

However, no matter how it is worded, not all Muslims see the Islamic finance banking institutions as true followers of Sharia. Instead, say critics, they are the same as the banks they claim to offer an alternative to, still taking in profit and cloaking "interest" under a different name and using external funders that don't practice Sharia. There are numerous websites in Australia even, with authors taking shots at the MCCA and others, claiming they essentially have the same practice as traditional banks, but under a different cloak.

"This is a matter of opinion," says Shanmugam. "The same criticism is often levelled at Malaysia as well, from the Middle East. When religion becomes the guidelines for economic activity, such comments may be expected, as religion can be interpreted differently by liberals and conservatives."

While a uniform regulatory and legal framework supportive of an Islamic financial system has not yet been developed in Australia, there is some oversight. The community-based Islamic co-operative financial institutions were registered and given licences to carry on cooperative businesses under the Cooperatives Act 1992, and they are subject to basically the same rules and regulations as other lending institutions.

A push for a more uniform and greater oversight specifically aimed towards Islamic finance is being pushed, however.

The future

To Shanmugam and other experts, there's no doubt Islamic finance will begin to massively expand in the coming years.

"Islamic finance has been around for a good 40 years, but after 9/11 it has seen astronomical growth, largely due to a consolidation of Muslim interest, sort of an Islamic Renaissance," he says. "With time, it has gained momentum and is progressing at full steam. With complete support from resource rich Arab nations, I do not see Islamic Finance as a passing phase. It is here to stay."

Since there is a greater risk in the lending sense, Islamic finance banks often are more careful in what they invest in. That's no doubt helped push them along while some of the major banks, especially in the U.S., have collapsed or needed billions of dollars in government funds after taking on too many bad loans.

Aykan says the MCCA has its sights set on not just filling a small niche, but eventually taking a stake in the mainstream Australian market in the long run. A lot of it comes with just educating the customers of what Islamic finance is, he says.

"At the moment, there isn't a great awareness about Islamic banking in the Muslim community," he says. "Once you have those resources and services, word will spread, branches will open up in every city and a domino effect will start."

Outside of Australia, Islamic banking is not limited to cooperatives and small businesses. Even some unusual suitors are lining up for Islamic finance. Most recently South Korea and Malta were among those countries expressing strong interest in opening some main branches. Major global banks have also signed on.

"Major global players (HSBC, Citibank) have embraced Islamic Finance in one way or the other," says Shanmugam. "This has come about due to economic demand and supply factors. If Aussie banks see sizeable profit margins or variable critical masses, then they may consider offering this alternate form of financing."

The National Bank of Australia (NAB) has already begun on its effort, although it doesn't yet offer any Islamic financing itself yet. Since 2007 it has been offering an annual $25,000 scholarship to allow young Australian Muslims to continue their studies in finance. The offer includes employment at NAB and has an aim of improving the bank's understanding of Islamic banking.

"There's an incredible potential in this market," says Aykan. "It's growing globally and the only way is up."

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