Reset, Refresh, Return, Revitalise

What is Ethical and Islamic Financing?

Islamic finance is still little understood in the United Kingdom, due to its emphasis on ethical norms which govern the lives of Muslims. However as dynamics in society change and there is a paradigm shift in the way we think about financing,  we have begun to see a surge in more ethically aware people, corporates and lenders in the United Kingdom. It is for these reasons we have seen a number of ethical lenders opening up across the United Kingdom, whereby consumers have started to look for alternative methods of financing purchases, investing their savings or to simple save money in an ethical ISA account. Often, the term used to describe such lending is “Ethical” rather than “Islamic”, but the two terms are really inter-changeable.

Ethical and Islamic Financing are two side of the same coin. Everything about Islamic Financing should be ethical by its very nature. What makes these transactions ethical are the very rules which govern them, the Sharia.

In financial transactions – those involving the circulation of money – the primary purpose of the Sharia is to curtail usury in the financial economy. You should not charge interest (riba). Interest, is considered a form of usury due to its uncertainty and because of market fluctuations in rates.  Such fluctuations are usually to the detriment of a borrower and to the fortunes of a lender. This is also relevant to another ethical finance consideration – the banning of uncertainty (gharar). This affects interest, and also prohibits investing in or dealing with gambling or speculative activities. Other activities which could be seen as immoral or unethical, such as pornography or arms dealing, are also prohibited. It is for these reasons sometimes Islamic finance is characterised as ‘prohibition-driven’.

This is attractive to many in today’s ethically conscious society, as we become more questioning of how our money is used and invested.

What needs to be reconciled with the Western banking system is that interest has a function. It is a pricing mechanism for risk. Ethical finance also addresses risk, just in a different way. Interest itself is prohibited, so instead there is a sharing of commercial risk, of monetary loss and gain, between lender and borrower. The traditional borrower – lender dynamic is altered.

In a typical ethical property transaction, an ethical bank and the “borrower” (called the participant) both share the equity of a property, and also sharing profits on a pro-rata basis. Instead of charging interest, a bank charges a rental payment on its equity share in the property. The contracts are written so that over time the bank’s equity share is reduced and, by the end of the contract, the property should be wholly owned by the participant. This is referred to as “diminishing musharaka” and the structure of this typical property deal will be discussed in more detail in my next blog, which focuses on ethical home purchase plans as an alternative to a traditional mortgage.

If you would like further information on the topic discussed in this article, please contact Awais Anwar g by email: aanwar@gilsongray.co.uk or by phone: 0131 285 7841. For more information on Ethical & Islamic Finance, please click here.

The information and opinions contained in this blog are for information only. They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice. Before acting on any of the information contained in this blog, please seek specific advice from Gilson Gray.

Newsletter 
Sign up to our News & Insights!