How Islamic Mortgages Differ from Conventional Mortgages, Supply, and Demand of Islamic Housing - Research Proposal Example

Islamic Mortgages Student’s Name Course Title Instructor’s Name 1st October 2012 1. Introduction Housing is considered a basic need of all humans. However, a basic fact is that, needs are unlimited and resources to satisfy the needs are limited. In order to get highest possible satisfaction humans have to prioritize their needs. Housing is necessity, its shortage is a major problem internationally, and to curb such problem, most countries have started looking into the need for housing finance. Islamic Financial Institutions (IFIs), in addition to conventional banks have started to provide housing finance as well (Dar, 2007). Islamic banking has become more and more significant in financial institutions in the West, particularly London, in spite of the regulatory hurdles presented by running in a non- Muslim monetary environment. The development of Islamic finance partially reflects demand from both resident and non-resident Muslim clients for Islamic banking facilities and fund administration services, which entail shariah compliance. Simultaneously, Islamic financing methods are seen as a challenge and an opportunity by bankers of the West, many of whom have sought after getting involved in this rising industry. In customer driven societies, there is enthusiasm by those in monetary services to listen and discover from the practices of Islamic banks, which in the end may bring a major breakthrough for Islamic banking at the retail stage in the West (Davies, 2002). The largest volume of Islamic financing business carried out in the UK at present originates in Muslim countries, largely the Gulf. However, there is a great potential domestic market that is only just starting to be tapped. The appeal of London for Gulf customers, which include all the main Islamic banks, is the extent of specialist monetary services provided, the depth to the market and the solidness of the key banks, which include all the topmost global players. London is closer to the Middle East than in the New York, and in a suitable time zone for connections (Follain & Dunsky 1997). The Muslim residents represents fifty percent of all UK ethnic minorities with estimated savings of about £1 billion and more than 500,000 Muslims visited Britain in 2001, spending almost £600 million. There is a significant number of Muslims living abroad, largely from the Middle East, who have expressed their wish to own properties in Britain, mostly as a holiday residence, but are hesitant to embark on an interest-bearing financing facility. For these investors an Islamic home financing scheme would present the opportunity to own property in Britain (Ford & Jones, 2001). The recent favorable regulatory and tax alterations by the Government for Islamic mortgages have appealed more banks to provide Islamic mortgages products. For instance, the elimination of double stamp duty offers a level playing field with conventional products. This has opened the door to new players and augmented competition in the Islamic financial market. The regulation of the home purchase plan (ijarah mortgages) became a reality and this improved customer self-assurance in Islamic mortgage products. The government could share the responsibility with the banks for raising the awareness of Islamic mortgages among the Muslim community (Datamonitor 2005). The extent of the Islamic mortgage market within the UK is estimated at only £500 million compared with over £1.1 trillion for the general mortgage market. Thus, in responding to the developments in Islamic mortgages in the UK, about ten regulated financial institutions, including major high street banks, provide Islamic retail products(Treasury a 2008). Yet FSA has received a number of applications to offer Islamic mortgage products by existing providers and more than 50 applications by intermediaries to enter the Islamic mortgage market(Treasury b 2005). 2. Research questions The main research question is that will guide the collection of data is; what is the supply and demand of Islamic mortgages and its perspective to Muslim clients in UK? In addition to this research question, the other questions that will propel the study are; 1. Does an effectual demand for Islamic mortgages exist in the UK? 2. What mortgage system do the Muslim community in UK prefer? 3. What challenges do the Muslim community residing in the UK encounter when purchasing a house? 4. What are the dynamics determine the choice of Islamic mortgages in the United Kingdom? 5. What perceptions does the Muslim community in UK have regarding Islamic mortgages? 3. Literature review In Islamic finance, the issues of gharar and interest consider haram or prohibited. This issue has been discussed in depth in many works (Dar 2007; Denby and David 1993; Foot 2003). Islamic mortgage or Islamic home financing is a kind of funding that is secured by actual property and offers a schedule of expenses of profit rate and repayment of the principal to a bank. This definition is dissimilar to that of George (2003) who stresses on “payments of interest” for conventional mortgage loans, which is impermissible in Islamic mortgage. Unlike conventional mortgage providers, Islamic mortgage providers practice profit rate instead of interest rate (Dreier 1997). This pricing policy is considered as fixed and higher at the beginning of a contract between a customer and an Islamic bank. Nevertheless, the rate will not fluctuate, even during inflation. Thus, it remains stable and constant, which gives peace of mind to the customer. The mainstream of Islamic scholars deems it permissible to charge higher costs for products if payment is postponed. Islamic banks have come up with a range of mark-up tools for that purpose (Ford & Jones 2001). With regard to Islamic home financing, the depository customer identifies the house he/she wants to purchase and the bank pays for the house from the developer/supplier at its normal value, for cash, and sells it again to the client at a higher value, in which the mark-up is used. The client then pays back the cost on an installment basis (Datamonitor, 2005). The difference between the cost price and the selling price is the net income for the bank, which is acceptable in an Islamic home financing framework (Davies 2002). Contrary to this, charging revenue is not permissible within an Islamic home-financing framework, as it leads to an unbalanced distribution of returns within the society (Follain & Dunsky 1997). Furthermore, although Islamic banks allow imposing mark-up, the level of mark-up should not be an expense to bank customers. As it is, Islamic banks should try to impose reasonable mark-up systems in order to promote fair pricing to their customers. According to previous studies such as Hills (1991), an Islamic bank ought not to be solely revenue oriented; rather it should aim at promoting Islamic customs and values as well as protecting the wants of Islamic society as in general. In this regard, Islamic banks must achieve the Islamic economic objective including social justice, equitable distribution of income and wealth and promotion of economic development (Iqbal & Mirakhor 2011). As far as Islamic home financing is concerned, the banks should be able to promote a more equitable pricing to their customers that facilitates customers choosing of a mortgage at a reasonable cost. Besides a reasonable pricing strategy, the banks should also provide a rebate in order to reduce the payment liability by the customer. A practice of “payment holiday” should also be provided in cases of financial hardship among customers. These pricing strategies are identified as promoting a good Islamic image of Islamic banks, as the banks with an Islamic identity. As it is, Islamic banks should be able to eradicate unjust dealing with their customers and promote a fairer transaction, relevant in the case of Islamic home financing (Davies 2002). 4. Methodology and data collection The data of this study will be obtained through a survey, conducted with Muslim families in London. A total of two hundred and fifty questionnaires will be distributed in the survey. A period of about two weeks will be spent carrying out this fieldwork. Owing to time and financial constraints, only two hundred and fifty questionnaires will be able to be distributed. No extra efforts will be carried out in order to increase the number of respondents. Non-probability, convenience sampling will be implemented. This sampling method is cost-effective and will facilitate the survey to be conducted quickly and easily (Iqbal & Mirakhor 2011). The data collected will be sufficient to compare Muslim and non-Muslim respondents, whereby the percentages will be on a fifty-fifty basis. Primary data will mainly be used to suit the nature and objectives of the research, which is to draw out the perceptions, opinions and attitudes of the respondents. The survey technique using questionnaires is perceived to be the most suitable method for collecting the required primary data. In addition, the research of this study will be based upon secondary data acquired from magazines, journals, books, reports and the web (Dar, 2007). 5. Chapter Summaries Problem Statement Given the increase in demand for Islamic products and banking services amongst bank clients, there is a growing argumentation and differing points of view about their nature, and the degree to which they are dissimilar from products offered by conventional financial institutions. There are some Islamic products that are similar to those offered by conventional banks, but there are others, which are different. Therefore, Islamic banks must develop products to attain the goals of Shariah, and simultaneously meet the economic requirements of society. Reviewers of the Islamic finance concept do not see any dissimilarity between Islamic and conventional finances, and if any exists, it is false in nature and not substantial in any way (Hills 1991). Consequently, the majority of clientele of Islamic products are persuaded that Islamic products are the same as any other bank products, and thus, breaking Islamic from non-Islamic businesses would be unrealistic. It is observed that there is an extensive application of securitization (tawreeq), fabricated Morabaha deals, and particular fictitious Sukuk, offered by some banks as Islamic banking goods and services. The rationale behind the prevalence of these practices is the participation of conventional banks in the provision Islamic products in a manner that does not differentiate between conventional and Islamic financial operations, and the control methods applied to it (Foot 2003). The problem of identifying clearly what an Islamic product represents, is compounded by the explanation by religious scholars of Shariah, and hence vague rulings, and the resultant difference of opinion from the agreement of Islamic scholars. This can lead to a inquiring of Shariah certification and verification of Islamic financial products. One cannot discount the presence of a fractional or an incomplete resemblance between Islamic and conventional products, since it is not a requirement that Shariah operations be totally different from conventional products. Nevertheless, there is a clear distinction between these products in appearance and substance, and in the ensuing outcomes (Hills 1991). Conventional Versus Islamic Mortgage Islamic financial principles share rewards and risks in wealth creation by way of equity rather than liability. It promotes free enterprise and creativity in the financial cycle. In the Islamic financial model, every individual takes part in the economic activity. This is different from modern capitalism where revenue maximization is the only motive and the bank is generally content with making interest on the loan not considering of the financial and social implications of the commerce. In addition, the point of reference of modern capitalism is not inclusive of God and society as its fundamental part of obtaining wealth. As such, it has no restriction in the manner in which wealth is obtained (Foot 2003). The financing concept in Islam differs with that of conventional banking. Loan is the main method under conventional banking using interest rate as a period value for borrowed funds. The Quranic sanction prohibits financial actions that have elements of interest and has no true nexus to business activities under the Islamic law. This means that money in itself has no inherent value and can only act as a measure of value and a medium of exchange. This differs from conventional banking where money is seen as a commodity and mortgages are lent out with interest as its valuation mechanism (Follain & Dunsky 1997). 6. Conclusion The Islamic banking and finance system provides a more efficient and ethical alternative to the profit-based conventional monetary system. Islamic finance institutions and banking appeared in the Middle Eastern fiscal markets in early 1970s, founded on models formulated by Islamic economists in the past decades. Other Muslim nations also followed the suit and initiated their own Islamic banking institutions. Some Western banks also established Islamic banking and investment products to supply their Muslim customers (Follain & Dunsky 1997). Mostly, Islamic values of interest are concerned with matters of justice and fairness rather than efficiency barely defined. These principles centre on the necessity of splitting risk in a fair and secure society, and upon struggles of exploitation in the markets where control is asymmetric, this is the actual Riba issue. As discussed earlier, it is evident that there are some principles differences between conventional and Islamic housing finance, the main one being that Islamic mortgage is equity based and conventional mortgage is debit based. Both the bank and the customer share ownership in an Islamic mortgage condition and therefore share the peril of equity ownership. In conventional banking, the customer is the owner of all the equity and the bank’s loan to the customer is secured on the price of the property (Datamonitor 2005). What the two mortgage systems have in common is a proscription of usury, or unwarranted interest rates. The Islamic approach stems from a foundation system of ethical principles. Islamic banks are becoming associates with Western market actors to support Islamic banking and business products and services within European markets. The European market environments have turned out to be more favorable for Islamic finance practices and banking. These developments are very hopeful, and have provided the Islamic banking and finance industries with a window of opportunity to turn into a really competitive and incorporated part of international financial markets. An Islamic finance system might create a more secure world financial market. Bibliography Dar, H. (2007). Incentive Compatibility of Islamic Financing. In M. Hassan, & M. Lewis, Handbook of Islamic Banking (pp. 85-95). Edward Elgar. Datamonitor. (2005). UK Islamic Mortgages. London Datamonitor . Davies, H. (2002). Islamic Finance and the FSA. Review of Islamic Economics , 101-108. Dreier, P. (1997). The New Politics of Housing: How to Rebuild the Constituency for a Progressive Federal Housing Policy. Journal of the American Planning Association , 5-27. Follain, J., & Dunsky, R. (1997). The Demand for Mortgage Debt and the Income Tax. The Journal of Housing Research , 197-214. Foot, M. (2003). The Future of Islamic Banking in Europe. Financial Services Authority. Ford, J., & Jones, A. (2001). Choosing a Mortgage: A Research Review. London: Financial Services Consumer Research . George, S. (2003). The Governor's Speech at the Islamic Home Finance Seminar in 27 arch 2003. Bank of England Quarterly Bulletin , 240-242. Gillham, B. (2000). Developing a Questionaire. London: Fabian Society. Hills, J. (1991). Unraveling Housing Finance: Subsidies, Benefits and Taxation. Oxford: Clarendon. Iqbal, Z., & Mirakhor, A. (2011). An Introduction to Islamic Finance: Theory and Practice. New York: John Wiley and Sons. Treasury, H. (2005). Housing Policy: An Overview. London: HM Treasury. Treasury, H. (2008). The Development of Islamic Finance in the UK: The Government's Pespective. Treasury Government. Read More