Banking Review

Finance with faith

The Australian Government is chasing the Islamic dollar in an effort to be the leading Asia Pacific hub for Islamic finance

BY ELTON CANE

Today there are only four organisations offering Islamic finance in Australia. But this is something the Federal Government is hoping to change, as it reviews the tax code and embarks on a mission to make Australia a hub for Islamic finance in the region.

While much of the rhetoric is about attracting inward investment to Australia and developing expertise and services for our financial services companies to export, the proposed changes would also promote the development domestically of consumer finance and insurance products that are compliant with Shariah law.

The target market for these products in the Australian market is not insignificant, and non-Muslim customers could also be interested in the ethical aspects and other features of Islamic finance products.

So what is Islamic finance?
Islamic finance avoids the traditional Western banking structures based on the time value of money, as interest, or riba, is banned under Shariah law. As a result, banks have embraced combinations of partnership, lease-back and profit share arrangements. These sometimes draw on classical Islamic finance, but are often new structures.

Generally speaking, financing should be based on the provision or exchange of actual physical products or tangible services (so no derivatives trading or abstract financing arrangements), and investment in companies involved in gambling, pornography and alcohol is strictly prohibited.

International religious bodies, such as the International Fiqh Academy of the Rabitah (World Muslim Congress) and the Accounting and Auditing Organisation for Islamic Financial Institutions, provide guidelines that are interpreted by each bank’s own Shariah supervisory board to decide what is and is not permitted under Shariah principles.

Islamic finance has experienced very strong and very consistent growth, even in the face of the global financial crisis, growing at about 10 per cent per annum for the past decade. The value of worldwide Islamic financial assets was US$822 billion in 2009 and this is projected to reach US$1.6 trillion by 2012. Moody’s Investor Services see a global market potential of at least US$5 trillion at maturity.

Level playing field for tax
Assistant Treasurer Senator Nick Sherry embarked on a regional tour of the Middle East in late April. Building on the recommendations of the Johnson report, he met with government officials, central bankers and regulators across the region to promote the country’s financial expertise and reiterate Australia’s commitment to reviewing tax laws to ensure that, wherever possible, they do not inhibit the expansion of Islamic finance, banking and insurance products.

Dr AbulKhair Jalaluddin is a director of the Muslim Community Co-operative Australia (MCCA). It is currently Australia’s largest provider of Shariah compliant financing – predominantly mortgages. Dr Jalaluddin welcomes the government commitment to tax code changes, and hopes that it will support his organisation’s goal of becoming Australia’s first fully-fledged Islamic bank.

“We’re really looking for a level playing field,” he says. “To do this, Australian authorities should look at how the products work and, more specifically, what is their economic function? Taxation should be based on this economic function rather than how each product is organised and designed, and the transactions that take place within the structure.”

Growth opportunities
MCCA has more than 8,500 members and a portfolio of more than $475 million in mortgages. Its growth from a small start-up 20 years ago funded by a group of associates with a few thousand dollars has seen it outgrow its co-operative structure. It is now in the process of corporatising as part of a three to five-year strategy to become Australia’s first fully fledged Islamic bank.

Official figures state that there are about 400,000 Muslims in Australia representing some 80,000 households that could be interested in refinancing with an Islamic mortgage. Dr Jalaluddin believes this figure is conservative, as some Muslim citizens might not declare their faith on census forms. The real figure could be about 500,000. In any case, he says, there is ample demand to support a number of competing Islamic finance providers in Australia, and as competition increases, prices for customers will inevitably fall.

The typical Islamic mortgage is transacted under a structure called murabaha. This entails the bank’s purchase of a house and the resale of that to the end-buyer with an added mark-up paid over time. Costs can be a little higher than the introductory rates offered by the Big Four banks, but the arrangement has other benefits. For example, there are no late payment penalties. While stricter collateral requirements apply, assets are registered to the name of the buyer throughout the transaction and, if there is a default, both the “borrower” and the bank receive proceeds from an auction based on the current equity.

Other structures are also possible, including musharaka – a shared equity rental scheme.

One example of the tax change that Islamic financiers are hoping for in Australia is that the murabaha mortgage be taxed as a single financing transaction, rather than the component transactions of purchase by the bank and resale to the customer.

Dr Jalaluddin says MCCA currently has a waiting list for mortgages. But the nascent bank is also planning to offer a broader range of services. It has already started Australia’s first Shariah-compliant income fund, and is licensed by ASIC as a financial adviser.

It has been working towards launching an islamic superannuation fund compliant with the Shariah law. And it is also looking at offering Islamic insurance, or takaful, a structure whereby a proportion of the profit made from investing surplus premiums each year (after claims are paid out) is returned to policyholders.

“We think within three to five years we should be there as one of Australia’s first fully fledged Islamic banks, including being an ADF, a licensed deposit taking institution,” says Dr Jalaluddin. “Maybe then we’ll embark on a strategy to grow the market, first by focusing on the large cities _ Melbourne, Sydney and Brisbane, and growing from there.”

In certain markets worldwide, Islamic finance offerings have also proven popular among non-Muslims. OCBC Al Amin Bank in Malaysia, for example, found that more than half of its Islamic finance customers were non-Muslims. Similarly, one of the Islamic banks in the US, Lariba, has a large and growing proportion of its business from non-Muslims.

“While these products are Shariah-compliant, it’s been proven that their ethical basis and sharing of profit and loss are attractive features to the wider community. So it’s not just a matter of faith,” says Dr Jalaluddin.

Increased competition
MCCA is not alone in being at the vanguard of Islamic finance in Australia. Two smaller firms, Sydney-based cooperative Islamic Cooperative Finance Australia (ICFA) and Iskan Finance, also offer consumers a range of products to facilitate home buying and funds for education and pilgrimage.

Kuwait Finance House Australia is the first foreign Islamic bank to set up operations in Australia. Currently, it is more focused on developing wholesale Islamic financial services here, but elsewhere such as in Malaysia, it does have experience in serving the retail market.

Other leading global banking groups such as HSBC Amanah, Citibank, Standard Chartered Bank, Deutsche Bank and UBS of Switzerland have already entered the markets to offer Islamic financing facilities in a significant manner through their trans-national banking subsidiaries.

Dr Jalaluddin says he’s not aware of any of these banks planning to offer Islamic banking in Australia. But there has been some interest among Australia’s Big Four banks. To date, this has mostly been in the area of Shariah-compliant commercial and trade financing.

“But I believe with their big branch networks, the Big Four could reach the Muslim population well,” says Dr Jalaluddin. “They might think the market is small. But it does have a lot of purchasing power when you consider the full range of their financial needs – not just mortgages. The big banks already have a lot of consumer confidence. And this level of trust and confidence is something that it’s taken us time to build.

“We hope there will be more and more organisations in the market and economies of scale. If you look at other markets, such as Malaysia or the UK, it’s very competitive, and this is a good thing for customers in terms of price and product innovation.”

An Islamic finance hub
Given the current low level of Islamic finance in Australia, it may seem ambitious for the Australia Government to set out to become an Islamic finance hub. But there is obviously a lot to gain.

“Australia is in a great position to capitalise on Islamic finance growth, particularly in the wholesale market,” Senator Sherry told media in Dubai. “One of our closest neighbours is Indonesia, with the world’s biggest Islamic population and we have a global leading edge in funds management.”

Dr Jalaluddin agrees. “Changes will benefit Australia as a whole. It diversifies Australia’s finance sector and brings more choices to retail and wholesale customers in this country. It will also open up the market up to the enormous cash surpluses in the Middle East.

“Australia has everything we need to attract this – political and economic stability, a good regulatory system and a good rate of return in the economy.”

But before this vision is achieved, changes will need to be made to the tax code and financial regulatory system. To the latter end, the Bahrain Central Bank has offered to work with Australian regulators to boost readiness for a range of Shariah-compliant products, both wholesale and retail.

No timeline has yet been set for the Board of Taxation review. But with the apparent commitment of the Federal Government, more Islamic finance courses being offered at Australian universities, the ambition of Australia’s existing Islamic finance providers and interest from the Big Four – it seems only a matter of time before Islamic finance here fully emerges from its cooperative roots.