Islamic Retail Finance in North America

A Discussion Outline for the Working Group

on Islamic Retail Finance at Harvard University

March 19, 2005

Yusuf Talal DeLorenzoShariah Consultant

The Definition and Objective of Retail Islamic Finance

the provision of financial services and products that can replace conventional/riba-based services and products is the ultimate goal of modern Islamic Finance in both commercial and religious terms

Chicken or Egg?

Products developed for Institutional/HNW investors lead to Retail products. Retail deposits for Islamic Banks (investment

capital) lead to product development …

Examples

1. Murabaha structures on metal markets developed for Institutions trickles down to retail as Murabaha for home finance

2. Mudaraba-based closed-end funds (leasing, real estate, stocks) trickle down to retail as mutual funds

3. Demand for stocks by institutional/HNW investors leads to creation of Dow Jones Islamic Market Indexes which then form the basis for dozens of retail investment products.

A Further Example

Demands for increased sophistication… by stock pickers and hedge fund managers… lead to further refinements in the screening criteria for stocks: i.e., two changes in the DJIMI criteria since 1999, and soon to-be-announced… possibly through AAOIFI… refinements in the screening criteria resulting from hedge fund development

Demand for Islamic finance in North America

Thirty percent of the seven million American Muslims (who account for two percent of the U.S. population) want to adhere to strict Islamic principles when dealing with their finances

The Numbers may be Enhanced by:

1. Consumer Education that introduces Islamic Finance to those unaware of its presence here and…

2. that dispels doubts and misconceptions brought on by either:

1. early attempts (in the 80's and 90's) to offer it here by small, inefficient, sometimes non-compliant (w/o proper Shariah supervision) and costly operators

Or that dispels doubts and misconceptions brought on by

2. failed attempts at "Islamization" of financial systems in the Muslim world (Iran, Pakistan, Egypt, Sudan)

Enhancing the Numbers

• Marketing efforts

• Tapping mainstream sources of distribution

Examples

1. Islamic mutual funds offered as a choice alongside conventional funds for the 401k plans of corporate employees

2. Islamic home financing options offered as options through mainstream brokers

3. Takaful policies offered on the same platform as conventional insurance policies by the major insurance companies

North American Muslim Demographics

Better education and higher earnings mean that a significant degree of sophistication is required in whatever financial products or services are offered to retail Muslim consumers

Consumer Mandate

1. Islamic financial products and services must be competitive in terms of pricing, range of options, service features.

2. The notion of a religious premium is one that many if not most Muslim consumers in North America will reject!

Demand for Islamic-based finance products

1. Financing home ownership

2. insurance

3. financing small businesses

4. saving plans

5. retirement

6. financing for education

7. credit/debit cards

8. investment vehicles

Beyond the Muslim Consumer

1. Synergies with ethically-based products, particularly for investments – a market that is particularly strong in the United States

2. While the Dow Jones Islamic Market Indexes may not correlate exactly to the Domini 400, managers and Shariah boards of Islamic funds may work together to constitute portfolios of socially-responsible investments (Azzad, for example)

3. Returns on profit-sharing deposit schemes may be attractive to ordinary consumers… or rates on home financing, or student financing, or takaful policies

Retail Growth

1. Real growth in the retail sector will begin (has already begun) with home finance, owing to:1. the emphasis on home ownership in the US

2. Incentives like tax benefits

3. The perception that real estate is the best kind of investment

The Key Product

1. Home finance is the key to the development of all other Islamic financial products and services in North America… 1. As a “big ticket” industry, in terms of revenues, it

leads all others

2. It provides the ideal “introduction to Islamic Finance” to consumers

3. The qualification process may expose consumers finances

2. THEREFORE… special care must be taken to “get it right”

An Important Clarification

» N.B. There is no value to the argument that different Shariah boards, or regions of the Muslim world, have their own opinions in regard to the characteristics of different transacting models (like murabaha, etc.), because the only result of such an argument will be anarchy in the marketplace.

» Free market forces are one thing, participation in a global industry (with its own standards and established standard-setting institutions) is another.

» Finally, consumers will decide what is right; but our govt agencies must be allowed to see for themselves what the issues are, and what is at stake.

Compliance

Compliance with regulations designed for finance that is heavily dependent on interest returns and rates for the management of risk and profitability demands cooperation from both sides.

The growing Islamic financial industry needs to commit resources to the education of both regulators and consumers. Such a commitment may take the form of advocacy group(s), lobbyists, resource center(s); perhaps under the umbrella of an organization(s) for Islamic financial service professionals, or Islamic financial service and product providers.