Guide To Islamic Finance – Forbes Advisor UK

Islamic finance is a way for Muslims (and others) to manage their money while observing the principles of Islam and Sharia law.

Here’s an overview of the main Islamic finance principles, and where to find Sharia-compliant providers in the UK.

What is Islamic finance?

Islamic, or Sharia, finance is the practice of organising your personal finances along Islamic ethical principles, as laid out in the Quran and Hadith, Islam’s main religious texts.

This means following certain rules and restrictions and choosing products and services that meet Sharia standards.

How does Islamic finance work?

The principles of sharing risk and profit, only supporting permitted (halal) activities and avoiding interest are at the heart of Islamic finance.

This means interest-bearing loans, mortgages, interest-paying savings accounts and certain investments are not permitted. 

The UK has a well-developed Islamic finance industry, supporting the country’s roughly four million Muslims. 

The first Islamic banks in the UK opened their doors in the 1980s. Since then, the sector has grown to around 20 Sharia-compliant banks, according to government figures.

In 2020, the Bank of England launched a non-interest bearing account, which allowed it to hold deposits from these providers for the first time.

To ensure they adhere to Islamic financial principles, Sharia-compliant providers usually employ a supervisory committee.

What are the main rules for Islamic finance?

Islamic finance has key principles:

• earning or charging interest (riba) is prohibited
• uncertainty (gharar) and gambling or speculation (maysair) must be limited as far as possible
• investments in forbidden (haram) activities must be avoided.

Sharia finance services in the UK

In the UK, Sharia-compliant options are available for most essential financial products.

Current accounts

Sharia-compliant bank accounts do not pay interest or provide an overdraft facility, since earning or charging interest is prohibited by Islamic law.

Aside from these restrictions, an Islamic bank account functions exactly like any other current account – allowing individuals to carry out day-to-day banking tasks such as making deposits and withdrawals, setting up regular payments, using a debit card and making bank transfers. 

In the UK, banks including UBL, Al Rayan and Nomo offer Sharia-compliant current accounts.

Savings accounts

Islamic savings accounts work along the Sharia principle of risk and profit sharing.

Rather than interest, they pay customers an ‘expected profit rate’ on their savings. These profits are generated by investing customers’ money in Sharia-compliant assets.

As with any form of investing, returns are not guaranteed – this means account holders may earn less on their savings than expected.

However, Islamic banks use careful risk management techniques to predict their profits as accurately as possible – and are usually successful.

Al Rayan Bank, for instance, has paid customers the rate it quoted them, or more, every year since it was established in 2004. 

Other banks that offer Islamic savings accounts in the UK include Gatehouse Bank, UBL and Bank of London and the Middle East.

Insurance

With conventional insurance policies, individuals pay a fixed annual premium to their provider, which will offer compensation under certain pre-agreed circumstances.

Since providers count on earning more from premiums than they pay out in claims, their activities are considered gambling (maysair) under Islamic principles, and are prohibited.

Insurers may also invest their customers’ premium payments into interest-bearing and other haram investments. 

Islamic insurance, or takaful, works differently. Instead of paying an annual premium to an insurance company, a group of individuals each contribute to a shared fund, which can be used to compensate members of the collective in adverse circumstances.

The overall principle of this system is to share risk within a community, to the benefit of all. 

A portion of each individual’s contribution to the fund may be taken by the takaful provider as payment for its service.

Takaful policies cover the same areas as conventional insurance, such as:

• car 
• home 
• travel 
• life 
• private health 

Takaful providers are relatively scarce in the UK, but a specialist insurance broker, such as Howden Insurance, may be able to help you find a suitable policy. 

Where insurance is a legal requirement, a conventional policy is generally considered halal if no Sharia-compliant options are available. 

Mortgages

Traditional mortgages are not Sharia-compliant, since lenders charge interest on borrowing. 

Islamic alternatives are effectively no-interest purchase plans, which involve buying the property jointly with a bank.

Each month, the homebuyer makes a payment that increases their share of the property, and covers rent on the portion still owned by the bank.

At the end of the payment plan, they own the property outright.

A few different options are available:

• Ijara – The homebuyer makes monthly payments, which are held by the bank. At the end of the term, these funds are used to buy the lender’s stake, and the homebuyer owns the property outright.
• Diminishing Musharaka – With this plan, each monthly payment increases the buyer’s share of a property, and the amount of rent they pay to the lender decreases. 
• Murabaha – A bank purchases a property on a buyer’s behalf, and sells it to them with an agreed-upon markup. Murabaha plans are more common among commercial buyers. 

To qualify for one of these plans, the homebuyer must provide a deposit – usually around 20% of the property’s value – and prove they can afford the monthly payment plan. 

In the UK, providers including Gatehouse Bank, Stride Up, Ahli United Bank and Wayhome offer Sharia-compliant home buying plans. 

Elsewhere, Al Rayan Bank provides purchase plans exclusively for commercial properties.

Personal loans

Conventional loans are not Sharia-compliant since lenders charge their customers interest.

Borrowing money with a credit card is also considered haram since providers change interest on the cardholder’s spending. 

Sharia-compliant loans are not widely available in the UK, and no mainstream providers offer them. However, you may be able to secure one through a local Islamic community fund or charity, such as Ansar. 

Student loans

In the UK, student loans charge interest, which means they’re not Sharia-compliant.

However, the UK government may introduce Sharia-compliant student loans in the future, having first proposed the idea in 2013.

These loans would be paid out from a takaful fund, managed by the Student Loans Company. After completing their studies, graduates would pay back into this fund via the tax system.

Car finance

Car finance plans that charge interest are not permitted under Sharia law. However, a 0% hire purchase agreement may be acceptable.

In the UK, companies such as Halal-Cars.co.uk and Interest Free 4 Cars offer Sharia-compliant, interest-free car purchase plans. 

Pensions

Whether or not a pension is Sharia-compliant depends on where it is invested, since Islamic law prohibits investment in certain activities (see list below), and prohibits earning interest. 

Workplace pensions are not necessarily Sharia-compliant, and providers don’t always offer an Islamic alternative – though it’s worth checking with your employer. 

Employees might choose to opt out of a non-Sharia workplace pension, and instead contribute to a private pension that invests along Islamic principles. They may alternatively choose their own investments with a Self Invested Personal Pension (SIPP).

Note, however, that leaving a workplace pension scheme could mean missing out on extra employer contributions. 

In the UK, providers such as Nest and GetPenfold provide Sharia-compliant private pensions. Elsewhere, mainstream providers including Aviva and The People’s Pension allow customers to invest their money in Sharia pension funds.

Financial planning

In the UK, many financial advisors specialise in Sharia finance, helping clients to organise their finances in line with Islamic principles.

Online directories such as Unbiased allow users to filter their search results for advisers who specialise in this area.

Sharia-compliant investment options

Investing in industries considered haram is prohibited under Islamic finance principles.

This means companies involved with the following industries are off the table:

• alcohol
• gambling
• pornography
• tobacco
• pork
• charging or paying interest
• weapons and armaments.

Since Islam also forbids gambling and speculation (maysair), investments in high-risk or highly speculative areas may be considered haram.

These restrictions apply to both individual shares and investment funds.

Jason Hollands, managing director of corporate affairs at investment firm Evelyn Partners, explains: “Sharia-compliant funds – like traditional ethical funds – apply a set of screening criteria to avoid exposure to certain types of business activities that are regarded as unacceptable for Muslims under Islamic law and ensure a portfolio that is consistent with Islamic principles.

“Of course some stocks are readily identifiable as to be excluded, but where further scrutiny is required is where a business may have a vast range of activities, potentially including certain activities that are not consistent with Islamic law.”

While Sharia guidelines may limit an investor’s choice, many of the world’s largest companies – such as Microsoft, Tesla, Exxon Mobil, Johnson & Johnson and Proctor & Gamble – are considered Sharia-compliant. 

Hollands adds: “To dispel any misconceptions, the underlying portfolios of most Shaira compliant funds will be full of very familiar names, and there are also passive funds – trackers – which screen out non-compliant stocks.”

Examples include the iShares MSCI World Islamic UCITS ETF GBP fund, and the Schroder Islamic Global Equity fund. 

HSBC also provides a range of Sharia-compliant exchange traded funds (ETFs).

For UK investors, however, access to Shaira compliant funds is fairly limited. Of the roughly 3,000 funds available through Bestinvest, for instance, just eight are Sharia-compliant.

Few of these funds can be held in sterling, so investors may also face a currency conversion fee when they invest – from US dollars back to pounds, for example.

To invest in line with Sharia finance principles, individuals must also consider whether their account pays interest on uninvested cash balances, since earning interest of any kind is not permitted. 

Some investing platforms do not pay interest on cash balances, while others allow you to opt out. Individual providers have different policies, so you’ll need to get in touch to check.

Can anyone use Islamic finance products?

You can use Sharia-compliant financial products even if you aren’t Muslim yourself, and there are plenty of reasons an individual might want to.

Investment options that avoid controversial industries such as gambling and tobacco may appeal to investors regardless of their belief system, while the expected profit rates paid by Islamic savings accounts sometimes outpace their interest-bearing counterparts. 

Islamic mortgages could also offer greater predictability than a variable rate product.

Overall, Islamic finance has become a small but significant part of the UK’s financial landscape, offering an alternative to traditional banks, lenders and insurers.