Islam-compliant financing

Muslims are now living in Germany in their third or fourth generation. Consequently, both the financial means and the desire to settle in their new familiar homeland are present. However, purchasing property in Germany poses significant challenges for Muslims. On one hand, conventional financial sectors do not offer Sharia-compliant financing options. On the other hand, the conditions of current alternatives are either not attractive enough or very similar to conventional financial institutions. The following article explores and evaluates Sharia-compliant forms of consumer and real estate financing.

Sharia-compliant financing techniques

Various instruments can be used for Sharia-compliant financing. In the following types of financing, the ownership first transfers to the financing bank and is then transferred to the customer according to the technique.

Murabaha financing

Here, the customer pays off the purchase price plus a profit margin in installments. The agreed installment is a fixed amount and remains valid until the end of the term. This technique is often used for the purchase of goods. A benchmark index like Libor or Euribor is often used as the basis for calculating the margin.

Note: The purchase contract between the customer and the bank can only be executed when the bank actually owns the item!

Ijara financing

The borrower (the lessee) receives the right to use the item for the agreed term. Unlike Murabaha, the agreed rate can change by mutual agreement during the term or be adjusted based on an adjustment clause. In practice, leasing financing with a purchase option (Ijara-wa-Iktina) is often used. When this option is agreed upon, the customer pays an additional amount alongside the leasing rate, which qualifies as a down payment for the property.

Note: It is prohibited to execute an Ijara with monetary values or consumables.

For Sharia-compliant real estate financing, the special forms of Modified Murabaha and Diminishing Musharaka are also available. They appear in the context of real estate financing in the following roles:

Real estate financing via Modified Murabaha

A possible variant of Sharia-compliant real estate financing is Modified Murabaha, which includes the contract forms Mudaraba (silent participation of the financial institution), Wakala (customer acquires the right of use in the name of the bank), and Ijara (paid use for the customer). The purchase contract is concluded between the customer and the seller, potentially solving the problem of double taxation. Additionally, the financing bank does not bear the same risk as in other variants, as it does not become the owner of the property. However, Sharia compliance is ensured by the existing silent participation.

Real estate financing via Diminishing Musharaka

This process involves the diminishing co-ownership of the bank in the joint property. In this form, the financial institution and the customer act as capital providers in a so-called "Joint Venture," with partially different shares. Through regular payments, the customer gradually takes over the share of the bank in this Joint Venture. Besides the bank's share, the rate includes the incidental costs incurred in acquiring the property and a rent or a leasing rate (profit margin) for the bank. As the borrower's share increases, the amount of rent or leasing rate gradually decreases until the borrower owns 100 percent of the shares and thus becomes the sole owner.

Summary assessment of Sharia-compliant financing

In general, in the context of classic conventional consumer financing, the risk of uncontrolled consumption must be pointed out, which should be treated with caution in Islamic finance. Various Sharia-compliant mechanisms thus serve as a precautionary function for both capital borrowers and capital providers.

Regarding regulations in Germany, the issue of double taxation fundamentally exists in real estate financing. However, there are already ways to eliminate double taxation within the current legal framework.

Furthermore, it should be mentioned that currently available financing models from Sharia-compliant financial institutions show a strong resemblance to the conventional market. This is partly because customers should be presented with a familiar instrument to overcome comprehension barriers. It should also be noted that traditional Sharia-compliant financing mechanisms inherently involve more risk and require more effort in administration and control for the capital provider.

The goal of the actors should be to use the Islamic fundamental rules as a basis and apply the most appropriate technique depending on the purchase and financing basis. The advantages and disadvantages of all parties involved and the success prospects of the financing should be considered.

Depending on the instrument, risk and profit sharing and the avoidance of interest-like components must be taken into account. Accordingly, Diminishing Musharaka provides an optimal methodology for acquiring property. The rental rate included in this contract forms the basis of returns. This allows for the generation of ethical and moral profits while effectively curbing interest. The terms can also be structured completely independently of interest benchmarks such as Euribor or Libor. Despite difficult implementation steps, Sharia-compliant methods and instruments should be sustainably established to create a clear and better alternative to conventional financing offers.