Economic analysis

Does Islamic finance have a place in Canada?

Tarek Fatah and Walid Hejazi debate the pros and cons of sharia banking
(Hasan Jamali/AP Photo)

Around $900 billion in assets across the globe are managed by Islamic banks that operate according to sharia, an interpretation of Islamic law. In recent years, so-called Islamic finance has been growing at a rate of 15-20 per cent a year, and proved remarkably resilient to the financial crisis. Proponents of the relatively new sector point to its back-to-basics financial structures, which have made it popular with a number of non-Mulsim clients who have little appetite for risk. Critics, though, say the restrictions it comes with–prohibitions, for example, on paying interest and investing in anything that involves porn, pork or booze–are archaic and unworkable.

Canada, with its 1.3 million Muslims, has lagged behind countries like the U.K. and the U.S. in embracing sharia-compliant financial products. None of the country’s big banks currently offer sharia-compliant services, though some smaller players do. Toronto-based UM Financial Inc., which issued home mortgages conforming to Islamic law, filed for bankruptcy last year, leaving 170 Muslim borrowers in limbo, and opening a legal can of worms. Is the firm’s failure evidence that Canada should steer clear of Islamic finance; or proof that the country needs more of it–i.e. that the banks and policymakers need to bring the practice into the mainstream, with tighter rules and better oversight? We asked the experts to chime in. 

Tarek Fatah is the founder of the Muslim Canadian Congress, a liberal-minded grassroots organization. He is also the author of Chasing a Mirage: The Tragic lllusion of an Islamic State, among other works. Walid Hejazi is associate professor of international business at the University of Toronto’s Rotman School of Management, where he is currently teaching an MBA course on Islamic finance.

What is Islamic finance?

Fatah: In the words of one New York Muslim banker, Islamic finance is little more than “a $300 billion deception.” According to Muhammad Saleem, former president and CEO of Park Avenue Bank, “Islamic banks do not practise what they preach: they all charge interest, but disguised in Islamic garb.” In fact, Islamic finance is just one more front in the worldwide Islamist movement’s attempt to depict all things Western as essentially inimical to Islam.

Its foundational doctrine comes from the writings of two people: Abul Ala Maudoodi of the Jamaat-e-Islami movement in Pakistan and Hassan al-Banna of the Muslim Brotherhood in Egypt. While these two pillars of the Pan-Islamist movement propagated jihad and war against the West, they also recognized the role international financial institutions could play in carrying out their political objectives. The theory was put into practice when the Islamist Pakistani military dictator General Zia-ul-Haq established sharia law in Pakistan, forcing the country’s public-sector banks to run their operations based on Islamic principles and without the role of interest. As professor Timur Kuran, who taught Islamic thought at the University of Southern California, notes in his brilliant book Islam and Mammon: The Economic Predicaments of Islamism, “There is no distinctly Islamic way to build a ship, or defend a territory, or cure an epidemic, or forecast the weather.”

Hejazi: Islamic Finance allows individuals or companies to invest in conformity with the principles of Islam. In the aftermath of the financial crisis, though, Islamic finance has been extending its appeal to a wide range of clients–regardless of religion–because it relies on rather conservative and low-risk banking practices.

It is critical to emphasize that sharia-compliant or Islamic financial products can be made available to anyone–not just Muslims. There are five key elements that must be avoided in Islamic finance: interest (riba); speculation (maisir); uncertainty (gharar); unjust enrichment/unfair exploitation; and unethical purpose. I will focus on the most well-known–and, I would argue, the least understood–dimension of Islamic finance: the ban on interest.

Many interpret this ban to mean that money can be borrowed for free. This is not the case. Rather, it implies that the investor must have a stake in the underlying asset. What does this mean in practice? Here’s an example (in which I am abstracting from differences that can arise in risk and administrative costs): Suppose you purchase a home for $300,000. Under a conventional mortgage, you may opt for a five-year, fixed-rate mortgage, say at five per cent, and amortized over 25 years. Your monthly payment would be about $1,745. Assuming that interest rates stay at five per cent, the amount that you would have to pay over the 25 year amortization period would be $1,744.81*300 months over 25 years = $523,443.00. In total, the homeowner will have repaid the $300,000 in principal plus $223,443.00 in interest. In reality, though, interest rates would vary and the mortgage would be renewed at whatever the prevailing rate is upon maturity of the mortgage.

With one form of sharia-compliant mortgage, the bank would buy the home on behalf of the customer for $300,000 and then sell it to the customer for $523,443.00. It means that over the 25-year period, the customer pays the fixed payment of $1,744.81, but unlike in the case of a conventional mortgage, there are no changes in these payments over the duration of the mortgage. A second difference is that late penalties are not allowed–the bank cannot charge punitive fees if a homeowner, for example, is laid off and has difficulty making some of the payments. It all goes back to the key principles above around partnership, fairness and eliminating uncertainty.

Should Canada embrace Islamic finance?

Hejazi: It is in the interest of Canadians to embrace Islamic finance, both on the retail and the commercial side. On the retail side, Statistics Canada estimates that Muslims will be about seven per cent of the Canadian population by 2031. A recent study prepared for the Canada Mortgage and Housing Corporation reported evidence indicating that the demand for sharia-compliant mortgages currently exceeds supply. This demand will only increase. We need to bring these Canadians into the financial mainstream and give them better access to a type of financing that is consistent with their religious principles. Doing so is entirely consistent with fundamental Canadian values and our proud history. These sharia-compliant mortgages would be profitable and self-financing–they would impose no extra cost to the institutions offering them or the Canadian government. In addition, these mortgages would be available to all Canadians, who feel that the structure of the mortgage better fits their personal risk and financial profile.

Perhaps more important, though, is the commercial side. As my research has documented, Canada needs more foreign investment and our country has been slipping behind in terms of its attractiveness to foreign investors. Now, the Gulf region has a tremendous amount of excess liquidity–upwards of a trillion dollars! However, investors from that region often require their investments be sharia-compliant. The Rotman School, in conjunction with Deloitte, Bennet Jones, Torys, and King and Spalding have developed case studies in which we looked at whether sharia-compliant financial structures would be more costly than conventional ones in the context of three major Canadian projects. Our analysis found that the costs associated with a sharia financing structure were similar to those of the conventional financing structure. Having a capability within Canada to undertake these transactions will make Canada more attractive to foreign investment, and this will help grow the economy and enhance the prosperity of all Canadians.

Fatah: Canadian banks and financial institutions are already flirting with the idea. Can we blame them? Who wouldn’t want gullible consumers who demand zero interest on their deposits but are willing to pay more on their monthly mortgage payments, all in the name of Islam and avoiding eternal hellfire. Islamists are lining up with such icons of global capitalism as Citibank NA, HSBC Holdings PLC, and Barclays PLC, which have all endorsed sharia banking and started offering Islamic financing products to a vulnerable Muslim population.

Promoting these products, of course, are a number of prominent Muslim corporate lawyers and bankers. This push from Muslim banking executives working inside the corporate world has had some success. While the Royal Bank of Canada didn’t find enough market interest for a sharia finance product it tested a few years ago, other Canadian banks are smelling easy pickings and lining up to wear the Islamic mantle. Scotiabank and Toronto-Dominion Bank have been quietly considering whether to start offering sharia-compliant products as part of the big banks’ strategy to reach out to a growing “immigrant population,” a politically correct way of labeling Muslims. Canada should not permit this charade of lies and deception posing as multicultural banking to segregate its Muslim population from the rest of society. If it does, there will be a huge cost to our values and to our future as well as to vulnerable Muslim-Canadians who are being blackmailed into paying more and receiving less for their banking needs.

Suppose mainstream Canadian institutions started offering Islamic financial instruments, making them widely available throughout the country. How would this affect, if at all, the integration of Canada’s Muslim minority?

Fatah: The question assumes there is one Muslim community. I suggest there are many and they will react in different manner. My cursory study of the clients of now-bankrupt mortgage lender UM Financial shows that the company appeals mostly to customers from the Indo-Pakistan subcontinent and Caucasian converts to Islam, with Arab-Canadians and Iranian-Canadians virtually absent. Thus the integration of Canada’s Muslims into the rest of society has very little to do with the success or failure of Islamic banking; it has everything to do with the failed policies of multiculturalism that encourage segregation and make it difficult to propagate Canadian values that have crystallized over 400 years of Western civilization and are the core of who we are as a country. Charlatans attempting to squeeze money out of an already marginalized minority community should be an affront to all of us—Muslim and non-Muslim alike.

Hejazi: If the mainstream financial institutions offered sharia-compliant financial instruments, such as mortgages, savings accounts, mutual funds, and so on, this would go a long way towards integrating conservative Muslims into mainstream financial markets and keeping our financial system strong and sound. At present sharia-compliant financial securities are not available in the mainstream; hence conservative Muslims who feel they must use sharia-complaint financial instruments are forced to deal with smaller, less well-known, less well-funded, and likely less well-managed financial institutions. Providing these Muslim-Canadians with this option does not come with any negatives.

Who opts for sharia-based financial instruments? To whom does this model appeal?

Hejazi: The Financial Times reports that the assets within the Islamic finance sector have now reached US$900 billion, double what they amounted to in 2006. This growth is remarkable given that it occurred during the global financial crisis.

A recent report by the International Monetary Fund attributes the growth in Islamic finance to three factors: increasing demand from the growing number of Muslims living in Western countries; growing oil wealth among the Islamic members of the Organization of Petroleum Exporting Countries; and the attractiveness of sharia-compliant financial products and services to non-Muslims seeking ethical investments or fair financial products, as well as lower-risk, back-to-basics banking.

Fatah: The primary movers and shakers of sharia-based financial instruments are the rulers of the petro-dollar states of the Persian Gulf. In the working class neighborhoods of Karachi, Jakarta, Cairo or Tehran, no one buys into this “paying more and receiving less” model. They may vote for Islamist parties, but when it comes to their hard-earned money, they trust their banks and credit unions, not the mullahs bearing tickets to paradise.

Even in Pakistan, which has played a pioneering role in Islamic finance, few have embraced the Islamic banking institutions. Even in Saudi Arabia, home of the Islamic Development Bank, no-interest sharia banks did not find favour with the country’s monetary agency, SAMA. In fact, as pious a leader as the late King Faisal allowed SAMA to place its surplus funds in interest-bearing accounts during the country’s cash-strapped years in the 1950s and 60s. One thing is for sure: Muslims have voted with their feet and their chequebooks.

UM Financial, a Canada-based Islamic financial institution, recently went belly up. What lessons does the bankruptcy hold for Islamic finance in Canada?

Hejazi:  At present, Canadians seeking sharia-compliant mortgages and other financial products are forced to turn to institutions which operate at the periphery of the financial system, such as UM Financial, because these services are not offered through mainstream financial institutions. As is now well known, Canada’s financial markets are among the most stable and well-managed globally. A collapse such as that at UM Financial is not consistent with Canada’s image, nor should such institutions be able to put so many Canadian homeowners at risk. Canada needs the financial mainstream to offer these products. It is mainstream institutions that should be reaping a profit from these instruments.

The demise of UM Financial makes the case for bringing Islamic finance into the mainstream even stronger. Besides, as more Canadian institutions enter the Islamic finance market, competition will force the cost of sharia-banking products down to the level of their conventional equivalents. As noted in a recent CMHC study, in Canada, sharia-compliant mortgages currently cost between one and three per cent more than comparable conventional mortgages due to their modest supply and firms’ relative inexperience with these products, as well as a lack of access to funding. In contrast, sharia-compliant mortgages in the U.S. cost only 0.4 to one per cent more than their conventional counterparts.

Fatah: The bankruptcy of UM Financial tells a simple truth: most Muslims would not want anything to do with financial institutions that promise a path to Paradise while enriching the pockets of those who sell Islamic indulgences. Court documents reveal that, just a few days before UM Financial went into receivership, its Sharia Advisory Board invoiced it for $2.1 million. This amount was ostensibly the fee charged for providing advice to UM Financial on the compliance of its products and services to sharia law.

In a scene that could have come straight out of a Bollywood crime thriller, UM Financial CEO Omar Kalair made this payment in gold and silver bullion at a Rexdale Parking lot, late into the night. The recipient, Joseph Adam, the finance manager of Multicultural Consultancy Canada, is said to have later flown to Egypt and is now reported missing—along with the gold. Canada has no room for charlatans who bring the medieval values of the pre-industrial era into the twenty-first century. Enough of this please.