Islamic Finance & Investment: The Next Wave

With the legal market saturated with lawyers in every conceivable practice area, from corporate to litigation, there are few opportunities to distinguish one's own practice. Islamic finance however, is gaining ground as a mainstream vehicle for individual and institutional investments, mergers, property development and acquisitions. Islamic finance refers to principles of funding and investment based on the Shari'ah, a corpus of rules derived from The Qur'an, Islam's holy text. Islamic finance is known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (usury). Common Islamic concepts are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leading (Ijarah). In sum, Shari'ah compliance typically relates to the prohibition on interest as security in the future event of financial delay or default.

To circumvent the use of interest, Shari'ah-compliant transactions have found innovative ways to finance. For example, in an Islamic mortgage transaction, instead of loaning the buyer money to purchase the real estate, a bank may purchase the real estate from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. In this context, there are no additional penalties for late payment and therefore, no use of interest arises. In order to protect itself against default, the bank asks for strict collateral. The real estate is registered to the name of the buyer from the start of the transaction, called Murabahah.

Another innovative approach applied to real estate loans is called Musharaka al-Mutanaqisa, which enables banks to institute a floating rate in the form of rental. The bank and borrower forms a partnership entity, both providing capital at an agreed percentage to purchase the property. The partnership entity then rents out the property to the borrower and charges rent. The bank and the borrower will then share the proceed from this rent based on the current equity share of the partnership. Concurrently, the borrower in the partnership entity also buys the bank's share on the property at agreed installments until the full equity is transferred to the borrower and the partnership ceases to exist. If default occurs, both the bank and the borrower receive the proceeds from an auction based on the current equity. This method allows for floating rates according to current market rate such as the BLR (base lending rate).

There are a variety of emerging, more complex financial arrangements that call for the application of Islamic legal principles. As Western and Islamic institutions grow in their financial ventures, U.S. lawyers should keep apprised of its developments and potential income opportunities.