11.3 Findings of the Case Study Through Documentary Analysis
11.3.2 Documentary Analysis of a Home Finance Product
The analysis of this type of financial product, offered by IFIs, is based on all available product documents that are part of the offerings. Islamic home finance is based on three main different structures amurabaha based home finance, an ijarahbased home finance and a diminishingmusharakawithijarahstructure, (see explanation of each of those principles in Chap.2, Sect. 2.4). For the purposes of this analysis, we have selected a structure based on diminishingmusharaka with ijarah for a home finance, which is also considered financial engineering as it involves employing various contracts within the product. The reason for choosing this particular structure for the analysis is because it is very common structure and is more complicated than other available structures, as it uses various Islamic finance principles (financial engineering) to offer the desired financial product.
The structure works as follows, as described by the Islamic bank offering this product: the bank and its client contribute towards the purchase or refinance of the chosen property, by the client, as partners. The Islamic bank (IB) agrees to sell its share of the property to the client over a period of time, known as the finance term.
The IB also leases its share of the property to the client, for which the client pays a monthly rent.
Therefore, the monthly payment consists of two elements: an acquisition pay- ment, which is the payment the client makes to acquire the IB’s share in the property; and a rental payment which is the charge for renting the IB’s share in the property. Monthly acquisition payments will remain constant throughout the term of the finance and the rent element is variable. Once the IB’s share is fully
acquired in the property, the monthly payments cease and full legal ownership of the property transfers to the client.
The analysis is based on reviewing four associated legal documents, diminishing musharakaagreement, lease agreement, service agency agreement and legal charge agreement, in addition to the offer document and product leaflet.
11.3.2.1 Shariah Objectives
The documents do not specify adhering to certain Shariah objectives, although it is a good Shariah compliance practice to do so. However, this is imbedded implicitly within the document. Two Shariah objectives were identified, whether intentionally or not, when the diminishingmusharakaagreement states that‘the transaction as a whole and each related agreement are for only enabling the IFI to provide finance in a Shariah compliant manner and all parties to the agreement agree to be bound by the rules of Shariah and never to claim interest payments from each other’.
This incorporates the Shariah objectives of preservation and maintenance of the religion, by avoiding interest-based transactions and providing clients with the Shariah compliant alternative. The second Shariah objective, that was met, is safeguarding wealth by ensuring that the customer share is paid towards a legiti- mate purpose under a Shariah structure that would financially benefit both the IFI and the client. The IFI financial benefit is made from the rent element in accordance with Shariah and the client acquires its home.
11.3.2.2 Social Welfare Impact
The social impact of this financial product is also not mentioned clearly in the documents. However, this is implied by the overall product structure, as there is an approved process as mentioned in the diminishingmusharakaagreement to ensure that the client chooses suitable property that they can afford. Also, providing the client with a Shariah based finance solutions for housing that meet pressing needs in the market. This product provides a solution for financial inclusion of Muslim clients to be able to finance their homes in accordance with Shariah. Also, ensuring that this process will not generate a negative or harmful outcome to other stake- holders in the society.
11.3.2.3 Suitability of the Selected Islamic Finance Principle or Structure
As mentioned above there are more than one structure available in the market for offering home finance. The diminishingmusharakawithijarah(DMI) structure is believed to be more appropriate and flexible than the other two structures, i.e.murabaha andijarahonly structures. This is because (Khir et al. 2008: 229) 168 11 Case Study: Analysis of Selected Shariah Compliant Financial Products
of the flexibility of the pricing structure of a DMI structure, which works better for possible adjustments of the product and its profit, i.e. rental rate, throughout the finance term, in order to facilitate refinancing, releasing equity, reducing the finance term, lump sum payments by the client to increase its equity or early settlement.
Also, this structure is believed to be more suitable from a profit rate risk manage- ment perspective, as the rental rate charged by the bank could be adjusted according to agreed intervals based on a benchmark or an index. This would work better for both the IFI and the client at the same time.
11.3.2.4 Compliance of the Structure with All Requirements of the Islamic Finance Principle Employed
Components of a DMI for home financing are:
1. The unilateral promise made by the client to purchase the IFI’s beneficial interest in the property over the finance term. This is, usually, countered by an open offer from the IFI to sell its beneficial interest to the client.
2. A lease agreement that specifies the terms of the lease and particulars of rental payments. It also stipulates the roles and responsibilities of each party, the IFI in our case shifted its responsibilities under the lease in relation to maintenance of the property to the client under an agency agreement.
3. A service agency agreement which appoints the customer as the IFI’s service agent in the IFI’s beneficial share of the property, this suggests that the IFI would pay its share of any costs incurred. However, nothing was mentioned in the document about this process in either the lease or the service agency agreements.
4. A legal charge agreement in order to secure the monthly payments, this should apply only to the rental payment but not the acquisition payments. Nevertheless, that was not the case in the reviewed documents and it is mentioned that a default on acquisition payments constitute an event of default. This could be due to regulatory guidelines in relation to regulated mortgages (in particular with the Mortgage Market Review (MMR), which became effective from April 2014, that was conducted by the UK regulator and tightened the rules on mortgage provides) and what constitutes an event of default. The rules do not differentiate between a Shariah compliant home finance and a traditional mortgage.
5. The approval of the diminishingmusharakamodel, by many Shariah scholars, was on the view that it is a form ofsharikat al-mulk(partnership in a property) not as sharikat al-’aqd (partnership by contract). While the parties are not allowed to agree in advance a fixed price for the forward sale of partnership shares among themselves, as this would constitute aribatransaction, this does not apply insharikat al-mulk(which the analysed product is based on) because the contract is not intended as a profit making venture for either party (El-Diwany 2010: 263). Other Shariah scholars disagree with this view, i.e. agreeing in advance a fixed sale price of the IFI’s share in the property,
because the IFI is not using the market value or price of the property at the time of sale (El-Diwany 2010: 263).
11.3.2.5 A Shariah Compliant Product or a Shariah Inspired Product in Form and Substance
The structure of this product seems to be Sharia compliant; it does not go beyond that to the category of being Sharia inspired in form and substance. The implied complexity in the structure is a key factor for that and differences in the scholarly views in relation to the principle itself. It, however, meets the minimum require- ments by Shariah as a Shariah compliance certificate of the product was also available, which explains the structure briefly. We would suggest a possible review of the structure of this product for enhancement of its structure, a better justification and further details in the Sharia compliance certificate of the structure.