Complex Made Simple

Saudi mortgage law sheds light on Islamic home finance potential

At the beginning of July, Saudi Arabia's consultative Shura council passed a full-fledged mortgage law. It still has to be approved by the Council of Ministers but the new law aims to encourage private real estate ownership in the kingdom. With a total population of 27.6 million, including 5.5 million foreigners, only one in five Saudis owns a home.

It is expected that the new law will boost Shariah-compliant home financing.

In Saudi Arabia Islamic finance is mainstream, with its biggest financial institution, the National Commercial Bank, having passed almost completely into Shariah-compliant banking two years ago.

Islamic home finance is one of the fastest growing segments in the industry.

Take the profit development of Dubai-based Tamweel or Amlak in recent years, both of which are pure Islamic home finance operators.

Tamweel, the UAE’s largest provider of real estate finance, posted a net profit increase of 195% in 2007, while Amlak went up by 131% to Dhs301m.

In September last year Amlak signed an MoU with the World Bank’s International Finance Corporation to explore Shariah-compliant opportunities in the Middle East.

Tamweel and Amlak are both listed at the DFM, outperforming the market on a year-to-date basis.

Guide to Islamic home financing

How does an Islamic home financing work? This form of financing is known as Murabaha, (Arabic for ‘sale’).

Under Murabaha or mark-up-sale, the bank purchases the house for its client and re-sells it to him on deferred payment basis. The mark-up-amount for the payment is spread over an agreed period of time.

A payment of riba or interest is avoided this way and the financing becomes halal. Is also avoids the uncertainty, or gharar, which is haram.

Under a conventional loan scheme home financing is often combined to the key interest rate. Because of its smooth payment structure, Islamic home financing has also become popular with non-Muslim customers in the UK.

International impact

In 2003, the Bank of England exempted Islamic mortgages from double stamp duty, a decisive move to boost the Murabaha in the UK with its two million Muslims.

Major conventional banks such as HSBC (with its Islamic arm Amanah) or Lloyds TSB moved into the market, which is home of three FSA-approved Islamic banks.

Other regulators of European countries with significant Muslim communities, such as France (6 million Muslims), Germany (3.5 million) or Switzerland (300,000) have not regarded Murabaha as a legal loan scheme (as yet).

In the US an Islamic mortgage scheme was introduced by the Federal Mortgage Association in March 2001.

The Saudi initiative demonstrates once again that, in many cases, only the national regulators can be catalysts for more growth in the industry.

Islamic real estate finance is also in the global spotlight due to the subprime crisis sweeping the US. However, it does not replace a meticulous assessment of the customers’ creditworthiness. At the end of the day it’s up to the bank to examine the client’s current and future ability to pay off his debt, whether his house is financed with interest or without it.

See also:
Global cities race to become Islamic finance hubs
High oil prices and the impact on Dubai real estate