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Islamic Finance in USA

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Muhammad Arif : Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan

There are no US laws specifically addressing Islamic finance in the United States, and financial institutions offering Islamic finance products are governed by the same federal and state laws and regulations as those offering conventional instruments. Islamic finance in the United States is market-driven; rather than support or promote Islamic financial products, federal and state regulators respond to applications and inquiries from Islamic financial institutions (IFIs) wishing to offer Islamic financial products on a case-by-case basis. The Federal Reserve has been helpful in organizing forums to discuss with prospective issuers and investment bankers alternative ways to advance and grow Islamic finance in the United States.
Retail Islamic finance has been well established in the United States since 1997, when the Office of the Comptroller of the Currency (OCC) approved the ijarah structure for home lending because it is ‘functionally equivalent’ to conventional secured real estate lending. In 1999, the OCC (office of the comptroller of currency) approved the use of the murabahah ‘cost plus profit’ structure for home financial products because this structure was deemed to be ‘functionally equivalent’ to conventional real estate mortgage transactions or inventory or equipment lien agreements. However, other than Fannie Mae and Freddy Mac, there is, in general, a paucity of investment capital and liquidity infrastructure in the United States for most kinds of Islamic ally financed transactions.
There are no US national Islamic financial institutions; rather, IFIs operate as state banking corporations. Conventional financial institutions have established Islamic ‘windows’, but more often use subsidiaries for Islamic finance transactions. The gross annual dollar value of retail Islamic financial transactions in the United States is only approximately US$4 billion, and most Muslims, constituting under 1 per cent of the US population, continue to use conventional financing in their US banking transactions.
Sovereign wealth funds have acquired considerable amounts of US real estate and remain active in this market, but typically use conventional financing for their acquisitions. While there have not been any listings of sukuk on US stock exchanges, publicly held and private Islamic funds are active and offer, buy and trade securities that are shariah-compliant. Investment in businesses dealing with haram goods and services may be made and held in the United States, provided they are de minimize and appropriate ‘purification’ is expected with respect to excess haram income.
The United States has not adopted any federal legislation specifically addressing Islamic financing. Islamic banking, capital markets and insurance are subject to the same federal and state law and are subject to the same tax treatment that applies to corresponding conventional instruments. Only two rulings have been issued by the OCC, approving an ijarah and a murabahah structure for home and other retail financial products. IFIs in the United States are state-chartered entities subject to state laws regulating corporate governance and banking and insurance operations. Despite a paucity of legislation and judicial decisions, these structures and deposit accounts have been developed and are being used in the United States by balancing Islamic finance concepts with US legal issues, such as ownership liability, taxation, real estate transfer taxes, bankruptcy and securities laws.
All deposit accounts offered by US banks are required to be insured by the Federal Deposit Insurance Corporation (FDIC), which is intended to assure the overall ‘safety and stability’ of financial institutions. Although no IFI offers interest on its Islamic deposit accounts, the FDIC has approved insuring such accounts on the basis that investment return does not have to be based on interest, but may be based on profit and loss participation.
State banking agencies regulate IFIs in the United States. Although IFIs may be qualified to do business in different states, the majority of an IFI’s assets are located in the institution’s home state and licensing and other conditions must be satisfied with respect to any state where the IFI wishes to be qualified as a bank or mortgage or loan finance provider. Illinois and some other states have enacted a ‘wild card statute’, which allows IFIs chartered in such states to do anything that is permitted by the OCC to be done by national banks.
The principal federal regulatory authorities charged with the oversight of US banking are the OCC and the FDIC. State banking authorities govern state-organized financial institutions, including IFIs.
The 1997 and 1999 rulings by the OCC approved the ijarah and murabahah structures for home finance and retail transactions. In addition, states such as New York and Illinois have enacted legislation intended to encourage Islamic finance transactions, such as the elimination of a double real estate transfer tax in an ijarah sale-leaseback transaction.
The United States has no central authority responsible for insuring that transactions or products are sharia-compliant. IFIs in the United States are not required to maintain their own sharia supervisory boards, but may work with the sharia board of another IFI, the Sharia’s Board of America or other scholars.
There is no regulatory approval required for the appointment by an IFI of sharia supervisory board members.
There is no nationally chartered Islamic bank in the United States because of the difficulty in complying with national banking laws and federal and state securities regulations The existing US Islamic banks, notably Devon Bank and University Islamic Finance Bank, are state-chartered, state-licensed banks, which have applied for and received FDIC insurance for depositors. Foreign involvement
Foreign financial institutions may offer in the United States Islamic banking structures approved by the OCC, which include the ijarah and murabahah structures for home mortgages and retail financing. Foreign institutions are required to comply with all applicable federal and state law, including obtaining all requisite state banking and retail lending licenses for the offering of approved products in those states where they operate. HSBC Amanah operates in the United States, but does not offer Islamic ally financed retail products, but only sharia-compliant investment securities options.
In 2008, American International Group Inc. (AIG) became the first insurance company to offer Islamic homeowners takaful insurance in the United States. Takaful is currently issued through AIG’s underwriting subsidiaries; Takaful operates to a large extent outside the reach of state insurance regulators. The ‘establishment clause’ of the First Amendment to the US Constitution presents a serious obstacle to the successful introduction of takaful and retakaful in the United States, as this mandates separation of church and state and prohibits the favoring of one religion over another. In addition, the insurance regulatory regime in the United States poses a problem for the introduction of takaful, as each state determines its own licensing requirements for insurance companies. In order to obtain a license, an insurance company must demonstrate that it has the experience and management capability to run the company, and that it is financially sound. Insurance companies are also
There are no specific disclosures or reporting requirements for takaful, sukuk or Islamic funds that differ from conventional products under applicable federal or state banking, insurance and securities laws.
The mudarabah structure is a type of profit-and-loss sharing (PLS) partnership, which separates responsibility for capital investment and management. This is often compared with venture capitalism in the United States, with the notable exception that in a mudarabah the manager (mudarib) does not share in any loss unless he or she is negligent, and any financial loss is suffered by the investor (rab-al-mal).
The mudarabah structure is also the basis for the deposit product developed by SHAPE and offered to US depositors by University Islamic Financial Bank. The depositors share in the profit of the bank but not any losses that might be incurred as a result of the bank’s investment in a sharia-compliant portfolio. Profit shares are derived from the rental income paid by those obtaining home finance from the bank rather than coming from income on interest-based loans and mortgages. The deposits are structured on a mudarabah basis, with a proportionate share of the profit paid out to the depositors. Mandatory FDIC insurance is provided to all depositors.
The murabahah structure is the most popular type of structure with respect to home financing in the United States. The bank purchases the property and resells it to the client at a mark-up. Devon Bank and other IFIs providing Islamic products can design their products to avoid private mortgage insurance for those making relatively low down payments.
Musharakah financing in the United States is a ‘rent to own’ financed sale of property by an IFI to its customer. The customer identifies the home he or she would like the bank to purchase on his or her behalf, the customer negotiates the price and all aspects of the purchase and the customer makes any initial payment of earnest money required to reserve the home. The bank purchases the property and the customer agrees to purchase the property from the bank over time, at cost. A portion of the property’s ownership is transferred to the customer with each payment he or she makes. Because he or she is using a property he or she does not own, the customer also pays rent on the bank’s portion of the property. As an equity-based project financing, the customer and the bank are co-owners and, thus, share in any loss realized upon the customer’s sale of the property, based on the bank’s and the customer’s respective percentage of ownership.
An ijarah is like a hybrid between a conventional operational lease and a finance lease. In this type of transaction, the bank purchases a property and places ownership in a holding subsidiary. Traditionally, title to the property is transferred to the borrower after he or she has paid the full cost of the property over time. The customer pays rent to the bank, which reflects an agreed profit element for the bank, as well as comparable rentals on conventional leases (where interest considerations would be relevant). Unlike a conventional finance lease, the obligations to insure and undertake major maintenance on the leased asset remains with the bank (owner and lessor), although these obligations may be shifted to the borrower (lessee) pursuant to a separate contract to provide services with respect to the leased assets. Further, the lessee is only responsible for the payment of rent while his or her use of the asset continues, and an ijarah cannot begin before construction of the leased facility; if the lessee is no longer able to use a leased asset (eg, total destruction), rental payments must cease. The lease-to-purchase model is known as ijarah wa iqtina.
The United States has seen few major sukuk issuances:
⦁ the East Cameron Gas sukuk, which was the first sukuk al-musharakah in the United States (backed by oil and gas assets);
⦁ a General Electric sukuk al-ijarah (backed by aircraft leases) in 2009;
⦁ a Goldman Sachs sukuk al-wakalah in 2014; and
⦁ A sukuk al-murabaha by the International Finance Facility for Immunization in 2014 on behalf of the US-based Global Vaccine Alliance to fund global immunization programs.
A principal challenge facing Islamic financial providers in the United States is offering products that conform to both Islamic religious doctrine and state and federal banking regulations. The same stringent licensing and supervision standards that apply to conventional financial institutions apply to financial institutions offering Islamic banking and financial services.

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