Islamic Finance United States Report 2019
By: Camille Paldi
*This article was first published in the Islamic Finance News 15th Anniversary Special in Feb. 2020.
Aside from the millions in sukuk issuances by East Cameron Gas, General Electric, and Goldman-Sachs and the billions in Islamic funds and under Islamic asset management in the USA, plus Islamic investing, and Islamic insurance or takaful, the main area of Islamic finance in the United States in 2019 is in Islamic home financing. The offering of retail investment products in the US is hindered by the fact that banks in the US allow consumers to share in profits, but not in losses. Under US regulations, a depositary amount must not be at risk and the system requires the backing of deposits by federal deposit insurance up to specified limits. In terms of equity investments, the US has had the Dow Jones Islamic Index among others since 1999. The index combines Islamic investment principles with the traditional Dow Jones index to allow Islamic investing in the United States. In 2019, the gross annual dollar value of retail Islamic finance transactions in the USA is approximately US$4 billion.
Although there is no nationally chartered Islamic bank in the United States, there are 25 Islamic financial institutions operating in the USA including University Bank’s subsidiary University Islamic Finance (UIF), LARIBA/Bank of Whittier, Devon Bank, and Guidance Residential among others. University Islamic offers home financing in the form of the Ijara home-financing model in California, Colorado, Connecticut, Florida, Georgia, Illinois, Indiana, Kansas, Kentucky, Maryland, Massachusetts, Michigan, Minnesota, Missouri, New Jersey, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Texas, Virginia, and Washington, deposit accounts, and Islamic mutual fund shares. SHAPE Financial Corporation modified the deposit product it offers through University Bank so that the principal is guaranteed, and the deposit-holders share only in bank profits and not losses. SHAPE offers asset financing and deposit account products in the US, Canada, Singapore, and Lebanon. J P Morgan started Islamic banking in 2013 and currently offers products in debt and equity capital markets, investor products, cash management and Murabaha liquidity products, risk management and asset management funds. Standard Chartered (UK bank) conducts Islamic finance worldwide through its Islamic ‘Saadiq’. Devon Bank in Chicago offers a mix of Islamic products including Islamic home, construction, and business finance. Devon bank also offers commercial murabahah and Ijara transactions for real estate acquisitions to business customers in Arizona, California, Colorado, Florida, Georgia, Illinois, Indiana, Michigan, Minnesota, Missouri, North Carolina, Ohio, Oregon, Texas, Utah, Virginia, and Wisconsin.
LARIBA/ Bank of Whittier (CEO: Yahia Abdul Rahman), based in California, offers banking and home financing across the USA in all fifty states. LARIBA offers a lease-to-purchase model with terms up to 30 years, or a variation of the Ijara model to finance homes, autos, and medical clinics and equipment. LARIBA also offers leasing with declining equity for construction of single-family homes and finances small businesses and trade. Guidance Residential offers home financing through its declining balance co-ownership program or a variation of the Musharakah in Connecticut, Massachusetts, New Jersey, New York, Pennsylvania, Rhode Island, California, Oregon, Washington, Alabama, Arkansas, Florida, Georgia, Mississippi, North and South Carolina, Tennessee, Colorado, Kansas, Missouri, Texas, Arizona, Delaware, Kentucky, Maryland, Virginia, DC, West Virginia, Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin.
Saturna Capital, an investment advisor and fund management company, manages funds, which are invested in Shari’ah compliant mutual funds, including Amana Mutual Funds such as the Amana Income Fund, Amana Growth Fund, Amana Developing World Fund, and the Amana Participation Fund. Other Islamic investment firms include Arcapita, Azzad Asset Management (Azzad Funds), and Allied Asset Advisors (the Iman Fund).
These institutions are state-chartered entities subject to the same state and federal regulatory guidelines, corporate governance, banking and insurance operations and tax treatment as conventional financial institutions in the US including the requirement to be insured by the Federal Deposit Insurance Corporation. The US has not adopted any federal legislation specifically addressing Islamic financing as of yet. Although Islamic financial institutions may be qualified to do business in different states, the majority of an Islamic financial institution’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 Islamic financial institution seeks to be qualified as a bank or mortgage or loan finance provider.
In 1997, the Office of the Comptroller in the United States (OCC) issued two rulings approving the Ijarah and Murabahah structures for home financing. These structures have now been approved by the federal government, the NYSBD or New York State Banking Department and the banking authorities of several other states. Furthermore, the relevant authorities have removed the double tax jeopardy of these products where tax was incurred by the initial purchase and at the transfer of final payment. The tax authorities in New York and other states have handled this issue by eliminating double tax burdens on a case-by-case basis where the Shari’ah compliant structure was equivalent to a conventional financing structure. In 2008, the New York State Tax Department determined that no real estate transfer tax is due when the deed is transferred by a bank to its customer at the end of the lease term in accordance with the terms of the Ijarah arrangement.
Currently, institutions such as Whittier Bank/LARIBA in California, University Islamic in Michigan, Devon Bank in Chicago, and Guidance Residential in Virginia among others offer Islamic home financing in the United States. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Mortgage Corporation (Freddie Mac) purchase Shari’ah-compliant mortgage contracts from financial intermediaries, allowing providers to originate further mortgages. In 2007, Freddie Mac purchased more than $250 million in Islamic home loans, a small fraction of the enterprise’s $1.77 trillion in activities. For the purposes of this short article, the author will focus on the Islamic home financing product offered by Whittier Bank/LARIBA.
The no-interest Islamic home-financing of LARIBA/Whittier Bank is based on two concepts: (1) Commodity Indexation and (2) Marking to Market. The no-interest discipline clearly states that fiat (paper) money can be used, and the U.S. dollar may continue to be the reserve currency of the world along with maybe the euro, but gold or a basket of commodities may be used to calibrate the real value of the currency. President John F. Kennedy and James Baker III (1987) have both approved and proposed these concepts previously in US history and monetary policy. John F. Kennedy attempted to introduce silver certificates with Executive Order 11110. In fact, at one time in history, the US dollar was backed by gold. Under the rule of the British Empire, the British pound sterling and the gold standard were adopted around the world. In 1913, the gold cover for Federal Reserve notes was set by 1913 law to be 40%. In 1945, the gold reserves against Federal Reserve notes were reduced to 25%, and to continue the inflation spiral, this figure (25%) had to be reduced to zero. Toward the end of WWII, the US dollar and gold became the principal international reserve assets under the Bretton Woods Agreement. The US dollar became the world reserve currency, and it was treated as if it were gold because the agreement defined its value to be $35 per ounce of gold. On August 15, 1971, President Richard Nixon ordered the gold window closed, ending the international currency’s link to gold.
This no-interest discipline is implemented in order to price things fairly in the market while detecting any overpricing ‘bubble.’ In fact, it is interesting to note that Dr. Rahman of LARIBA through his LARIBA system detected the 2008 bubble as early as 2005 using this Commodity Indexation Discipline. In fact, this system helps to fairly define prices and to standardize and stabilize markets, allowing the efficient working of the market forces of supply and demand. It lays the foundation of fair pricing for products and services, based on real market values within an open and free market operation. Thus, we can see that the no-interest banking brand is not based on renting money at a rental price (interest), but on the actual measured fair market rent of properties, businesses, and services.
The following example illustrates how the no-interest discipline may be used to buy a house. The buyer who wants to obtain no-interest finance and the no-interest bank should mark the house to market. The best way of doing this is to find out how much a similar house in the same neighborhood and with similar specifications would rent/lease for in terms of U.S. dollars per square foot (or euros/square meter). This mutually agreed-upon live market lease rate is used to calculate the rate of return on investment of the proposed purchase and no interest transaction, looking at it as a no-interest investment. If the rate of return on investment makes economic sense, the no interest bank proceeds to finance (invest in) the property. In addition, the no-interest bank does its best to make the monthly payments in the no-interest mode of finance competitive with those offered by conventional banks. Basically, the no-interest banking and finance discipline, in an effort to neutralize the effects of the prevailing fiat currency in the local markets, requires that the financier first apply the Commodity Indexation Discipline to check, in a macroeconomic way, on the existence of a bubble in the business/asset that is being considered for finance. This process is followed by the Mark-to-Market Discipline and approach, evaluating the economic prudence by calculating the real return on investing in this item, using its actual real market rental value. In this way, it is affirmed that money is not rented with interest and that the rent is that of the market rent of the facility in the marketplace.
With federal and state regulatory approvals in effect for Islamic home financing in the United States, there is an increase in the number of institutions providing Islamic home finance above and beyond the major providers of Whittier Bank/Lariba, Devon Bank, University Islamic, and Guidance Residential in the USA including Ijara Community Development Corporation and Ameen Housing Cooperative of California plus others. For 2019 and ahead, Islamic home finance is the future of Islamic finance in the United States with room for sukuk, Islamic funds and asset management, Islamic investing, and Islamic insurance or takaful however, in general, Islamic finance remains a niche segment of the larger conventional financial world for Americans.
In terms of the takaful or Islamic insurance business such as offered by AIG through Risk Specialist Companies Inc., Lexington Insurance Company, and Zayan Takaful among others, the US has a state-regulated insurance system whereby each state determines its own licensing requirements for insurers. In order to obtain a license, a company must demonstrate that it has the experience and management capability to run the company and show that it is financially sound. Insurers are also required to justify their premium rates.
In addition, companies must fulfil the solvency requirements set by the state. Furthermore, there may be limits on the types and concentration of investments made with ‘held’ reserves. These issues should be addressed in the state and federal takaful laws. The biggest challenge in introducing takaful, sukuk and Islamic finance in the US is the First Amendment of the US Constitution, which prohibits the making of any law respecting an establishment of religion or impeding the free exercise of religion as well as the Establishment Clause. (Murray v Geithner)
In Murray v Geithner, a case was filed against the Federal government challenging the permissibility of bailout money provided to AIG under the Emergency Economic Stabilization Act (EESA) legislation saying it violated the Establishment Clause. The Act gives the Treasury the ability to purchase troubled assets from any institution. In this case, EESA was used to purchase $40 billion in AIG shares. AIG conducts takaful business in Bahrain and the US. The plaintiff alleged that tax dollars were going towards the financing of Shari’ah products and activities. The court found that the EESA legislation and the AIG bailout were created for a secular purpose and did not violate the First Amendment of the Constitution.
In the US, the only type of takaful being offered includes commercial and residential property insurance.
In the United States, there are no specific disclosure or reporting requirements for takaful, sukuk, or Islamic funds that differ from conventional products under applicable federal or state banking, insurance, and securities laws.
Court disputes will be dealt with by applying applicable state law or foreign law, if the governing law of the contract is that of another country and US courts will not comment on whether an agreement or contract complies with Shari’ah principles.
Although there is a green light for Islamic finance in the USA, Islamic financial institutions may be at a disadvantage in possibly not being able to gain access to federal funds. Islamic institutions may also experience compliance issues as well as legal challenges. There are currently no listings of sukuk on US security exchanges.