Islamic Finance in the US: Slowly but Surely
The US houses one of the World’s most developed economies, yet the country is seemingly lingering behind when it comes to comprehensively participating in the Islamic financial industry.
There are several reasons for this conundrum ranging from America’s secular history, lack of knowledge regarding Islamic business principles, and absence of data surrounding the bankable Muslim markets residing in the US. Still, Islamic finance exists in the American market, and the potential for the industry’s growth is becoming more and more apparent.
The evolution of the Islamic finance industry in the US has been a slow process. As of today, there are roughly twenty financial institutions with Islamic offerings scattered throughout the US - with products ranging from Shariah-compliant mutual funds, private equity investments, venture capital, commercial real estate funding, insurance, residential or car financing, and deposits. Ultimately, each institution is presenting its offerings through Islamic ‘windows’, with the exception of one subsidiary.
A stand-alone “Islamic” bank does not currently exist in the US. Without question, regulators seem open and willing to the industry’s development, but only vis-a-vis conventional counterparts. Nonetheless, Islamic finance practitioners in the US have managed to do well within these parameters. Retail banking products continue to dominate the Islamic financial space in the US. In the late 1990s, the Office of the Comptroller of the Currency (OCC) issued two interpretive letters in response to proposals submitted by the United Bank of Kuwait. In the context of Islamic alternatives to conventional residential mortgages, the first letter (1997) approved a residential lease-to-own structure - the Islamic equivalent to an Ijara.
The second letter (1999) approved the cost-plus structure, the Murabaha. In a published speech given at a 2005 Arab Banker’s Association of North America (ABANA) event in New York City, William Rutledge, executive vice president of the Federal Reserve Bank of New York, expressed that this was regulators’ way of exemplifying openness by overcoming the inherent tensions between conventional and Islamic financial procedures. The crucial issue in both cases was the bank’s ownership of the respective property for the period of financing - which is forbidden in conventional banking practices. William Rutledge noted that “the OCC demonstrated its flexibility... by looking beyond the restrictions on bank ownership of real estate to conclude that... the risks that drove the general restrictions were not present...”
Ultimately, the only Islamic products introduced are those with a conventional counterpart. However, the Islamic finance industry exists peripherally as offerings are manifested through windows of conventional institutions and ultimately regulated at an arm’s length through a lens that is designed to assess only conventional products. Current policies do not provide a platform to promote the development of authentic Islamic finance products.
In fairness, the industry’s development has to start somewhere. IMF working papers have been issued discussing the evolution of an Islamic financial system outside of a Muslim country. ‘Windows’ introducing certain Islamic products first seem to be a natural part of the industry’s progression and serve as viable platforms for the industry’s growth, particularly in Western countries. Over a decade later since the first procedures surrounding Islamic banking products were introduced, the US is still operating under the same rubric which is in sharp contrast to other countries such as the UK which houses several fully Shariah compliant financial institutions) And, The UK accomplished this feat within 5 years of identifying the bankable Muslim market.
Practitioners overseas often doubt the industry’s significance in the US. This is likely due to presumed American sentiment towards Islam along with the lack of a concentrated presence of Islamic financial institutions. However, given the global economic downturn, everyone is in search of investments from diverse capital pools, and Islamic finance has attracted more attention from conventional investors as an alternative field for investment.
In an effort to better understand the principles of Islamic finance, the US treasury department hosted an Islamic Finance 101 Workshop in October of 2008. Coming on the heels of the financial meltdown in the US, there was some American public sentiment that viewed the educational initiative as a distraction from the current financial crisis and a violation of the First Amendment of the US Constitution.
The First Amendment clearly states:
Congress shall make no law respecting an establishment of religion ... or prohibiting the free exercise thereof.
Ironically, the First Amendment argument works in favour of Muslim constituents, as well. It is incumbent upon US financial regulators to make sure that they do not thwart the industry’s development-based on the First Amendment, since the state cannot prohibit the free exercise of any particular religion.
Another major hurdle for Islamic finance in the US is the deposit issue. Under federal law, deposits are currently insured, up to $250,000, by the Federal Deposit Insurance Company (FDIC). This is an obstacle that needs to be resolved within a Shariah-compliant framework; while still satisfying banking regulations. Essentially, the deposit insurance diminishes the profit-loss sharing (PLS) element. A deposit in the American banking system cannot however be subject to principal risk. If it is; it is not a deposit.
Some possible solutions for the deposit hurdle could be drawn from considering the industry’s use of “profit stabilization reserves” or Malaysia’s deposit insurance schema. The deposit issue is a crucial hurdle to overcome. And, there appears to be a desire from regulators to learn more about the industry overall through domestic and global conferences, programs, etc.; possibly to derive feasible resolutions to the challenges mentioned.
Although exhaustive data on the US Muslim population does not exist (figures range from 3 to 8 million); the market has potential and the industry is positioned well to flourish in America. Islamic finance in the US can also be used as a tool - akin to the UK’s strategy - to further engage its Muslim constituents. Undoubtedly, it is apparent that Islamic products are in demand, and financial regulators are open to accommodating the industry. However, the US Islamic finance industry has reached its limits under the current regulatory framework. The new decade calls for more innovative and autonomous approaches to supporting the industry’s development.
The next steps remains to be seen.
By Fatimah S. Baeshen
This article has focused more on the banking sector of Islamic finance and acknowledges the following sources:
- Islamic finance in the US: What are the Challenges to Overcome in order for the Industry to Subsist under Secular Regulation?Fatimah S. Baeshen- MA Thesis, University of Chicago 2009
- Islamic Banks in the US: Breaking through the Barriers. New Horizon Magazine, April 2009. Abdi Shayestah, Senior Associate at King & Spalding
- Introducing Islamic Banks into Conventional Banking Systems IMF working paper, Juan Sole
- University Islamic Financial, an Islamic banking subsidiary of University Bank, based in Michigan.
This article was originally published in the Muslim Council of Britain’s publication entitled ‘Nurturing the Future in Islamic Finance and Thought Leadership’ as part of an international delegation to the 6th World Islamic Economic Forum in Kuala Lumpur, Malaysia May 2010. The article is reproduced on this website with the kind permission of the Muslim Council of Britain and the full brochure can be accessed here: http://www.mcb.org.uk/wief/Documents/6WIEF%20Brochure.pdf