Islamic Finance

Bank of England paves way for Islamic Mortgages to get cheaper

For years, Muslims have complained that Islamic mortgages are too expensive. There are lots of reasons for that, but in a nutshell it’s more expensive for Islamic banks to get hold of money.

The Bank of England (“BoE”) has announced a new facility which could allow Islamic banks to become competitive with mainstream banks in the long term.  This has long been on the cards: the BoE first started work on this in 2015. But now they have announced that the facility will be going like in Q1 2021.

Historically, the reason Islamic banks are more expensive is because of the banking infrastructure underpinning everything.

In this article we’ll explain exactly what this new facility means for you, the wider market, and exactly what is happening in the pipework to make all this happen.

What this means for you

You could be able to access Islamic mortgages at much more competitive rates in the long term, but this won’t directly make things cheaper right now.

At the moment, Islamic banks are sadly not very competitive. Customers of Islamic mortgages are largely people who do it for religious reasons only. But there are a massive number of Muslims who go with conventional banks, primarily based on pricing.

A more competitive landscape for Islamic banks means that they can now attract Muslims who would probably prefer an Islamic product if the prices were more competitive.

It also opens up the door to Islamic banks taking a share of the mainstream market too and really chiming with the ethical considerations of many mainstream consumers.

We have asked for comments from the main two Islamic banks in the UK – Al Rayan and Gatehouse. We will update this article accordingly.

How this will help long term

So it’s not going to help right now but how will it help long term?

Well first we need to understand the current situation.

Banks are (rightly) very heavily regulated. One requirement they have is that they must have healthy levels of cash (or high quality assets which can quickly become cash) to fall back on in case of hard times (like 2008). We’ll refer to this as a capital requirement. [1]

The wisdom behind this is it ensures that banks don’t lend out too much and they have cash ready in times of stress.

So how do banks achieve this capital requirement? Do they just keep it as cash? No they don’t, because that would be a tremendous waste. Imagine locking up billions of pounds from the economy.

Instead, the BoE has a facility for them. They tell the banks to keep their money with them, and in return the BoE pays them some interest. This facility that the BoE provides is called a reserve account. The money in a reserve account counts towards a bank’s capital requirement.

So the overall picture is that it’s pretty easy for mainstream banks to meet their capital requirements. They just put depositors’ money into a BoE reserve account.

How Islamic banks have been losing out

Islamic banks cannot use the BoE reserve account because it pays interest.

That means it’s harder for Islamic banks to meet their capital requirement. Typically this means Islamic banks have to buy high quality assets like sukuk.

These sukuk are not as highly rated as a BoE reserve account in the regulator’s eyes though. Different assets get different ratings – so even if all the assets in the bucket are classed as high quality, they have different grades even within that bucket.

So when an Islamic bank buys sukuk instead of depositing with the BoE, the regulator basically says that’s great, but you need to buy more sukuk because we don’t rate them as highly as a BoE reserve account.

The net result of that is more Islamic bank money gets tied up. Money which they’d otherwise be able to lend out to you and me.

The Future

With this new facility from the BoE, Islamic banks will benefit from more liquidity. Broadly, we think that will probably mean three key things:

  1. Islamic banks will be able to lend more out and as a corollary, may slightly reduce rates (but may not);
  2. Islamic banks now have a ready facility to park cash (instead of having to buy sukuk). This means it can increase marketing attempts to get more customers and more money through the door, without worrying about how to then meet their capital requirement;
  3. Islamic banks will possibly reduce their savings rates. This is because it will actually likely be earning less income from the BoE facility than with the sukuk that they would otherwise buy to meet their capital requirement.

What would the game-changer be?

What we do sincerely hope though is that this paves the way for the BoE to offer a sharia-compliant interbank lending facility. That would be the game-changer.

Currently the BoE lends to banks but in a non-sharia-compliant way. So whenever the Government lends money to banks in times of need, Islamic banks miss out.

Banks get money in “normal” times from the wider wholesale lending market open to banks. Big banks get a better deal there because of volume. So the sure-fire way for Islamic banks to become competitive, as we have always maintained, is to support them to help them to become behemoths.

[1] Bank of England report: Shari’ah compliant liquidity facilities: establishing a fund based deposit facility

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