What is Islamic Finance and Sharia-Compliant Savings Accounts?

What is Islamic Finance and Sharia-Compliant Savings Accounts?
27th January 2023

What is Islamic Finance and Sharia-Compliant Savings Accounts?

“We need to give each other the space to grow, to be ourselves, to exercise our diversity. We need to give each other space so that we may both give and receive such beautiful things as ideas, openness, dignity, joy, healing, and inclusion.” - Max De Pree

Islamic Finance is a method of managing money which follows the ethical standards of Islam. Islamic services range from saving and current accounts, to buying a home and investing and borrowing.

The Moral standards followed by most Muslims in their everyday life are sometimes referred to as ‘Shariah which is why Islamic services may be described as either ‘Islamic finance or Shari’ah Compliant.

History of Islamic banking:

There are roughly 520 banks and 1,700 reciprocal funds globally adhering to Islamic standards. Islamic banking practices are thought to go back to the Medieval era when business professionals in the Middle East began interacting with European counterparts. Islamic Banking started with the same financial standards as European financial services.

However, this began to change when trading systems advanced and European countries began launching local branches of their banks in the Middle East, European banks implemented some of the local customs of the regions where their banks were located which had mainly no-interest financial services and operated on profit and loss sharing strategy. Implementing these customs, was beneficial for European banks to provide financial services to Muslim business experts.

Islamic Banking remerged at the beginning of the 1960s in the modern era, and since 1975 there has been an establishment of a substantial number of interest-free banks.

However, most of these establishments were established in Muslim countries, and Islamic banks opened in Western Europe in the early 1980s. Moreover, national interest banking services were developed in Iran and Sudan by their governments.

Where and when was the first Islamic Bank in the Modern Word opened?

Mit-Ghamr Savings Bank was founded in 1963 in Egypt and is often described as the first Islamic bank of the Modern Era. Mit-Ghamr loaned money to companies and used the profit-sharing technique. Mit-Ghamr closed 5 years after opening in 1967, because of political circumstances, however, while it was operating, the bank was very cautious about approving loan applications with just 40% of business loan applications accepted.

Who is a Sharia-compliant account suitable for?

A sharia-compliant savings account is suitable if:

  • You would like a savings account that follows Islamic principles

  • Want savings to grow a savings pot that does not grow through interest but through Sharia-complaint profits

  • Are opposed to your bank lending money to businesses that offer goods or services – such as alcohol and tobacco, that would not be in favour of Islamic policies or your individual beliefs

How do Sharia- Compliant savings accounts function?

Every Islamic-compliant savings account foundation is based on the tenets of Sharia, or Islamic law. Interest is not permissible in Islam, therefore Islamic banks run without the use of interest.

However, the bank will invest the funds you place into your account, but interest is replaced by money earned through money made by investments. Islamic banks will not invest in any products or services considered harmful under Shari’ah law.

Moreover, a part of the profit the bank receives from their investments is returned to the saver, so savers will notice that savings will increase even without interest being applied to their account.

Islamic banks have a committee of Muslim advisors who are responsible for making sure investments are compliant with Sharia principles.

Sharia accounts do not pay interest in current accounts this is used as an interest-free loan and is referred to as ‘qard’.

Islamic banks do not offer overdrafts, because this is also deemed harmful and not Sharia-Compliant.

What is an Expected profit rate?

Islamic banks do not pay a yearly equivalent rate of interest on savings, instead, they have an ‘Expected Profit Rate’ (EPR), this means that the amount savers earn on their savings accounts is dependent on the revenue their bank makes. EPR is a replacement for interest and is used to estimate the likely sum of money you are likely to earn during your investment, though the way this is calculated is different to interest rates to abide by Sharia rules.

How does Sharia-compliant savings differ from other saving accounts?

The belief behind Islamic finance is that money should hold no insignificant value, other than being used to exchange products and services which have value. As part of this belief making more money out of the money you already have should be avoided for instance by paying or receiving interest.

Islamic finance also underlines the importance of not causing harm, therefore Islamic services do not invest in gambling, tobacco or alcohol.

Islamic Finance also believes in partnership when viable, and that revenue and profits must be distributed. For instance, among an individual and business, or two businesses. Islamic Finance products and services are accessible to everyone.

What are the names of the Islamic banks operating in the UK?

Banks with a UK licence:

  1. Al Rayan Bank

    Al Rayan bank is a retail bank which has five 5 high-street branches, 10 offices and more than 85,000 clients. Al Rayan offers services such as savings, finance and current accounts. This bank has been situated since 2004.

  2. Bank of London & The Middle East (BLME)

    The Bank of London & The Middle East (BLME) is the biggest Islamic bank in Europe, this bank was established in 2006 and its services include corporate banking, treasury and wealth management, and customer saving accounts.

  3. Gatehouse Bank

    Gatehouse Bank was instituted in 2007, services include saving accounts, home finance, and buy-to-let products. Gatehouse is London based

  4. QIB (UK)

    QIB (UK) is a subsidiary of Qatar Islam bank and has investment amenities such as savings and current accounts. In addition, QIB (UK) also offers private equity and asset management. Customers usually have a high-level net worth.

  5. Abu Dhabi Bank (ADIB)

    ADIB operates in the UK, Egypt, Iran, Saudi Arabia and Qatar. Other than the UK there are no other ADIB branches in Europe. This bank manages current accounts, savings, property search and management and relationship management

Are Sharia-compliant savings only available to Muslims?

The answer is no, you do not need to be Muslim to open a Sharia account as this account like other saving accounts is available to every saver.

Are Sharia-Compliant accounts taxed?

Yes, Shira accounts are taxed for income tax, unless they have advantages to being an ISA. For instance, interest on Cash ISA is not taxed no matter the amount you deposit this does not acquire tax. But the maximum amount which can be deposited for the tax year 2022-2023 is still £20,000.

What does the Bank of England do to support these types of accounts?

The bank of England is responsible for the UK’s financial structure and making decisions on bank rates according to the condition of the economy and maintaining stability with the courses of action they implement. The BOE enable banks to have deposits with them so that banking services can continue to be offered to everyone as part of stabilising the economy.

However, the Bank of England realised that Islamic banks were being left out in the cold because the BOE paid interest on accounts. Therefore, the bank of England took action by introducing a new kind of account for Islamic banks in the UK that does not pay interest. Islamic banks can now access some of the same support other banks are given.

Are Sharia accounts protected by the FSCS?

The Financial Compensation scheme does cover Sharia accounts. Therefore, every Shari’ah-compliant bank that is approved in the UK is covered by the Financial Comprehension Scheme (FSCS) which protects up to a maximum of £85,000 of savings per individual, or (170.000 for joint accounts) in case a bank goes bankrupt or fails. Islamic banks follow the same protection policies as other providers in the UK.

Do Sharia accounts support ISA?

Yes, Sharia accounts support ISA. In fact, they offer a variety of ISAs for savers seeking a tax-free option for their savings. ISAs function similarly to a savings account and will have an expected profit rate to adhere to Shari’ah’s law, paid into the account tax-free.

In addition, Shari’ah-compliant stocks & shares ISAs are also accessible to consumers. The cash is invested into Shari’ah-approved ethical practices, rather than companies which have involvement or links to practices such as alcohol and weapons.

The Financial industry has had many developments such as open banking, Fintech and Islamic Finance. Islamic Finance is continuously expanding and even increased in 2020 during the Covid-19 pandemic, where Islamic holdings rose to over 10%. And in 2021 -2022 the expected growth was expected to expand further because of an increase in bond insurance and a consistent monetary recovery in financial markets, this was according to S&P Global Ratings.

The finance sector will continue to develop, and within the banking sector, Islamic Finance will continue to generate more interest from savers and potential savers.

Ultimately, implementing what people deem important as part of their banking services such as with Islamic finance is something that should continue to be at the forefront and developed further. It will be interesting to see how the world of Finance shapes up in future.