Tod Murray finds a way to bring Islamic mortgages to Scotland
When Islamic Bank of Britain launches its Islamic mortgage across Scotland this Wednesday it will largely be thanks to the efforts of Edinburgh law firm Tods Murray.
The firm had to invent a brand-new way of structuring an Islamic home purchase plan after the model used by providers in England and Wales proved unworkable under Scots Law.
Islamic Bank of Britain (IBB), the UK's only standalone Islamic bank, has offered a home purchase plan to customers in England and Wales since 2008. However, that product could not be sold in Scotland as it is structured using a 25-year sale-and-leaseback agreement. Under Scots law a residential lease can not run beyond 20 years, but as it turned out there was an even bigger issue preventing the English product being used in Scotland.
Graham Burnside, partner at Tods Murray, explains: "The 20-year rule wasn't really the core problem, it was just arbitrary and we could probably have found a way round that. The real issue arose because Scots law doesn't allow for distinctions in equity.
"This meant that a customer would be paying back the capital over 25 years but it wouldn't be until they had paid off the very last penny in year 25 that they would have the ability to have the property made over to them. So that means that, in principle, after 20 years of payments if the bank itself went bust - and that is not so theoretical now - then the customer could be at risk."
Tods Murray originally came up with two possible options for building consumer protection into a Scottish product: a shared ownership structure, similar to that used by housing associations; and a trust structure. However, on closer inspection another specific "quirk" of Scots law rendered the fi rst option less appealing.
Specifically, as both bank and customer were deemed to own a property, should anyone living in the property be deemed to be disruptive, the bank would be held jointly liable for sorting out the bad behaviour.
Burnside says that under a trust structure such a dual-ownership problem would not arise as the customer would be viewed as being the sole owner of the property, if any disruptive behaviour occurred. He says this distinction is significant as it effectively clears the way for Islamic buy-to-let mortgages .
"The model that we came up with effectively turns the whole English model on its head with regards to legal title, " said Burnside. "With IBB's product the customer owns the property but not outright, because the customer holds the property as a trustee. So they hold it in trust for the bank, as the funder, and for themselves, as the ongoing purchaser, in proportion to the share that they own at any one time.
This is possible to do because in a trust you can have this fluctuating level of interest [ownership] in a way that you can't have in a title [deed]."
Tods Murray shared its work with IBB with delegates attending Scotland's first Islamic finance conference hosted earlier this month by Scottish Financial Enterprise and the Islamic Finance Council. Owen Kelly, SFE chief executive, welcomed IBB's market entry. He said: "We warmly welcome IBB to Scotland as it establishes itself as a provider of sharia-compliant home-purchase plans. IBB's entry to the market adds another option for bank customers in Scotland and widens the range of organisations operating in the industry."
The Financial Services Authority insists that Islamic mortgages are advertised with what it calls an equivalent interest rate - basically, the provider has to state the repayment costs of the product as a percentage, so that it can be easily compared to a traditional mortgage The equivalent interest rate on IBB's home finance product is 3.99per cent.
The product is available to nonMuslims as well, and the bank believes it will prove attractive to all Scots.
Indeed, sharia rules give the product two distinct advantages in the current mortgage market. Firstly, there are strict rules about how much a provider can charge by way of an arrangement fee which cannot exceed what it costs the bank to actually process the application. This means that the fee on IBB's home loan is GBP299 - considerably less than the current average mortgage arrangement fee of GBP937 Secondly, sharia rules forbid a provider to make money from customers who get into trouble with their repayments. IBB has to donate any late payment penalties to charity.
Commenting on the attractiveness of IBB's product, Sultan Choudhury, commercial director at IBB, said: "We are delighted that we can offer Scottish consumers ethical and competitive home finance, especially at a time when people are looking for stable alternatives due to the current uncertainty of conventional banking establishments."