A topic which warrants inclusion in Joe Hockey’s planned Financial System Inquiry – but probably won’t make it in – is the regulatory and institutional impediments to Islamic finance.
The 2% of the Australian population who want these Sharia-compliant products face significant problems in accessing them.
Islamic finance is different from regular banking for a number of reasons, one of which is a prohibition on interest. Others include acceptable insurance arrangements and restrictions (which look much like socially responsible investment criteria) on acceptable investments.
I don’t see a point to these religious-based constraints –- but in a free society, governments should not be putting unnecessary impediments in the way of those who want to adhere to them.
And it should be a concern that some regulation, like compulsory superannuation, and institutional indifference, force individuals into financial products not compatible with their beliefs.
Among the various problems which exist, two stand out. The first is the question of designing Islamic financial products enabling families to buy homes. Because interest is prohibited, a conventional mortgage loan is not acceptable.
Islamic finance works around these prohibitions with some simple financial engineering. The financial institution buys the house an individual wishes to own, and leases it to the individual on agreed terms in a long term contract.
At the end of the contract the ownership of the house is transferred to the individual.
The main problem with implementing that in Australia is double stamp duty, once on the initial purchase by the financial institution and second when the house is transferred to the owner at the end of the lease.
Under conventional mortgage finance, stamp duty is only levied once when the house is initially purchased.
The Victorian government has removed this impediment, by allowing house purchase under Islamic financing arrangements to only incur one lot of stamp duty, but other State governments have been unwilling to take that step.
Islamic financing of small business enterprises faces similar problems, a compounded by tax and legal issues.
And the government should turn its attention to superannuation. All employees, regardless of their religious faith (or lack thereof) have compulsory contributions paid by their employers into a super fund of their choice.
And there are significant tax advantages for voluntary contributions as well.
But what does the typical institutional super fund’s portfolio allocation look like? Even allowing for a member’s choice between different investment options, the only portfolios generally available will still have a significant fixed interest component.
This is based on the widely held view of trustees that prudent asset allocation involves a significant share of investments paying interest. That doesn’t sit well for fund member wanting only Sharia-compliant investments.
It is possible – in principle – to construct portfolios which don’t have an interest component but which have some “fixed-interest like” investments. Established infrastructure assets are one example. Lease income is another, such as that which might flow from Islamic financing of home ownership as discussed above.
But more relevant is whether conventional institutional norms about what are acceptable portfolio allocations for super, and institutional inertia, should prevent or inhibit Sharia-compliant super options being offered to individuals forced to invest in super.
Self managed super is always an option – but that’s only cost-effective for individuals with substantial super savings.
While it does look as though some institutional super offering of Sharia-compliant super is now emerging, the impediments and lack of interest have apparently been substantial.
Will Islamic finance get an airing in the proposed Financial System Inquiry? Probably yes, but in the context of what is needed to make investment in Australia attractive to wealthy international Islamic investment houses – because that caters to the interests of, and potentially benefits, the financial community.
That may be worthy of attention, but there’s more value in focusing on whether impediments to providing suitable savings and funding vehicles affecting this group of individuals and businesses can be reduced.