Western investors turning to Islamic finance during recession

American bank Goldman Sachs invested $2 billion in Islamic bonds last year, and despite critics’ concerns that they will be unable to completely comply with shariah finance regulations, more Western banks remain interested in Islamic financial products, according to a Reuters report.

The global financial crisis has led some bankers and individuals to turn to interest-free Islamic finance as a more conservative investment strategy.

“We’ve gotten to think that the only way we get ahead in life is if we borrow money. Because of this financial crisis, we’re getting back to the idea of living within our means,” said Monem Salam, a Sugar Land-area native and University of Texas grad who works as a portfolio manager for Amana Mutual Funds in Bellingham, Washington.

The majority of Amana’s shareholders are actually non-Muslims who choose the company based on its return rate, Salam said.

According to guidelines set forth in Muslim texts and traditions, Amana and other Islamic investment companies do not collect interest and avoid investing in businesses that violate Islamic principles (no alcohol, pork, pornography or gambling, for example).

USA Today explained some interpretations of Islamic finance this way:

Islamic banks get around the prohibition on interest by treating loans more like leases or profit-sharing arrangements.

An Islamic mortgage, for instance, looks like a lease-to-own deal. The bank, not the borrower, buys the house. The borrower makes installment payments to the bank for a period of years, at the end of which he or she gets the title to the house.

The bank’s profit technically comes from renting the house, not lending the money. Loundy notes that Islamic mortgages are more costly than traditional mortgages because they involve paperwork for two home sales: the first by the bank, the second by the borrower after the installment payments are finished.

In business loans, the bank essentially shares profits with the borrower, making Islamic financing more like an equity investment than a loan. Even depositors at Islamic banks are supposed to share profits and losses with the bank, instead of receiving interest payments

There’s been more attention on these centuries-old investment strategies, including the formation of Harvard University’s Islamic Finance Project and even praise from the Vatican.

“The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Vatican’s official newspaper Osservatore Romano wrote at the start of the crisis in 2009, Bloomberg reported.

Salam explains the major principle of avoiding riba, or interest, as a mandate from God to be charitable.

“It gets oversimplified and misunderstood. The biggest thing is charging interest. Giving loans has always been a charitable act. Instead of receiving money for them, let God reward you in the hereafter,” he said.

Among Muslims, there’s a debate over whether certain financial investments actually comply with shariah’s ban onriba. Among the most controversial are sukuk, or bonds, such as those owned by Goldman Sachs. Sukuk bonds provide a fixed return, which some see as the same as interest.

A report on Muslim-Americans released in August by the Pew Forum found that this population has been particularly hit by the recession.

“The percentage of U.S. Muslims who say they own their homes has slipped since 2007, and the portion at the bottom of the income ladder has grown; 45 percent of Muslim Americans now report having total household income of less than $30,000 a year, compared with 36% of the general public,” Pew found (report PDF here).

For Muslim families who find themselves struggling, Salam recommends taking on a more conservative outlook: paying cash for big purchases, avoiding borrowing and divesting from assets that you no longer need.