Islamic Financing and Foreclosure

By Varian, Keith S.; Rockwell, Jennifer M. | Real Estate Issues, Spring 2009 | Go to article overview

Islamic Financing and Foreclosure

Varian, Keith S., Rockwell, Jennifer M., Real Estate Issues

IN THE PAST SEVERAL YEARS, THE UNITED STATES HAS SEEN substantial growth in a subsection of international finance sometimes called "Islamic Finance." Although conclusive data is not yet available, Forbes magazine recently estimated that at least $500 billion in assets around the world are managed in accordance with Islamic principles--known in Arabic as Shari'ah--and the sector is growing at more than 10 percent per year. Management consultants McKinsey & Company predicted that the value of assets managed by Islamic banks will grow to $1 trillion by 2010 as more Muslims seek financial services that comply with their beliefs.

Islamic finance is, in many ways, similar to socially conscious investing and is based on the principles of Shari'ah, which typically prohibit investment into industries such as gambling, pornography, alcohol, tobacco, defense, banking and insurance. The most well-known aspects of Islamic finance are the prohibitions of: 1) interest (riba); 2) speculation, betting and gambling (maisir), including the trade or exchange of money for debt in the absence of an underlying asset transfer; and 3) preventable uncertainty (gharar) occurring, for instance, in certain financial derivative instruments and forward contracts.

As opposed to conventional finance, where interest represents the agreed-upon cost for funds, the central concept of Islamic financing is the prohibition of riba. Most Islamic scholars agree that riba covers not only usury but also the charging of interest and any predetermined rate of return that is guaranteed regardless of how an investment performs. Since Islamic finance permits only those forms of finance that are interest-free, financial relationships between banks and borrowers are governed by shared business risk (and returns) from investment in lawful activities. Profits must not be guaranteed in absolute terms but in specified ratios, and can only accrue if the investment itself yields income.

Shari'ah -compliant mortgage financing emulates key economic features of secured lending through (more) complex financial structures. We first discuss the common forms of Islamic financings and how they each compare to traditional mortgage financings to understand the foreclosure issues facing courts. There are three main types of Islamic financing structures available when purchasing and refinancing real estate to replace the traditional mortgage structure: 1) Ijarah is the rental of a property by the bank to the customer, combining aspects of a finance with an operating lease; 2) Murabaha is the acquiring of property first by the bank, as identified by the customer, then the selling of it to the customer at an agreed-upon markup; and 3) Musharaka is used now as a primary means of a diminishing partnership between a bank and the customer. For a longer list of terms commonly used in Islamic financing and their respective definitions, please see the Islamic Financial Services Board's Web site at


Ijarah, or lease-based transactions, are becoming increasingly popular and are a significant portion of the current Islamic banking and finance market, particularly in the U.S. Ijarah is a form of leasing in which the bank acquires the asset, whether real estate or otherwise, and then immediately leases that asset to its customer for a determined period of time at the end of which the customer will own the asset, either by the terms of the lease or by purchasing it at an agreed-upon nominal sales price. Both the acquisition by the bank and the lease to the customer are intended to occur at a single closing. This form of financing is used for both acquisitions and refinancings.

Regulatory agencies have examined the question of whether U.S. banks may enter into Ijarah transactions. The Office of the Comptroller of the Currency, for instance, has issued a detailed advisory letter guiding U.S. banks so as to lawfully enter into Ijarah transactions. …

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