Shariah’s Black Box

c.       Banks and consumer loans

Regulated commercial banks and private lenders have recognized the SCF market and have made significant inroads establishing this new industry. At least one U.S.commercial bank has attempted to design a Shariah-compliant depository account.[300] The unique feature of this kind of account for it to comply with contemporary Shariah rulings is that it must be “at risk” as an equity investment and not viewed as a guaranteed deposit with interest income. Although a U.K. bank has developed a regulatory work-around[301], so far U.S. regulators have not permitted such accounts although one community bank in Illinois advertises a Shariah-compliant “profit-sharing deposit account” which purportedly does not earn interest but rather a share of the bank’s profits. It apparently received an exemption from some Shariah authority because the bank guarantees the principal of the deposit as is required by U.S. banking laws but such “no risk” guarantees are typically considered forbidden according to Shariah.[302]

Another impediment for commercial banks entering this market, however, does appear to have been overcome. In a typical SCF home mortgage transaction, the lender purchases the property and either resells it immediately to the borrower at a stepped-up price to be paid out over time (i.e., a cost-plus sale) or leases it back to the borrower through a sale-lease back arrangement. The problem for commercial banks in these transactions is that U.S.law does not allow banks to own real estate except in limited circumstances, such as the bank’s own offices or property acquired through foreclosures on bad loans.[303] Two banks have received approval from the Office of the Comptroller of Currency (“OCC”) for such SCF transactions.[304] The rationale for the approvals was a substance-over-form analysis. Since these mortgage products were in fact disguised loans with interest and the real estate was only owned for a limited purpose, the Comptroller did not see these Shariah-compliant mortgages as a violation of the prohibition against owning real estate. The OCC also granted one of the banks approval to use the cost-plus sale transaction structure to accommodate construction loans and other consumer loans.[305]

While the Comptroller was focused on the real estate-banking regulations, one area missed in the analysis and which the attorney for any lender must pay special care to address is compliance with all of the various consumer anti-fraud statutes. The statutes implicated in traditional bank lending are found in TILA, the Lanham Act, and many of the anti-fraud statutes referenced above.

For example, commercial banks and other lenders must comply with TILA[306] and its complex Regulation Z.[307] TILA prohibits specific types of misrepresentations or misleading omissions in advertising.[308] TILA’s provisions require lenders to make standardized disclosures whenever other price terms are advertised. For example, any advertisement that states an interest rate must state the annual percentage rate (“APR”).[309] An oral response to consumer inquires about closed-end loans, however, may only state the APR.[310] Advertisements quoting a down payment by percentage or amount; the amount of any monthly loan payment or finance charge; the number of payments; or the period of repayment must also state the APR, the terms of repayment, and the amount or percentage of any down payment.[311]

The problem lenders have is that they are marketing the SCF products as interest-free and therefore Shariah-compliant.[312] In fact, and as scrutinized by the OCC and likely by the IRS and state tax authorities[313], these various interest-free transactions are merely disguised loans. In other words, the banks are treating these products and representing them to the government authorities as conventional loans with interest income while marketing them to the public as interest-free Shariah-compliant non-loan transactions.[314]

About David Yerushalmi

Mr. Yerushalmi is a lawyer specializing in litigation and risk analysis, especially as it relates to geo-strategic policy, national security, international business relations, securities law, disclosure and due diligence requirements for domestic and international concerns. David Yerushalmi has been involved in international legal and constitutional matters for over 25 years. David Yerushalmi is today considered an expert on Islamic law and its intersection with Islamic terrorism and national security. In this capacity, he has published widely on the subject including the principle critical scholarship on Shariah-compliant finance published in the Utah Law Review (2008, Issue 3). This work and the empirical investigation known as the Mapping Shariah project in America was the focus of a recent monograph published by the McCormack Foundation and the Center for Security Policy.