Is it okay for an expatriate who is unfamiliar with the Sharia Law to avail a loan from an Islamic bank?

When someone is planning to avail a loan from a bank to buy an asset, the points he should invariably take into account are the following:

1. Interest or profit rate charged on that loan

2. Aggregate cost of the loan including the loan processing fee

3. Terms and conditions applicable to the loan

4. Service-orientation of the bank

5. Ethics and related policies of the concerned bank

So here, let us take a hypothetical case. Supposing you are an expatriate who has recently relocated to Dubai and you never had any opportunity to deal with an Islamic bank before. As such, you are unfamiliar with the Sharia Law and the rules of Islamic financing. You are now planning to apply for a loan and two leading UAE-based banks are willing to offer you the required finance. One of them is a conventional bank and the other one is an Islamic bank. And you are wondering whether you should avail the loan from the conventional bank or the Islamic bank.

As a prudent borrower, you should opt for the bank which offers you the loan that is more favourable to you when viewed from the angle of the abovementioned five aspects. Supposing, it is the Islamic bank that offers you a loan that is more favourable as compared to the one being offered by the conventional bank when viewed from the angle of the aforesaid five factors.

In that case, the answer to your above question as to whether you should avail a loan from an Islamic bank is an emphatic yes. In other words, in the above case it is definitely okay to avail a loan from an Islamic bank though you are not much familiar with the Sharia Law or the rules of Islamic financing.

However, anyone dealing with an Islamic bank should remember there are some concrete differences between conventional banks and Islamic banks and how they extend loans to customers. So, it would be better to familiarize oneself with the basic tenets of the Sharia Law before availing a loan from an Islamic bank and to also understand how Islamic banking differs from conventional banking.

One major point one should know is that since Islamic banking is based on the principles of Sharia Law derived from the Koran, it strictly prohibits the payment and receipt of interest (known as Riba) and promotes profit sharing in lieu of interest. So business transactions under Islamic banking and finance are based on the principle of sharing the accrued profit or resultant loss.

As such, the Islamic bank you deal with will be using the term ‘profit rate’ in lieu of ‘interest rate’ because your loan would not be structured as a loan, but as the purchase and resale of a real asset – such as a house, car, consumer durable, stock, commodity, among others – depending on the specific purpose for which you are availing the proposed loan.

The second key point to remember while availing a loan from an Islamic bank is that Murabaha is the most common and most popular mode of Islamic financing and it operates in the following manner. When you approach an Islamic bank to get a loan to purchase an asset, it cannot lend you the amount on interest because of the restrictions under Sharia law.

So, here the Murabaha mode of financing, which is also called the “mark-up” or “cost-plus-profit” financing, offers the right solution to enable this transaction to go through. Under the Murabaha model, the bank will purchase the asset on cash and sell it to you by adding its profit margin.

Since you don’t have ready money to buy the asset, the bank will sell you the asset on deferred payment basis and charge you a profit for doing so. Thus, you will get the asset, which you wanted to buy, on a deferred payment basis and the concerned Islamic bank will make some profit on the amount that it has paid to buy the asset on your behalf.

The third important point you will notice is that while a conventional bank has provision to charge penalty and compounded interest in case a customer defaults on his repayments, an Islamic bank does not have the mandate to do so. So, instead of a penalty, an Islamic bank may charge a nominal amount as compensation from the defaulter according to its discretion and may even give away that amount to charity.

Taking into account the points stated above, it is quite okay for an expatriate who is unfamiliar with the Sharia Law to avail a loan from an Islamic bank.