The new federal budget announced measures to improve access to property. Among the measures announced is the option of offering interested Muslim consumers parallel financial products such as so-called “halal” mortgage loans. The budget document did not offer further details on this, leaving the door open to multiple interpretations. In what follows, we propose to answer important questions on the subject, whether for the consumer or for financial institutions and provincial and federal regulatory bodies.
What do we mean by a “halal” mortgage?
This is a “special” mortgage contract insofar as its provisions are consistent with the precepts and doctrine of the Muslim religion. The basic principle is that the financial institution issuing the mortgage loan must not explicitly charge interest (or usury) because this is a practice that is not permitted by Islam . The doctrine explains that the prohibition of the practice of usury aims to protect people who find themselves in the need to borrow money because this would worsen their financial situation and keep them in poverty.
It is important to mention that even if the practice of interest is not permitted, the structure of the “halal” loan is constructed so that financial institutions can still make money. For example, the so-called “Ijara” formula is equivalent to a lease-purchase contract where the borrower would pay monthly payments equivalent to rent until the price of the property is fully paid. Or the “Musharaka” formula, according to which the borrower gradually earns a percentage of the property as he makes his payments. There is also a scheme known as “Murabaha”, where the borrower buys the property at a premium price up front and then pays monthly installments to repay this premium sum.
In all the cases mentioned above, the payments will be of the same order as those of a traditional mortgage loan, with a small supplement which reflects the cost incurred by the financial institution to offer this “special” type of financial product. It’s like consuming organic or vegan or eco-friendly: it costs a little more than consuming in the traditional way. Basically, the consumer agrees to pay a premium to satisfy his preferences, whether gastronomic or ecological or religious.
Why did the federal government choose precisely this type of financial product to include in its budget?
A portion of Canadian Muslims would certainly be willing to pay a little more to have a halal mortgage. The more competitive the market for financial products, the cheaper it will be. This type of financial product is especially important for practicing Muslims, since they are more orthodox in the practice of their faith. They represent less than 1% of the Canadian population.
In this sense, the effect of this provision on the real estate market, on banking profitability and on access to property would be rather minor. Furthermore, since these products are aimed more at the practicing faction of Muslims in Canada, this would make it possible to integrate them into the Canadian banking system, whose operations are subject to the monitoring and surveillance of the relevant regulatory authorities (OSFI and FINTRAC at the federal level, in addition provincial organizations).
Financial integration is important for regulatory bodies since it increases the transparency of transactions carried out by different financial operators. If a part of the population does not have access to financial services in a certain market, the Canadian market in our case, they will tend to look for another market that will serve them. Islamic finance markets in Southeast Asian countries as well as the Middle East are prolific and offer Shariah-compliant financial services.
It is precisely these types of scenarios where Canadian consumers are served by markets outside Canada that regulators are trying to avoid.
What does this new provision in the budget imply, once implemented?
Costs, costs and costs!
Financial institutions will need to equip themselves with the technological infrastructure to integrate these products into their systems. They will also need to equip themselves with the legal and financial expertise to be able to serve this clientele. The bill will likely be passed on to customers.
Regulatory bodies will also need to equip themselves with resources with expertise in this area in order to be able to effectively exercise their supervisory mandates. An essential aspect in Islamic financial products is the sharing of risk between the lender and the borrower (“ profit and loss sharing).
This dimension has implications on the risk taken by financial institutions and, in turn, on their capitalization levels, which would need to be adjusted to take into account the risk linked to these new products. Costs incurred by regulators are usually passed on to financial institutions so that taxpayers do not inherit them. Financial institutions will pass them on to consumers based on the financial products offered to their clients.
In short, how can we evaluate this initiative set out in the federal budget?
On a political level, it certainly sends an attractive signal to the Muslim population, regardless of their intention to have (or not) a halal mortgage. The initiative would be seen as a sign of consideration towards Canadian Muslims, especially in the global context where Canada had offered its support to Israel in the conflict which followed the attack perpetrated by Hamas in October. It is thus a clever attempt to redeem itself with the Muslim community, which would rather feel betrayed by the rather pro-Israeli Canadian foreign policy.
Furthermore, from an economic and financial perspective, the impact is minor since the population targeted by this provision of the budget does not represent more than 1% of the mortgage loan market.
Finally, it must be said that the approach adopted by the federal government is a little hasty, which explains the limits of the initiative. In fact, a halal mortgage loan cannot be made, if we rely on the doctrine, by a non-Islamic bank. It’s like making a stew with halal and non-halal meat mixed together: everything combined is obviously no longer halal. Then, a halal mortgage loan cannot be made without opening a checking account or a savings account. Would these accounts be halal? It will therefore be necessary to create these products in the same way as halal mortgages.
In addition, any account at a Canadian financial institution is protected by Canada’s deposit insurance system (or the provincial equivalent). The fact is that insurance is a non-halal concept, which implies that the Islamic equivalent (called takaful “).
All this to say that the halal mortgage initiative proposed by the federal government is only the tip of the iceberg of an entire system, and that for a practicing consumer to agree to adhere to it (still according to the doctrine of the text Koranic), you will have to offer him the halal “combo”: he will not accept an Islamic product here and other non-Islamic products there.