Islamic Model of House Financing

Presented By:Mohammad RazaVice Chairman - AMBP

EVP & Head of Consumer Banking & Marketing

Meezan Bank Ltd.

Presentation Outline

Growth of Islamic Housing Finance – Statistics

Islamic Housing Finance Model – Diminishing Musharakah

Documentation of Islamic Housing Finance

Why Islamic Housing Finance.

Issues in Islamic Housing Finance

Conventional

Banks/DFIs (Excluding HBFC)

HBFC Islamic Banking

Industry

Gross Outstanding as at 31-Dec-2012 (PKR in Billions)

28.40 12.80 13.80

Share in Percentage 52% 23% 25%

It is encouraging to note that share of Islamic Banking in Pakistan’s banking

industry is around 10% whereas incase of housing finance, the share of

Islamic Banking Industry is 25%.

Source: SBP Quarterly Reviews for the year 2012

Share of Islamic Banking in Housing Finance Portfolio of all banks/DFIs in Pakistan

Growth of Islamic Housing Finance in Pakistan

Gross Outstanding as at

31-Dec-2011(PKR in Billions)

Gross Outstanding as at

31-Dec-2012(PKR in Billions)

Increase / Decrease in a year

All Banks / DFIs (excluding

Islamic Banks & HBFC)

37.40 32.20 (5.20) 14% Decline

HBFC 13.20 12.80 (0.40) 3% Decline

Full Fledged Islamic Banks 8.70 10.00 1.30 15% Increase

TOTAL 59.30 55.00 (4.30) 7% Decline


Last Two years comparison of Gross Outstanding of Housing Finance

Housing Finance Quarterly Disbursements

in the year 2012

All Banks/DFIs including HBFC & Islamic Banking

Industry (PKR in Billions)

Only Islamic Banking Industry

(PKR in Billions)

Share of Islamic Banking Industry

Qtr-1, 2012 (Jan to Mar) 1.6 0.7 44%

Qtr-2, 2012 (Apr to Jun) 2.7 1.0 37%

Qtr-3, 2012 (Jul to Sep) 1.4 0.9 64%

Qtr-4, 2012 (Oct to Dec) 2.0 1.1 55%

Total 7.71 3.66 47%


Share of Islamic Banking Industry in Fresh Housing Finance Disbursements

Islamic Housing Finance structures:

•Murabaha

•Ijarah

•Istisna

•Diminishing Musharakah (Mostly used in banks for Islamic Housing Finance)

• Diminishing Musharakah is kind of Shirkat-ul-Milk.

• It involves taking share in the ownership of a specific asset and then

gradually transferring complete ownership to the other partner.

• This concept is based on Declining ownership of the bank.

Three components Joint ownership of the Bank and customer

Customer as a lessee uses the share of the bank

Redemption of Bank’s share by the customer

Concept and Application of Diminishing Musharakah


Musharakah is a form of partnership (Shirkat). & there are two types of Shirkah:

1. Shirkat-ul-Milk : Joint ownership of two or more persons in a particular property.

2. Shirkat-ul-Aqd : A partnership affected by mutual contract. It can also be translated as a joint commercial enterprise

General Process Flow for Diminishing Musharakah Transaction

a) Customer approaches Bank with the request for House financing.

b) Bank enters into a Musharakah (Joint Ownership) agreement with the customer and both the parties provide their investments to be utilized for the purposes of purchasing a property from the seller of the asset. (This Musharakah is based on the principle of Shirkat ul- Milk).

c) The Bank’s share is divided into ownership units and is given to the customer on rent via Monthly payment agreement (Ijarah agreement).

d) The Customer promises to purchase Bank’s share (units) over the tenure of

the transaction. This promise from customer is made in writing through Undertaking to Purchase.


Cont….

e) Every month customer pays rent for the use of the Bank’s share in the property.

f) The customer also purchases the Bank’s Musharakah units every month.

g) The rental amount is adjusted according to the bank’s share

(units) remaining in the property.

h) Eventually customer becomes the owner of the property and bank’s ownership diminishes.



CUSTOMERBANK

Joint Ownersh

ipGradual Transfer of Ownership

House Cost Price 1,000,000

Customer Share 400,000 40% Total Units 60

Bank Share 600,000 60% Unit Sale Price 10,000

Profit Rate 13.00% Monthly Rent/Unit 108.33

Tenure in Years 5

Months Rent Unit Price Monthly PaymentBalance Unit

Price Balance

Units

0 600,000 60 1 6,500 10,000 16,500 590,000 59 2 6,392 10,000 16,392 580,000 58 3 6,283 10,000 16,283 570,000 57 4 6,175 10,000 16,175 560,000 56 5 6,067 10,000 16,067 550,000 55

Easy Home - Home Buyer

56 542 10,000 10,542 40,000 4 57 433 10,000 10,433 30,000 3 58 325 10,000 10,325 20,000 2 59 217 10,000 10,217 10,000 1 60 108 10,000 10,108 0 -

198,250 600,000 798,250

Illustration

Islamic Housing Finance normally has following product options

Home PurchaseTo buy a new house or apartment.

Home Building / ConstructionTo construct house on already owned land OR purchase a piece of land and construct house thereon.

Home Renovation To Renovate the existing house.

Home Financing Facility Transfer / ReplacementTo transfer the existing home financing facility from one bank to another.

Diminishing Musharakah Application

Musharakah Agreement:This is the main agreement that establishes the share of bank and customer in the musharakah Property.Components:

- Both parties share - Musharakah Property detail

Monthly Payment Agreement (Rent Agreement):

This agreement is signed after the Musharakah Agreement. Bank gives out its share on rent to the customer via this agreement.

Components:

- Rent Schedule

- Formula of calculation of rent

Documentation of Diminishing Musharakah Transaction

Undertaking to Purchase Musharakah Units:

This is an undertaking by the customer to purchase Bank’s Musharakah units from time to time.

Components:- Normal Sale Price- Additional Unit Purchase Price

Undertaking to Sell Musharakah Units:This is an undertaking by the bank to sell Bank’s Musharakah units to the customer.

Components:

- Normal Sale Price- Additional Unit Purchase Price

Documentation of Diminishing Musharakah Transaction

Why Islamic Housing Finance ?

1. The Nature of contract is a co-ownership. The transaction is not based on lending & borrowing of money but on the joint ownership of an asset.

2. In Islamic Housing Finance, bank takes risk in property up to the extent of it’s ownership share.

3. Incase musharakah property is collapsed, rental payment is stopped, as due to non-availability of asset, rent cannot be charged.

Why Islamic Housing Finance ?

4. With the purchase of musharakah share consistently, the rental amount is gradually reduced every month.

5. No restriction on purchase of additional musharakah share.

6. No fixed penalty on early termination. Bank’s profit on early purchase of musharakah share is subject to the appreciation of the musharakah property value.


1. Use of Interest based benchmark for calculation of rent.

2. There is a need to formulate a mechanism to calculate rent based on real-life market rate for rent in the area where property locates.

3. Unavailability of financing to lower-middle class segment which is in dire need of home shelter.


4. Although the public awareness about Islamic mortgages is increasing but still at large, public is not aware of the Islamic Mortgage.

5. Further research is need from shariah perspective to develop more Islamic modes for mortgage financing.

Jazak Allah &

Thank You

Islamic Model of House Financing

Documents

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