In the UK Sharia based fixed rate accounts offer higher interest* than any others. This is despite the fact that they still have to follow the same UK regulations**, and provide themselves with a list of restrictions on investment which would seem to put themselves at a competitive disadvantage. Is there a catch, is there any reason I shouldn’t invest my money with a Sharia bank? (Gatehouse, Al Rayan etc.)
*Termed “profit” as an ethical kludge so they don’t offer “interest” which is forbidden but for all intents and purposes exactly the same.
**Most importantly fully guaranteed by UK Government up to £85000
Your savings are the bank’s lendings. If their borrowers want to be Sharia compliant their choice is restricted, they may be paying a bit more. That said, some non Islamic banks are moving into the Islamic mortgage market.
In order to be compliant, the bank treats your savings as a kind of joint investment in some sort of useful project which they anticipate will be profitable. Not a specific project but the pool of the banks lending.
If you read the T&C’s closely, you’ll likely find that there is an element of risk involved in that they can’t absolutely promise a return at the advertised rate. For fixed term savings they usually have arrangements for you to get your money out early if it becomes clear they can’t honour the advertised rate.
The increased returns may reflect the increased risk involved, which is small. The “interest” rate differences are also small, amounting to tenths of a percent.
Where are you seeing “fixed rate”? The only products I see have an “expected profit” and small print saying you may get less, and that they’ll endeavor to pull your money if it looks like you might start losing.
From Al Rayan’s terms on fixed term deposits:
Or in other words, you won’t lose any money under any circumstances, but if the market crashes and you don’t take it like a man, God will hate you.
That makes no sense when we’re talking interest on saver’s deposits. It’s true that Muslim savers who want to get a halal product are restricted to Islamic banks, but the converse is not true for conventional (i.e., non-muslim) savers who don’t care about the shariah compliance of their accounts. Such a saver would gladly put his money into an Islamic bank if, ceteris paribus, the “profit” rates offered there are better than the interest rate in a conventional bank. So you would expect, ceteris paribus, arbitrage to drive down the profit rates on savings accounts to that of their non-halal competitors.
My guess is, therefore, that Islamic banks are perceived as a higher risk from the savers’ perspective than conventional banks, possibly because in a market such as the UK, shariah-compliant banking is still a relative novelty and Islamic banks therefore tend to be smaller compared to conventional banks. This higher perceived risk drives up the bank’s funding costs, i.e., the rates it has to offer.
How much greater is the advertised interest than market? According to the bank’s link, the “interest” compounds quarterly, so they could advertise a yearly APR slightly higher than a bank which compounded more frequently or continuously at the market rate yet still yield the same effective APR.
I eventually went with a Sharia bank for 2.55% over 3 years. According to moneyfacts there are 3 Sharia banks offering 2.5%+. The highest non-sharia is 2.4%
The other responses have it essentially correct. In order to ‘lend’ money and make their ‘profit’ the bank must source that money from somewhere in the first place. That’s true of any bank in the world. The complication for a Sharia bank in the U.K. is that they have a limited set of places they can obtain that initial cash from. Where other banks take out loans from various sources, Sharia banks cannot, so they are far more reliant on depositors money to secure their funding.
They offer higher rates to secure that money, noting a few factors that drive those higher rates:
They tend to lack name recognition with the average UK customer, who by and large is relatively conservative, and also has a high level of inertia in changing their banks and/or seeking out higher rates.
Not the major factor, but it exists, that some people would be reluctant to deal with a Sharia bank on moral/religious grounds.
Fear of the unknown, ostensibly you’re investing in a ‘project’, this is not just a safe and simple fixed term deposit. As is demonstrated with the T&C exert, for a non-sophisticated investor, that’s a bit scary.
As an interesting data point, one of the bigger Sharia compliant banks in London had data that showed if their interest rate offer put them in the top 5 on a moneysupermarket search, that would generate ~£50M in additional deposits per week. To get them in the top 5 required on average, 10 basis points above market.