Regulatory landscape of Islamic finance in the US By Camille Paldi
There are currently 25 Islamic financial institutions (IFIs) operating in the US. These institutions are state-chartered entities subject to the same state and federal regulatory guidelines, corporate governance, banking and insurance operations, and tax treatment as conventional financial institutions in the US. The US has not adopted any federal legislation specifically addressing Islamic financing as of yet (Vogel: 2016). Although IFIs may be qualified to do business in different states, the majority of an IFI’s assets are located in the institution’s home state and licensing and other conditions must be satisfied with respect to any state where the IFI seeks to be qualified as a bank or mortgage or loan finance provider (Vogel: 2016). CAMILLE PALDI examines the US regulatory landscape and the possibilities for Islamic finance business in the US in the future.
Illinois and other states have enacted a ‘wild card statute’, which allows IFIs chartered in these states to do anything that is permitted by the Office of the Comptroller of the Currency (OCC) to be done by national banks (Vogel 2016). The existing US Islamic banks, such as Devon Bank and University Bank, are state-chartered, state-licensed banks, which have FDIC insurance for depositors (Vogel 2016). Three main regulatory issues for Islamic finance include bank ownership of real estate; good programs for anti-money laundering (AML) and Bank Secrecy Act (BSA) compliance; and whether deposits can be approved and insured (Lynn: 2009).
US bank offerings abroad
The Board of Governors of the Federal Reserve of the United States allows US financial institutions to offer Shari’ah compliant products in foreign countries where they are mandatory or where they are necessary for the financial institution to be competitive (Vogel:2016).
Foreign IFI offerings in the US
Foreign financial institutions may offer in the US Islamic banking structures approved by the OCC or the Office of the Comptroller of the currency, which includes the Ijarah and Murabahah structures for home mortgages and retail financing such as the United Bank of Kuwait (UBK). Foreign institutions are required to comply with all applicable federal and state law, including obtaining all requisite state banking and retail lending licenses for the offering of approved products in those states where they operate (Vogel: 2016). As a recent trend, Muslim investors from the GCC countries have sought to diversify their financial portfolios and to invest their wealth into US assets. For example, Arcapita Bank and UBK have structured Shariah compliant transactions in private equity and real estate in the US to meet client demands (Ilias: 2010).
Two OCC rulings in favor of Islamic banking in the US
Only two rulings have been issued by the OCC in 1997, approving an Ijarah and Murabahah structure for home financing and other retail financial products. (Vogel 2016) In 1997, the United Bank of Kuwait (UBK) requested interpretive letters from its regulator, the Office of the Comptroller of the Currency (OCC) on Ijarah and Murabahah mortgage products. The OCC approved both on the grounds that they were economically equivalent to traditional conventional products (Ilias 2010). In terms of Ijarah, the OCC determined that Ijarah is the functional equivalent of secured lending. In 1999, the NYSBD or New York State Banking Department also approved the Ijarah and agreed with the OCC that the product was functionally equivalent to secured real estate lending. In terms of Murabahah, the OCC determined that the bank would be functioning as a riskless principal (Cavanaugh: 2011).
According to John Vogel, these structures have now been approved by the Federal government, the New York State Banking Department, and the banking authorities of several other states. Furthermore, the relevant authorities have removed the double tax jeopardy of these products where tax was incurred by initial purchase and at transfer of final payment. The tax authorities in New York and other states have handled this issue by eliminating double tax burdens on a case-by-case basis where the Shariah compliant structure was equivalent to a conventional financing transaction. In 2008, the NYS tax department determined that no real estate transfer tax is due when the deed is transferred by a bank to its customer at the end of the lease term in accordance with the terms of the Ijarah arrangement (Vogel 2012).
In terms of Musharakah (and diminishing Musharakah), this type of joint-ownership is not approved for use by banks in the US and is used only by nonbank mortgage lenders in the US. The Musharakah transaction must be structured to be the functional equivalent of a debt transaction. (Hartom: 2014)
In the US, housing agencies Freddie Mac and Fannie Mae started buying Islamic mortgages in 2001 and 2003 to provide liquidity and they are now the primary investors in Islamic mortgages (Rutledge: 2005). Companies such as LARIBA, Bank of Whittier, and Guidance Residential are offering home financing through the Ijarah and Murabahah models.
Islamic deposit products
In terms of Islamic deposit products in the US, deposit products must be guaranteed by FDIC or the Federal Deposit Insurance Corporation (Vogel: 2016). A Shari’ah compliant profit and loss deposit product is difficult where the deposit must be insured by FDIC as losses cannot be shared by the bank and customer in the US. In 2001, SHAPE Financial Corporation sought FDIC Deposit insurance for an Islamic deposit-like product based on profit and loss sharing. The FDIC refused because the bank would be sharing loss with the customer (Haltom: 2014). SHAPE was forced to change the product structure to be based solely on profit and not loss sharing. The SHAPE profit sharing deposit pays a yield upon the gross operating profit of University Islamic Financial Corporation’s Shari’ah compliant portfolio of assets, including mortgage-alternative assets. The yield may drop to zero, but there is no possibility of loss of principal because the account is FDIC insured (Cavanaugh: 2011).
Central Shariah authority in the US
The US does not have a Shari’ah central authority like many Islamic countries, which is responsible for insuring that transactions or products are Shari’ah compliant or for regulating how Shari’ah professionals are appointed to and composition of Shari’ah boards. IFIs in the US are not required to maintain their own Shari’ah supervisory boards, but may work with the Shari’ah board of another IFI, the Shari’ah Board of America, or other scholars such as AMJA or the American Muslim Jurists Association. (Vogel: 2016).
The ‘establishment clause’ of the First Amendment to the US Constitution presents an obstacle to the successful introduction of Takaful and re-Takaful to the US as this mandates separation of church and state and prohibits the favoring of one religion over another. In addition, each state determines its own licensing requirements for insurance companies. In order to obtain a license, an insurance company must demonstrate that it has the experience and management capability to run the company and that it is financially sound. Insurance companies are also required to justify their premium rates. In addition, insurance companies must meet or exceed the solvency requirements set by the state.
Furthermore, there may be limits on the types and concentration of investments made with collected premiums via each state’s insurance laws. For example, investment in non-Shari’ah compliant investment grade rated bonds may be the only option. Therefore, it may not be possible to have 100% Shari’ah compliant Takaful in the US, however, if written into the contract, Takaful is still possible.
Since the members in a Takaful arrangement agree to insure one another and share in risks and profits, there may be some obstacles in establishing the company as a financially sound insurance provider and in justifying Tabarru or donation amounts. In case of potential insolvency, the shareholders’ fund must provide an emergency loan to the takaful company to meet existing claim obligations. Capital requirements imposed on US insurance companies may not take into account the separation between policy holder and stakeholder funds in Takaful insurance.
Another obstacle includes the fact that setting up a state or federal Shariah Board for the Takaful fund may contravene the separation of church and state. However, it may be possible to outsource this function to foreign countries, other IFIs, or organizations such as AMJA.
The US has seen two major Sukuk issuances — the US$165.67 million East Cameron Gas Sukuk, which was the first Sukuk al Musharakah in America backed by oil and gas assets and the US$500 million General Electric Sukuk (Sukuk al Ijarah backed by aircraft leases). Both New York and Illinois have enacted legislation enabling Sukuk transactions and Islamic finance. Goldman Sachs issued a US$2 billion Sukuk in 2012. There are currently no listings of Sukuk on the US security exchanges.
The US has no special courts, tribunals, arbitral or other bodies, which have jurisdiction to hear Islamic finance disputes in the US. Islamic finance disputes are subject to US federal and state courts and depending on the contract, may be subject to arbitration. (Vogel: 2016) I recommend forming one global, centralized Islamic finance arbitral tribunal with a standardized dispute resolution contract for Islamic finance, Sukuk, Sukuk bankruptcy, and Takaful
There are currently no applications for a fully fledged Islamic Bank in the United States. Islamic banking in the US remains largely confined to home finance and further to the two approved models of Ijarah and Murabahah home financing. However, there also exists banking, asset management, sukuk, takaful, and funds. There has been no new regulatory developments affecting the retail market since the late 1990’s. Institutions wishing to engage in Islamic finance will have to address various challenges, many of which are briefly stated in this article.
Camille Paldi, graduated from the Durham University Islamic Finance Program in the UK, an International Bar Association Scholar 2009/2010 and a qualified lawyer in the UK through the UK QLTT in 2013. Paldi is the founder of Ethical Finance Forum based in Palo Alto, CA, USA. She can be contacted at firstname.lastname@example.org or email@example.com