The Islamic model of business financing, widely available throughout the Muslim world, is seeing growth in the United States as the demand increases from observant Muslim entrepreneurs who are trying to stay within the boundaries of Shariah, or Islamic law. What makes this type of financing distinct from traditional loan structures is that it stays in compliance with Islamic anti-usury laws, which prohibit the paying or charging of interest.
In Islamic finance, deals are structured not around interest rates but rather so that the bank ends up buying into the venture with the entrepreneur. The small businessman or entrepreneur then buys the bank out, with payments structured so that the bank is adequately compensated for its investment. In the meantime, profits and losses are shared.
While this type of loan looks significantly different from traditional business loans, in the end the overall cost of the loan for the small business is comparable to traditional loan repayment at a standard interest rate. While this type of funding for residential and commercial mortgages is relatively straightforward, it can be more complex for business and entrepreneurial financing, which involves the assessment of the business plan, evaluation of associated risks, and establishment of a way for the bank to share in profits and losses. The underwriting process is fairly comprehensive, relying heavily on credit scores and borrower collateral. However, there tend to be minimal losses over the long run due to the level of detailed financial and business analysis involved.
The growth in availability of this type of loan comes in response to a surge in the population of Muslims in the United States, with 2.6 million in 2010 and a 2011 Pew Research Center report projecting that the Muslim population will more than double to 6.2 million by 2030. In 2012, it was estimated that there were 81,000 Muslim-owned businesses in the U.S., with at least half of those located in the hubs of New York, Chicago, and Houston. While most obtain their small business financing through conventional means, about 20 percent of the more devout Muslims are concerned about finding Islamic finance options.
Interestingly, some analysts feel that Islamic finance fits well with overall trends toward more socially responsible and faith based investment practices, especially since Islamic law prohibits investments in alcohol, casinos, and the adult entertainment industry. In fact, the topic was addressed at a 2012 Harvard University Forum on Islamic Finance.
Klein, Karen E. “‘Halal’ Financing for Muslim Entrepreneurs Gains Currency.” Bloomberg Businessweek. 2/6/13.