Look at the best savings accounts in Britain right now and you’re likely to see three names at or near the top of the charts.
Those are Al Rayan Bank, Gatehouse Bank and BLME, the Bank of London and the Middle East.
Exotic as they might sound, these banks aren’t the next Icesave. They’re all covered by the Financial Services Compensation Scheme, UK regulated and based (if not necessary owned) in the UK.
What these banks share in common is they’re all Islamic Banks, meaning they operate under Islamic, otherwise known as Shariah-compliant, banking principles.
Now, before we get any further we need to point out that, although they generally sit in the same best buy savings tables, they don't offer traditional savings accounts at all as they don't pay interest.
Instead, you're effectively making an investment when you take out a Shariah-compliant bond.
For this reason, they qualify for slightly different protection than traditional savings accounts, but at the same time shouldn't be seen as being risky like traditional investments, which we'll cover in detail a little further on.
The boom in Islamic finance
Shariah-compliant accounts continue to be among the top-paying options for savers – finally confronting the notion that being ethical won’t make you money.
There’s now an Islamic investment platform, Wahed Invest and Gatehouse Bank has become the second bank to offer ‘Islamic mortgages’.
Even the UK Government is getting in on the act, creating a sukuk, an Islamic bond, to raise money from devout investors, whilst the Royal Mint already sells Shariah-compliant gold bullion.
But does Islamic finance really give ethically-minded consumers the best of both worlds?
We talked to Islamic finance experts and took a look at the alternatives.
Religion and ethics
For those of us uneasy at mixing money and religion, it’s easiest to break down Islamic finance down to its basic principles.
“The main advantage is the guarantee”, explains Ben Collins, head of marketing and communications at Al Rayan Bank, the UK’s longest-running Islamic bank.
The guarantee to which Collins is referring is Islamic finance’s ‘no-ifs, no-buts’ rule “that your money won’t be invested in industries like pornography, tobacco, alcohol, arms and gambling.”
“If you want your money to go into ethical areas then Islamic banking is of huge use to anybody”, says Collins.
Those policies are enforced by institutions’ Sharia supervisory committees, made of Islamic finance experts who constantly monitor investments.
More broadly, Islamic principles also hold that money has no intrinsic value: it’s just a medium of exchange.
That’s the reason that Islamic savings accounts pay an expected profit rate, not an interest rate, why Islamic banks can’t charge interest and can’t invest in anything not backed by a physical commodity
That means no payday lending – but it also means no credit cards, personal loans and a completely different approach to mortgages.
So how do these banks actually make money?
Why Islamic banks offer such high rates
Prior to 2004, Muslims in the UK had two choices.
They could use financial services that contradicted their faith. Or, explains Al Rayan’s Collins, “they were simply excluded from the financial system, which is really not a good place to be.
“[They were] not able to purchase their own homes; not able to save for their families or businesses; not able to operate a current account and accept and make payments.”
Those who wanted to invest faced a similar choice, as Junaid Wahedna, founder of investment platform Wahed invest explains.
“While investment products aimed at Muslims do exist, they haven’t been accessible to mainstream retail investors mainly due to the products' hefty deposit requirements, long lock-in periods, high fees, and physical on-boarding processes.
“This means Muslims may also be unable to diversify and are over-exposed to property, gold and cash.”
These new Islamic banks needed to make money, but being barred from many investments – and from the Bank of England’s Funding for Lending Scheme – they decided to focus on Islamic mortgages.
With Islamic mortgages, otherwise known as 'home purchase plans', the bank buys a portion of the property, along with the borrower. Gradually the borrower buys the bank’s share, whilst also paying rent on the bank’s share of the property.
Mortgages are available for buying your home and buy-to-let properties.
To get the money to buy property, Islamic banks needed to offer savings accounts, explains Collins.
“The depositor places their savings with the bank, which enables the homebuyer to purchase their house and likewise the homebuyer, through payments on their property, feeds back to the savers.”
To attract savers away from the big banks, Islamic banks offered higher interest rates on their savings accounts and ISAs.
15 years on, there are three Islamic banks offering savings accounts, two offering mortgages and one offering a current account.
They’re still offering high rates and today an estimated nine out of 10 of Al Rayan’s savings accounts customers aren’t Muslims.
Is your money safe?
As mentioned earlier, Islamic banks don’t pay you interest for your savings: instead, they pay an expected profit rate.
This follows the principle that you’re not just making money from money: you and the bank and investing it, and you’re sharing the risk.
As the name implies, an expected profit rate is not guaranteed. You could receive less, or indeed more interest than expected. However, it's not equivalent to investing in stocks and shares.
While the money you deposited is protected by the Financial Services Compensation Scheme, the FSCS won’t cover any interest you didn’t get paid – potentially creating a big problem if you’ve locked your money away for several years.
It also raises a worrying question: are Islamic banks able to offer such high rates because they're not realistic?
Potentially – but, at the time of writing, none of the UK’s three Islamic banks had ever failed to pay the expected profit rate.
“In 14, nearly 15 years of operating, we’ve never failed to meet that expected profit rate,” says Al Rayan’s Ben Collins. “The risk is extremely small, but the risk is there.”
Both Al Rayan Bank and Gatehouse Bank have assured loveMONEY that, should their banks anticipate it wouldn’t be able to pay the expected profit rate, depositors would be able to withdraw their money with the interest they had earned up to that point.
The green gap
Given that Islamic finance principles were developed 1,400 years ago, it’s perhaps unsurprising they don’t cover the environment.
While individual banks might have sustainable policies, there’s no across-the-board prohibition on investing in fossil fuels, for example, or prioritising green companies.
Ethical investment is, of course, a broad church, with the term notoriously ill-defined.
But if the environment is important to you then there’s already three ‘green’ banks you can join: Triodos Bank, the Charity Bank and the Ecology bank.
All offer savings accounts, whilst Triodos has a current account and Ecology Bank offers mortgages.
However, the interest rates offered to savers are, in general, far lower than those of Islamic Banks – over a full percentage point on fixed-term bonds, at the time of writing.
That could make the difference between your savings keeping up with inflation or shrinking over time.
Investing in stocks and shares is another matter and whilst it isn’t possible to generalise about returns on ethical investments, several investment platforms offer ethical portfolios at little if any extra cost.
A long way to go yet
Whether because of the high rates or their ethical credentials, more people are joining Islamic banks.
But could Islamic finance provide a true mainstream alternative? Beyond savings, Islamic finance products still aren’t that competitive.
Islamic investment platform Wahed Invest, which works in a similar way to robo-investment platforms, has higher platform charges than most of its competitors – including competitors with their own ethical funds.
Those high charges will chip away at your returns.
Islamic mortgages, meanwhile, have slightly higher interest rates – around 1% more than the market average at the time of writing.
Again, this might not seem like a big number but will mean paying back thousands of pounds extra over time.
One reason for higher costs, according to Wahed Invest boss Wahedna explains, is that Islamic finance “[is] not as mature as the conventional finance one, and fund costs tend to be higher due to certain inefficiencies.”
UK regulations also play a part.
At present you can’t get an Islamic car loan, or credit card, in part because the Consumer Credit Act doesn’t recognise Islamic lending principles, observes Al Rayan’s Collins.
“Interest is integral to the Consumer Credit Act, which means that Islamic banks can’t use it, which means that we’re unable to offer personal loans, or car loans: products that you would expect a bank to be able to offer.”
That could change of course, and the UK Government has stated an aim “to be the western hub of Islamic finance”. Al Rayan bank’s Collins is positive that regulations will catch up with Islamic banking in time.
“There’s an even greater awareness and acceptance of Islamic finance as having a place in a modern western society.
“Islamic banking is 14 years old and the banking system has been here for hundreds and hundreds of years.”