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Canada bankruptcy may hurt Islamic finance in North America

Mon Dec 5, 2011 6:43am EST

 

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By Shaheen Pasha and Cameron French

DUBAI/TORONTO (Reuters) - The insolvency of an Islamic mortgage lender in Canada may hinder the growth of sharia-compliant finance in North America, where the industry has struggled to gain traction in the absence of a supportive regulatory framework.

UM Financial Inc was ordered into receivership in October, leaving about $32 million worth of mortgages in the hands of Toronto's legal system. Accounting and business advisory firm Grant Thornton was appointed receiver by the Ontario Superior Court of Justice.

The case has exposed uncertainty over the legal treatment of sharia-compliant mortgages in default, and questions over the transparency and oversight of smaller Islamic lenders. Industry experts said this could make investors in Canada and the United States more wary of considering Islamic finance in future.

"The failure of an Islamic financial institution should not immediately be construed as a failure of sharia-based financing," said Sheikh Muddassir Siddiqui, sharia scholar and partner at SNR Denton in Dubai.

But he added that the insolvency could give Islamic finance a bad name if the Canadian legal system determined that Islamic mortgage holders were not the ultimate owners of property for which they had been paying.

Since Islam forbids the use of interest, sharia-compliant mortgages rely on a "diminishing musharaka" contract to help Muslims finance homebuying. A lender and a homebuyer share the costs of purchasing a home; the homeowner then pays rent to the lender while purchasing the lender's share of the house in installments. When the value of the house is eventually paid off, full title is transferred to the homeowner.

But it is unclear who ultimately owns the home in the case of a bankruptcy by the lender, if legal title remains with the lender. This raises concern that mortgage holders could lose their homes if creditors come after the lender's assets.

In UM Financial Inc's case, homeowners are in limbo while the receiver investigates the insolvency. Some clients say they are reluctant to continue their normal payments to a non-sharia compliant entity, which raises the risk of them losing their homes for non-payment.