Ethnic Marketing: Disinterested banking (November 2007)
Islamic law bars the faithful from paying or receiving reba, interest. But how do you run a bank without it? Michigan’s University Bank has learned to be halal.
By Steve Cocheo, executive editor, firstname.lastname@example.org
Avoiding “reba” in all its forms, Ann Arbor’s University Bank establishes a foothold in Islamic banking in America.
I have a complaint…” the business executive started off. He was meeting banker Stephen Lange Ranzini a little while after a celebration the bank had hosted to mark a great CRA rating.
Little did the banker know at the time that those four words would end up taking him on a nearly five-year odyssey that few American bankers have experienced—or, likely, have even conceived of.
An unserved market knocks
In 2003 FDIC gave $86.8 million-assets University Bank an “Outstanding” CRA rating. It came about in no small part because Ranzini, for a time, made it his mission in business life to call on every black minister in Ypsilanti, Mich., the town next to his bank’s home of Ann Arbor. In all, he’d visited 42 minority clergy, bringing each one the message that the bank wanted to serve their congregations and their churches. Other institutions had avoided expanding their business in Ypsilanti. Ranzini, president and chairman of a bank that lives by niche marketing, saw an opportunity, and he reached out.
Indeed, today, one in ten of University Bank’s customers resides in Ypsilanti. But, getting back to the celebration, FDIC had praised the bank in its report, and the banker and his staff were feeling good, surfing a little wave of favorable publicity.
“We were really proud,” recalls Ranzini. And then that executive came to see him.
“I have a complaint,” he said. “You’re an ‘Outstanding’ bank. But you’re not serving my community.”
Ranzini asked where the bank fell short. The customer told him he was a Muslim. Ranzini was confused, as the bank did have Muslim customers. Michigan has large concentrations of Muslims and Muslim-Americans.
“What don’t we have? What don’t we offer?” the banker asked.
It wasn’t what the bank didn’t have, but what it did: banking products and services that violated Islamic religious law, making them off-limits to the devout.
“All of your products have interest,” the man told Ranzini, referring to loans, deposits, and investments. Ranzini says he simply blurted out, “How could you do a banking business without interest?”
How, indeed? On a subsequent visit, the fellow brought an Islamic banking consultant with him, who has worked with the bank since. Interest—“reba”—is forbidden under Islamic law. Ranzini learned that serving the Islamic market hinges on finding the answer to the interest question, and more, and has built his search into a significant new line of business for his bank.
Islamic banking products, including deposits and mortgage alternatives, represent a market of potentially $2 billion in the U.S. and $500 billion worldwide, according to research Ranzini cites. Tapping this market has been anything but simple.
Along the way, Ranzini has encountered challenges in product design; training; processing; business structure; human resources policy and employee relations management; compliance; and more.
Some elements of Ranzini’s efforts border on the diplomatic—“I have learned enough Arabic to engage in all the pleasantries,” says the banker, who is Catholic.
Ticklish matter of reba
Ranzini received his board’s authorization to venture into Islamic banking readily enough, but that hurdle, as it turned out, was the simplest part of a complex venture.
The central issue is Shariah, Islamic law. All forms of traditional Western financial relationships involving payment or receipt of interest violate the Shariah prohibition of participation in usury, whether as payor or receiver. Any pre-determined return on a contract, in the sense of interest, is barred. Investments in activities forbidden to or distasteful to Muslims under Shariah are also barred, ranging from mutual funds involving investments in interest-bearing instruments, or involvement in alcoholic beverages, gambling, pork processing, or pornography. (For further discussion, see the digital edition of the September ABA Banking Journal, page 38c, “Cultural challenge makes banking Minneapolis’ Somalis difficult.”)
Further, some basic concepts of Western credit are not accepted under Islamic law. Ranzini explains that the Islamic culture has no concept of a personal guarantee, hence personal notes are irrelevant in Islamic banking, and therefore no parallel exists for unsecured credit. The arrangements aren’t even properly termed “loans,” because they are, in a sense, structured more as partnerships with the hope that the bank and the borrower/partner will both gain from the relationship. Thus, says Ranzini, “you have to make your recovery from the asset, and you can’t go after the individual,” should something go wrong. Thus, while the bank’s operation, University Islamic Financial Corp., which is structured as an 80%-owned, “firewalled” bank subsidiary, offers multiple home financing options and is about to launch a commercial real estate secured loan product, personal unsecured loans and credit card offerings don’t appear to work in the Islamic vein.
(The remaining 20% is owned by Virtue Investors, LLC, an Islamic investors group.)
What does work is up to groups of experts. There is no central authority in Islam, no equivalent of a Pope.
Thus institutions that would engage in “financings,” as Ranzini terms Islamic credit arrangements, as well as offering deposits and investments, must obtain rulings from groups of scholars called “Shariah boards.” If the scholars engaged by the institution approve of the structure of the institution’s programs—including every document involved, lest a slip of terminology taint the arrangement—a “fatwa,” or holy document, is issued to that effect. (Some institutions attempting to serve the Islamic market have actually been hit by fatwas criticizing their programs.)
This is an ongoing challenge, not unlike compliance with secular laws. The program must be re-assessed annually, to make sure nothing has gone off track, says Ranzini. Adding further challenge, should the scholars find something lacking, the fault is not disclosed. The bank must review what it is doing and submit to re-examination after addressing what it perceives to have caused the disapproval.
When University Bank developed its initial product line, it took about nine months to come up with arrangements that met the requirements of religious law and public law, according to Ranzini.
This is no mean feat. Any new player who attempts to cut corners or take easy ways out risks the displeasure of an ethnic community that Ranzini says is well-educated and that “doesn’t have patience for nonsense.”
“If what you come up with is not Islamic,” says Ranzini, “you’re done, because after that people won’t talk to you.”
Even then, some products required very careful deliberation by the scholars the bank engaged. Take deposits.
Islamic law positions the deposit as a sum at risk in a business venture with the bank—think “profit sharing.”
While business deals do go wrong, wiping out investments, that runs into U.S. regulation. FDIC rules bar banks from offering accounts that can pay less than 0% interest, implying a potential loss of principle by the saver, Ranzini explains.
“That rule actually gives the Islamic scholars some difficulty,” says Ranzini. However, he says, the rule has been deemed acceptable because some practices are permitted under Shariah if they are “of necessity.” One ground for this finding is if secular law mandates such a practice or condition.
Handling people factors
Cultural differences have been a challenge for University Bank’s Islamic program at various stages. At the beginning, when the bank let its staff know what was coming, some employees objected. These workers opposed reaching out to the Islamic community, and some actually quit. Ranzini says he answered accusations that the bank was promoting Islam simply: “No, we’re meeting a need.”
Early on, Ranzini found that the Islamic operation, now totaling 11 employees, couldn’t function effectively as a side activity of the bank’s main operation. The first mortgage officer, working on Islamic home financings part-time, built a $1 million portfolio, but Ranzini became convinced that “if you don’t have a dedicated full-time team you won’t succeed.”
All of the bank’s sales associates working on this program are Muslims. And the bank quickly learned it had to grow its own staff.
“You can’t find 100 Muslim bankers in the U.S.,” says Ranzini. “You don’t have a lot of mainstream bankers who are Muslim, because everything about an ordinary bank is haram (forbidden and unlawful), versus halal (lawful, permitted).
The bank began hiring Muslim employees and training them in financing methods that comply with Shariah. The dedicated staff work in a separate area, and observe some different holidays than the rest of the bank’s staff.
All concerned had learning to do. “In the beginning, I made a lot of mistakes,” says Ranzini, using traditional bank terminology, for instance, from force of habit. “I’m pretty good now, but it was tough. It’s our mindset. But your credibility can go down the drain in a second.”
Ranzini hopes to reach the large Islamic community in the Washington, D.C., area. The next batch of trainees will be assigned to an office there.
University Islamic Financial has gained a large portion of its deposits from this out-of-state market, “so we’re going to our strength,” the banker explains.
A gradual pathway to profit
Ranzini admits that Islamic banking is a very different, and ongoing challenge. Because the financings and the deposit gathering must be firewalled from the bank’s ordinary lines of business, ALCO challenges rise above the norm. Ranzini notes that if growth of the bank’s Islamic financings slowed, it would have to slow down the growth of Islamic deposits, lest it find itself without an acceptable place to put those funds.
And Bank Secrecy Act compliance hits a level that many bankers, already beset with BSA headaches, would cringe to consider.
“We’ve got to be above average,” says Ranzini, “because we are going to attract more customers who have the potential to be ‘of interest’ to the law enforcement community.” The bank maintains tighter controls and provides much more training than is typically the case, Ranzini says.
“Reputation risk is a big issue for us,” the banker allows. He adds that the first tab on his own internet browser is the federal Office of Foreign Assets Control website.
Is the game worth all the effort?
After five years working at Islamic banking, the only overall profit that University Bank has seen resulted from the 20% stake sold in the subsidiary, for $3 million, reflecting a 50% premium over book value. In 2006, the bank’s holding company reported a loss, due in part to a costly restructuring of its deal with its Islamic banking consultant, and acquisition of some of its operations, in order to keep more of the program’s profits in the long-run. But Ranzini is far from discouraged.
“I’m not in this for short-term profit,” says Ranzini. “This is a long-term play.”
In 2008, Ranzini hopes the bank’s heavy investment of effort and funds in Islamic banking will begin paying off in the form of wholesale originations of Shariah-compliant financing for other institutions that don’t wish to go through the same learning curve.
“Right now we’re working on getting our own ducks in a row,” he says. “In every state we wish to expand to we have to come up with state-compliant documents and then we have to go back to the scholars.”
Ranzini notes that 15% of the bank’s revenue comes from Islamic banking activities today, and two-thirds of its residential mortgage originations come from its Islamic operations. He says that, like some of the processing activities the bank specializes in, this offsets its location in Michigan, a state whose traditional industries have been suffering.
“If I stuck to traditional banking in Michigan, what kind of results would I have?” Ranzini asks. “The economy just stinks.” BJ
The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj1107/index.php?startid=52