1. Regulatory Aspects of Islamic Banking in the United States Fourth UC Berkeley Islamic Finance Forum UC Berkeley School of Law April 9, 2011 Greg Cavanagh, Counsel and Assistant Vice President Federal Reserve Bank of New York

2. 2 The views expressed in this presentation do not necessarily reflect the views of the Federal Reserve Bank of New York or any other component of the Federal Reserve System. Important note

3. 3 Observations of the retail banking market Financing products Ijara Murabaha Deposit products Supervisory issues FRBNY participation at Islamic finance events Parting observations Outline

4. 4 Retail product offerings have been concentrated in home finance Several community banks offer Islamic banking products, including: University Bank (Michigan): deposit and financing products Devon Bank (Illinois): financing products Bank of Whittier (California): financing products Nonbanks have also been active in providing financing, including: Guidance Residential (Virginia) American Finance House LARIBA (California) Observations of the retail banking market

5. 5 Financing products: ijara 1997 OCC interpretive letter Approved a residential net lease-to-own home finance product (ijara wa iqtina) Determined to be functional equivalent of secured lending

6. 6 Financing products: ijara 1999 NYSBD approval Approved a net lease product Agreed with OCC that the product was functionally equivalent to or a logical outgrowth of secured real estate lending

7. 7 Financing products: ijara 2008 NYS Tax Dept advisory opinion 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 ijara arrangement

8. 8 Financing products: murabaha 1999 OCC interpretive letter Approved murabaha-based financing Commercial inventory or equipment Real estate Determined bank would be functioning as riskless principal

9. 9 Financing products: murabaha 2001 NYSBD approval Approved murabaha-based home financing Again, agreed with OCC that such financing was functionally equivalent to conventional financing transactions

10. 10 Definition of deposit under U.S. law FDI Act: the unpaid balance of money or its equivalent received or held by a bank or savings association in the usual course of business and for which it has given or is obligated to give credit… Implications for Islamic banking Deposit accounts that do not bear interest are not problematic from either a bank regulatory or shariah perspective But what if a customer wants a return on his or her deposit? Deposit products

11. 11 Ordinarily, a bank in the United States that borrows funds from its customer by taking a deposit pays the customer interest (a rate of return on that borrowing) FDIC insurance stands behind the banks borrowing (up to $250,000), so there is no possibility that the customer will lose money Outside the United States, Islamic banks often offer profit- and loss-sharing accounts: Customer places funds with the bank as its mudarib Bank uses its expertise to invest the funds and earn a return for the customer Customer may earn a net profit or incur a net loss Deposit products

12. 12 One example: University Banks SHAPE TM Profit Sharing Deposit Pays a yield based upon the gross operating profit of University Islamic Financial Corporations shariah-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 Deposit products

13. 13 Concentration risk Preference for tangible assets Liquidity risk Limited supply of short-term, shariah-compliant investments Limited shariah-compliant government debt instruments Lack of access to shariah-compliant central bank liquidity Consumer protection issues Supervisory issues

14. 14 IFSB Summit on Islamic Financial Services and the Global Regulatory Environment (London, May 2004) IFSB Seminar on Legal Issues in the Islamic Financial Services Industry (Kuwait, March 2005) Harvard Law School Workshop on the Supervision and Regulation of Islamic Financial Institutions (Cambridge, March 2005) Arab Bankers Association of North America (ABANA) Conference on Islamic Finance (New York, April 2005) IFSB Summit on Corporate Governance in the Islamic Financial Services Industry (Doha, May 2005) Interagency Forum on Islamic Banking in the United States (New York, March 2006) Harvard University Forum on Islamic Finance (Cambridge, April 2006) IFSB Summit on Aligning the Architecture of Islamic Finance to Evolving Industry Needs (Beirut, May 2006) National Bureau of Asian Research Conference on Islamic Finance in Southeast Asia (Washington, October 2007) US-Bahrain Business Council/Embassy of Bahrain Conference on Islamic Banking and Finance in the Kingdom of Bahrain (Washington, April 2008) U.S. Department of the Treasury Islamic Finance 101 Seminar (Washington, November 2008) FRBNY participation at Islamic finance events

15. 15 Fordham Law School Islamic Law and Finance Symposium (New York, February 2009) UC Berkeley Islamic Finance Symposium (Berkeley, February 2009) ABA Section of International Law Program Through the Eye of the Credit Storm: A Comparative Look at Islamic Finance Products, Risks and Rewards (Washington, April 2009) IFSB Seminar on Legal Issues in the Islamic Financial Services Industry (Kuala Lumpur, September 2009) FRBNY participation at Islamic finance events

16. 16 On the retail level, Islamic banking in the United States remains largely confined to home finance There have been virtually no new regulatory developments affecting the retail market since the late 1990s Institutions that wish to expand their product lines will have to address various challenges Federal Reserve staff continue to monitor developments in the field Parting observations