By Salman Ahmed Shaikh
Abstract
In this paper, we revisit the design of interest free house finance. First, we discuss the current practice in conventional banking and Islamic banking. Then, we discuss an alternate design for interest free house finance. The proposal we present attempts to analyze the implication of using market based rent setting in place of using an interest rate benchmark. In the alternate design, the Islamic bank buys the house by paying the house owner full amount of the house upfront. Then, the bank gives the house on rent to the client and the Islamic bank also enters into an options contract as the call option writer. If the call buyer does not exercise the call option, the options contract expires and the Islamic bank is in a position to give the house on rent again. We present numerical examples of computing rents in two separate structures. In structure I, call option is used with the lease contract. In structure II, house is resold at market price with stated price floor.
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