The Muslim faith has very strict rules and restrictions when it comes to money. Most notably, followers of the Quran and even those who are less observant abide by the law of not receiving or paying interest. This poses a problem for forex brokers all over the world as small interest charges are a daily norm.
In order to cater to a large and mostly wealthy demographic group, forex brokers are offering a Forex Islamic account. These accounts are designed to be compliant with strict Islamic rules.
Interest Is Forbidden
According to Islamic law, money itself has no intrinsic value and it is simply a medium of exchange. Strict observers of Islamic law states that Muslims are not permitted to profit from lending or receiving money.
The concept of interest within Islamic culture has been a religious, moral, and legal issue for centuries. Many brokers and other financial service providers are aware of this reality and have every interest in adapting their business model to accommodate religious laws and customs.
Simply put, an Islamic forex account is designed to avoid transactions involving the collection or payment of interest.
How To Apply For An Account
The process of signing up for an Islamic compliant forex account varies from broker to broker. Some forex brokers openly advertise the availability of Islamic compliant accounts while others choose not to.
Some brokers may even ask for proof they are in fact Muslim while others would be happy to open an account to people outside of the Islamic faith.
If a broker doesn’t advertise an Islamic account, the best course of action is to simply inquire. Chances are likely the customer support team is very familiar with this request and can advise accordingly on how to proceed.
Where Interest Is Charged In Forex
The foreign exchange market operates 24 hours a day and the total value of transactions far outweigh those seen on major stock exchanges. This makes it an ideal venue for day traders that want to enter and exit positions within the same day.
Traders that hold a position for less than 24 hours are not subject to any interest. So, Islamic traders that follow this guideline may not need an account with special status. However, holding an open position in a forex account for more than 24 hours is subject to a very small interest payment called a SWAP.
Every currency comes with its own interest rate that is established by the central bank. For example, the U.S. Federal Reserve determines interest rates related to the U.S. dollar while the Bank of Japan determines interest rates related to the yen.
The amount of interest charged to customers is also dependent on other factors, including a fee charged by the broker.
Generally speaking, if a trader holds a currency that has a higher interest rate compared to the currency sold, the trader will receive a credit in their account. On the other hand, if the interest rate is lower on the currency that was bought, an interest fee would be deducted from their account.
A Swap Example
To better understand the concept of a foreign exchange swap, it is important to look at a theoretical example. Suppose a trader opened a long EUR/JPY position for one lot (i.e, 100,000 units) and wants to hold it overnight. In essence, the trader bought euros by selling yen.
Suppose the EUR/JPY pair is trading at 120.0, the interest rate established by the European Central Bank (ECB) is 4.2% and the interest rate on the yen is lower at 3.4%. Assume also the broker charges a commission of 0.15% as well.
Since the euro carries a higher interest rate compared to the yen and the trader bought euros by selling yen, a SWAP will be credited to the trader’s account. Again, this is not permitted according to Islamic laws.
The formula used to calculate SWAP is = position size times (interest difference less commission) / 100) times price / days per year.
So, the SWAP in our example is calculated as:
(100,000 * (0.8-0.15) / 100) *120.0 / 365 = 213.7 JPY.
A SWAP credit of 217.7 yen will be added to the trader’s account when the position is rolled over the following business day.
Islamic Account Is SWAP Free
As we can see from our example, the amount of interest is dictated by central banks worldwide. There is simply no way to avoid these fees since it is outside of the hands of a brokerage firm.
Forex brokers have found creative ways to avoid a SWAP fee. Islamic forex trading accounts could instead be subject to a flat rate financing charge or by increasing the spreads on trades in the account.
This workaround technically satisfies the conditions of not charging or receiving interest. But anyone still left with concerns should check with their spiritual and/or religious leader before proceeding.
Conclusion: There Is An Entire Islamic Compliant Industry
Financial institutions of all sorts have adapted their business model to accommodate followers of Islam. These include mortgages, car loans, and even the creation of a £200m Islamic bond and an Islamic Market Index.
It is simply bad business for companies not to adapt to the needs of the global Islamic community.
