Government gives Sharia-compliant student finance the go-ahead

In April the Government ran a consultation on Sharia-compliant student loans and received 20,000 responses, with 94% saying that Muslim students needed an alternative to the current system.

Under Sharia law, paying interest is prohibited. This means current-style student loans are not suitable for Muslim students, effectively shutting many out of the UK university system.

MoneySavingExpert.com creator Martin Lewis said last year that an alternative system was needed, writing about the issue in his A Generation of Muslims not able to go to university? blog post. This month the Government said it will look into introducing alternative finance for affected students.

"Making higher education more accessible to all is part of Government's long-term economic plan to boost skills and strengthen growth. The overwhelming response to our consultation has shown the strong demand for a Sharia-compliant alternative finance model for student loans that everyone can access," it said.

The new-style loans will be offered alongside the current student loan system and will be available as an alternative to all students no matter what their religious belief. They will mean students repay the same amount as the current student loan, but the loan will be structured so it's acceptable under Sharia law.

In the consultation the Government proposed the finance on the basis that:

• Repayments after graduation and the amount of debt are the same as a traditional loan. This means students who choose the alternative finance are in no worse or better position than those who take out a traditional loan.

• Making repayments is as easy for students who choose alternative finance as it is for those with traditional loans. So it is possible for repayments to be made directly through the UK tax system.

• Students apply for alternative finance in the same way as a traditional loan, through the Student Loans Company (SLC).

• It is clear how the finance works and easy for students to understand.

The consultation only looked at the system in England, as higher education is devolved in Scotland, Wales and Northerm Ireland.

Why do we need Sharia-compliant student loans now?

All three student loan types – pre-1998, 1998-2011 and 2012+ – require interest to be paid. Suggestions have been made, however, that prior to 2012, some Muslims were able to borrow the cost of student fees from family members and pay for these up-front but that due to the large increase in the cost of these fees they're no longer able to do this.

An additional problem under the 2012+ system in particular is that the interest graduates repay is calculated based on the Retail Prices Index (RPI) measure of inflation plus 3%. But as the interest repaid is higher than the rate of inflation, there is also an additional 'real' cost for students.

Under the pre-1998 and post-1998 student loan systems, the interest charged is set at the rate of inflation so there is no 'real' cost (see our Student Loans Mythbusting guide for more on this).

How will the alternative finance work?

The Government has proposed setting up the loans on a 'Takaful' basis, which is a system used in Islamic finance. It worked with experts in Islamic finance to set out how this will work and has proposed the following:

• There will be a student finance fund (Takaful fund) managed by the SLC under the Islamic finance principle of Wakala. The SLC can charge a fee for managing this fund, but whether or not it will is still being looked into. It would be managed separately to the current student loans.

• Students apply for finance from the fund and enter into a contract, which guarantees they will repay a Takaful contribution. This is perceived as a charitable contribution from a Sharia perspective for the benefit of the members of the fund.

• Students will make repayments into the fund once they earn above the same repayment threshold that applies to traditional student loans, which is 9% of everything earned above £21,000.

• The repayments will be contributions into the fund, which will help future students benefit from the fund. The repayments are the same amount as if they had taken a traditional loan.

• The fund will be overseen by a Sharia advisory committee.

What happens next?

The Government will continue to work with the experts on developing the system and looking at how it will work in practice. It will also start working on making changes to legislation to allow this.

It says it's unlikely the alternative finance would be available for students before September 2016.