Sharia student loans are flawed, but it’s not just Muslims being let down by the government’s tuition fees obsession

The government's addiction to its tuition fees policy has stopped thousands of would-be Muslim students going to university. Now its attempt to fix the problem by providing a sharia-compliant alternative is in danger of backfiring.

That, at least, is the view of the experts. This debate remains far from resolved. But one thing is clear: when the government enters into the game of trying to find a loophole around religion, it is on very dodgy ground indeed.

What ministers are now developing, following a consultation on the issue earlier this year, is a version of the Muslim 'takaful' model of finance which will help Muslim students get to university. Islam forbids lending out money at interest, making the bog-standard British student loan unacceptable. After the coalition hiked the costs of higher education upwards, what had been a serious obstacle for many Muslim families become a decisive one.

In a society striving to make multiculturalism work, the coalition's policies were a real disappointment. British Muslims are twice as likely to be unemployed than the national average. The rate is even higher among young men. Tuition fees reform limited opportunities for Muslims, creating a built-in sense of exclusion from a careers market set up to reward graduates.

So ministers proposed an alternative. The 'takaful' approach involves the establishment of a mutual fund, a pot of money from which Muslim students can pay for their higher education. Once their degree is completed, the idea is they pay back a small proportion of their income into the pool, replenishing the fund so that the next generation of students can take advantage of it. The system is administered by a bank, which takes a fee for its troubles.

There are practical problems with this, warns Dr Vasileios Pappas of Lancaster University. In the long-term, the dynamics are stable. But in the short-term there needs to be a certain level of student entrants every year or the fund starts to build up a deficit. "Who would provide the financial support to fill the gap?" Dr Pappas asks. "A loan from any other financial institution would not be possible. Would the government be expected – and willing – to bail it out? The supply issue has been exacerbated by the tightening up on student visa rules, which is likely to have a serious impact on the appeal to international audiences and viability of a sharia student loan."

This is not the biggest problem with the takaful solution the government is now committed to. A bigger headache is the danger that it will be rejected outright by some Muslims.

Sharia law is not determined by any one organisation or body. Around the world different kinds of Islamic financial products are deemed acceptable or rejected outright. In Malaysia, for example, the takaful is judged to be fine. But in the Gulf States it tends to be greeted with suspicion. "Why is it that there is so often a correlation between the bank's profit margin from its fee and conventional interest rates?" Dr Pappas asks. "Any financial institution involved in managing the fund would need to be entirely free from involvement in 'unlawful' investments (linked to pork, alcohol, conventional forms of financing). Would we expect this to be the case for an institution that finances student loans?"

Clearly, the answer is 'not necessarily'. But the government appears to be going out of its way to deter international students who view the takaful with suspicion. The very first of its five criteria which it says a sharia-compliant student finance model needs to emulate is that "repayments after graduation and debt levels must be identical to that of a traditional loan, so that students who chose the alternative finance product would be in no worse or better position than those who took out a traditional loan".

At one level this makes sense. It would be political madness to give Muslims a cheaper ticket to university. Right-wing newspapers would have a fit. But it does not seem to offer the best option for Muslims.

Peter Ainsworth, who has penned a report on student finance for the Institute of Economic Affairs think-tank, says:

"The fact that the payments under their proposal are identical to the payments a student would make under the standard student loan scheme means that even if they consider part of the payments to be not interest, they're exactly the same quantities as if they are. The government scheme is effectively simply dressing the interest payments up in another label."

This is a shame – because there is a much more attractive shariah-compliant alternative that the government could have developed.

The general principle which underpins Islamic finance is one of risk-sharing and cooperation. Some even suggest that the western model of capitalism has a lot to learn from the Islamic approach. Whatever its relative merits, Dr Pappas believes another of its financial concepts – the ludaraba sukuk, or Islamic bond – could end ministerial guilt over tuition fees without putting off significant numbers of potential overseas students.

By issuing a sukuk with equity participation from a syndicate – say one made up of the government, the Student Loans Company, a group of universities and an Islamic bank – the cost of doing business would not be about paying off a bank. It would be a shared venture. Dividends issued to the syndicate would reflect the financial success, or otherwise, of the graduates paying back a set proportion of their income. Because of the similarity with income tax, the levy could be structured in a progressive way. Graduate students' income would go up alongside inflation, ruling out one of the big downsides of other investment options.

"With the right impetus from government, HE institutions and banks, the first wave of new Muslim students funded in this way could begin their studies in 2015, opening up a previously locked door to career opportunities and involvement with wider society," Dr Pappas believes. And Ainsworth, whose report extols the virtues of abandoning the student loans system and switching to a graduate levy, agrees. His argument is that by giving universities a stake in the postgraduate prosperity of their students, everyone will benefit.

"At the moment, the risk is shared between the taxpayer and the student – and yet the university, the provider of the product, doesn't take any risk," Ainsworth says.

Changes to tuition fees provoked the angriest reaction of any of this government's policies

"But if the money goes directly to the universities and the student does well, they benefit. It also saves the taxpayer an arm and a leg, which is another bonus. The student has a much greater degree of confidence they'll get a course that's valuable, because the university is in there with them.  The university becomes a lifelong education partner. And it's all through this risk-sharing: you take the sukuk and extend it, and you have all sorts of positive offshoots."

The government has shown no interest in pursuing a sukuk. It says the feedback from its consultation indicates the takaful product meets the needs of the majority of students. It is examining what's required to allow the product to be offered through the Student Loans Company, but doesn't think the alternative could actually be introduced before the 2016/17 academic year at the earliest.

Clearly, the takaful product is better than nothing. But it may not have been the best option to go for. The coalition's determination to support student loans over alternatives continues to take its toll.