Islamic home lending is a thriving business at the few U.S. banks offering Shariah-compliant, no-interestfinancing. Meanwhile, the big banks are still hanging back, wary of the high costs of entry.

As word gets out to Muslim customers and more banks work out the regulatory kinks, the market is getting smoother and more profitable, according to those involved.

Two years ago, only three banks offered Islamic financial services: Devon Bank in Chicago, University Bank in Ann Arbor, Mich., and HSBC in New York. The two community banks are still in the business, but HSBC dropped out of the market in December. A company statement said volumes “were not large enough to warrant continuation of the product at this time.”

“Large institutions aren’t moving into the market in the United States as much as they have been abroad,” said Shirley Chiu, an economist at the Federal Reserve Bank of Chicago.

Meanwhile, Broadway Bank in Chicago and United Trust Bank in Bridgeview, a West suburb, have both started offering Islamic finance products.

Devon Bank started offering Islamic services in response to requests from Muslim customers. Nazir Gurukambal, Devon’s vice president of Islamic finance international services, saidthe bankstarted offering Islamic home financing in June 2003, and now this makes up more than half of the bank’s mortgage portfolio.

Devon offers two different forms of Shariah-compliant home loans. With Ijara financing, the bank sets up a trust, which costs about$500,to purchase the house on the customer’s behalf. The customer gradually pays off the purchase price and at the same time pays rent, based on interest rates. With Murabaha financing, the bank buys the house and sells it to the client over time at a mark-up. In both methods the total cost to the borrower is about the same as for a conventional mortgage loan.

Chiu said Muslims are an attractive target for banks because they tend to be well-educated and in professions with stable salaries. “They are technically ideal homeowners, and they’re basically in a market that has been untapped because these commercial products did not meet their religious tenets,” Chiu said.

There are about 400,000 Muslims in the Chicago area, according to the Chicago chapter of the Council on American-Islamic Relations.

Gurukambal said about one-third of Muslims refuse to use financing that is not Shariah-compliant, about a third would prefer Shariah-compliant financing but will use conventional banking, and about a third don’t care and will use whatever offers the best rate.

Developing a system that works can take a year or more, with banks and their lawyers having to go back and forth between the Shariah scholars and bank regulators to make sure both groups are satisfied.

Gurukambal said Devon Bank has been looking into auto financing, but it’s even more difficult.

“One of the main issues is you don’t want someone driving a car that is owned by the bank — that’s a liability there.”

Devon Bank offers Islamic home financing in more than 30 states, but it can be difficult as regulations vary from state to state. Gurukambal said the bank has been waiting for more than two years for approval to offer its products in New Jersey and Maryland.

But programs like Devon’s have demonstrated that there is a market, and Gurukambal predicted bigger banks will start taking advantage of this within the next few years.

“It’s only a matter of time,” he said.

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