Controversial Debt Based Financin

8/18/2019 Controversial Debt Based Financin

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CONTROVERSIAL DEBT-

BASED FINANCING PRODUCTS


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I. Tawarruq (Monetization, Tripartite Sale)

Tawarruq is a combination of two separate sale transactionswhereby an individual in need of funds purchases a

commodity from a seller on a deferred payment basis and then

sells the same on spot basis in order to realize cash to a party

other than the original seller.

Tawarruq is a financing product that is cited as a classical case

of hiyal, or legal tricks, but has been permitted by mainstream

scholars under certain conditions.


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In modern Islamic banking practice, the bank usually performs

all the transactions needed as it first buys the commodity under

its own name, then sells it to the customer on credit, and finallysells it on behalf of the customer to a third party for its cash

value.


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The procedures of tawarruq as a financing product involves the

following steps:

1. Client approaches Bank with a specific need for cash;

2. Bank purchases commodity X of value equivalent to the Client’s

need, (say P) from a Seller.

3. Bank sells X to Client on a deferred basis for P+I.

4. Bank as Agent of Client sells X in the open market or back toSeller for P* on cash basis

5. The three transactions occur within a short time period between

each other

6. In practice, the bank often acts as an agent on behalf of thecustomer (in the customer’s transaction with the commodities

broker)


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General rules to legitimate the tawarruq

transaction:

Scholars have permitted tawarruq since it fulfills a genuine for

funds. It is permitted as long as it does not violate the norms of

Sharia’a. Hence, all care should be taken to ensure that it does

not involve riba.


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For the sale transaction to be acceptable,

1.The buyer should fully possess the goods before selling them for

the second time, in order to expose the buyer to the risk associated

with holding the commodity and storing it.

2. The second sale should be separate from the first sale to avoid

complexity and not to fall in gharar .

3. The good should not be sold to the same person it was originally

bought from. , The client must sell the commodity in the market

place to a third party. Otherwise, it would be a case of bay'-al-einah.


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4. There must be a time gap between the first sale by the bank to

client and sale by the client in the market. This is in addition to

the time gap between the purchase by the bank and its sale toclient as in case of all permissible murabaha.

5. Another condition of a valid and permissible tawarruq is the

absence of any pre-arrangement between the three parties.

In tawarruq, therefore, one needs to exercise extra care and

subject the product to an additional investigation before

accepting it as Shari’a compatible


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II. Bay'-al-Einah (Buy-back sale, Repurchase)

A very popular mechanism used by Islamic banks in South East

Asian countries is based on repurchase or bay'-al-einah.

A murabaha can change into bay'-al-einah if the identity of the

seller is not different from its client.

Bay’ Al-Einah represents the purchase of a commodity on

deferred basisand the commodity is then sold for cash on a spot

basis, at a price lowerthan the purchase price, back to the original

seller.

The rate of profit in this case is indistinguishable from prohibited

riba on a conventional loan.


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You may note that bay’ al-einah involves a mere debt creation

exercise;there is no sale in the real sense, as the commodity does

not move fromthe client to the bank or vice versa.

The market price of the commodity, under bay'-al-einah, need not

bear any relationship with the amount effectively borrowed.

There is no genuine trade and exchange in bay'-al-einah; and the

cash sale in bay'-aleinah may be for the amount that the client

needs to borrow. The deferred repurchase may be for the loan

amount plus interest.

There is a consensus among Muslim scholars that bay’ al-einah is

not permissible.


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III. Bay'-al-Dayn (Sale of Debt “Bill Discounting”,

“Bill Factoring”)

Islamic Shari’a allows selling on credit as in murabaha on

deferred payment terms. The ongoing debate is whether Shari’a

allows the selling of debt!

Much of today’s business is conducted on credit. Businesses

that sell commodities on credit tie up their financial resources

in the form of IOUs. Thus, liquidity may become a business

concern


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A bill of exchange originates with a sale or purchase. The seller

draws a bill of exchange asking the buyer to pay a certain

amount (value of purchase plus interest) after a certain time period called maturity. When the buyer “accepts” the bill of

exchange, it becomes a valid financial instrument that can be

traded in the market. The seller now has two options.

1. He may wait until maturity and realize the full maturity value-value of his sale plus interest for the maturity period. In this

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2. He may go to the market (such as a commercial bank) andsell the instrument at a discount to the maturity value. The

discount is determined by the rate of interest and the time

between date ofpurchase of the instrument by the bank and the

maturity date.


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* When the bank buys the instrument, it effectively engages in

lending at interest.

* Mainstream Islamic scholars have put a plug on the possibilityof earning interest by insisting that any sale of debt (bay'-al-dayn)

or transfer of debt (hawalat-al-dayn) must be at par. This means in

the above case, when the bank buys the instrument of debt from

the original buyer, it is not entitled to any discount.

* Riba is avoided by disallowing any difference between what it

pays (purchase price of the instrument) and what it receives on

maturity (its maturity value).

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Another similar financial product that involves bay'-al-dayn is

factoring in which a company transfers its selected accounts

receivables to a bank (factor). The bank is now assigned theaccounts receivables and entrusted with the task of collecting the

receivables. Against these receivables, the bank provides

financing. While an Islamic bank may legitimately charge a fee

for its collection activities, it cannot accept interest on the loanextended.

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Controversial Debt Based Financin