Islamic Trade Financing:Islamic Trade Financing:Tools for Trade Competitiveness Tools for Trade Competitiveness

Presentation by:Presentation by:Asnulhadi Yeop AzizAsnulhadi Yeop AzizWholesale BankingWholesale Banking

for:for:

Seminar on Islamic Banking & Capital Market: Seminar on Islamic Banking & Capital Market: Products & InstrumentsProducts & Instruments

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Islamic Trade Financing: An overview

Types of Products & Instruments & Shariah Principles/contracts

Letter or Guarantee

Letter of Credit

Working Capital Financing

Islamic Accepted Bills (AB-i)

Islamic Export Credit Refinancing (IECR)

Prospects & Challenges

Presentation Outline

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Trade FinancTrade Financing : An Overviewing : An Overview

Manufacturer (Exporter)

Buyer (Importer)

Merchandise

Payment

•Advanced Payment

•Documentary Collection

•Open Account

•Letter of Credit

Modes of Payment:

Which comes first?

Trade FinancTrade Financing : An Overviewing : An Overview

RECEIVABLE RAW MATERIAL

CASH

FINISHED GOODS

Cash Operating Cycle of both Exporter & Importer

Trade Finance ToolsTrade Finance Tools

Bank Guarantee Letter of Credit Overdraft Trust Receipt Bankers Acceptance

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Bank GuaranteeBank Guarantee

Bank

Guarantee

Manufacturer (Exporter)

Buyer (Importer)

Merchandise

Payment

Bank GuaranteeBank GuaranteeTypes of Guarantee

1.Tender Guarantee/Bond 4. Customs Guarantee

2. Performance Guarantee 5. Utility Payment Guarantee

3. Advanced Payment Guarantee 6. Others

Islamic Bank Guarantee

•Based on the principle/contract of Kafalah or Dhamanah (guarantee)

•Operationally, there is no difference between conventional and Islamic guarantee where bank charges commission/fee (ujr) for the guarantee.

•Certain Islamic banks adopt pro-rated commission (i.e. based on actual number of months)

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Differences Between Pro-rated vs Per annum Commission

Amount : RM200,000-00

Commission : e.g. 1% p.a.

Tenor : 6 months

Pro-rated Basis Per Annum Basis

Commission : RM2,000-00 RM1,000-00

Letter of CreditLetter of Credit

Written undertaking by a commercial bank to seller (beneficiary) to effect payment on behalf of the buyer if terms & conditions of the LC (i.e. terms of credit) have been complied with.

Advantages

•Provides importer with credit backing & eliminates buyer risk to exporter

•Importer may get better pricing & payment terms

•Importer is assured documents presented are as per requirement and duly examined by experts in the field as per UCP500.

•Exporter may get sale proceeds faster (via negotiation of LC)

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Letter of Credit- The MechanicsLetter of Credit- The Mechanics

EXPORTER IMPORTER

ISSUING BANK

ADVISING/ NEGOTIA-

TING BANK

2. Issue LC

1.Apply LC & place 100%

deposit

3.Advise LC

4.Client provide document &

receive payment

5.Forward document

7.Client receive

document

6. Payment reimbursement

Letter of CreditLetter of CreditIslamic Letter of Credit•Based on the principle/contract of Wakalah

•If deposit is placed upfront by client, it will be placed under wadiah.

•Customer will pay commission/fee (ujr) for the service

•Operationally, no difference from conventional LC.

•Main advantage: No interest payment on Settlement Period.

Settlement of LC

•via upfront wadiah deposit placement

•via Murabahah Working Capital Financing

•via Equity Financing namely Mudharabah or Musyarakah financing.

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Letter of CreditLetter of Credit

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DIFFERENCES IN COSTS BETWEEN CONVENTIONAL & ISLAMIC LC

Assumption

LC issued on 1 Apr 2006 and expires on 30 May 2006

Beneficiary : In the USA

LC Amount : USD100,000-00

Foreign Exchange : 3.60

Amount in MYR : RM360,000-00

Commission : 0.1% p.m.

Tenor : 2 Months

Foreign Interest : 6%

SWIFT Charge : RM25.00

CONVENTIONAL LCRM

ISLAMIC LCRM

Commission(RM360,000 X 0.1% X 2)

720-00 720-00

Interest from date of negotiation to date of reimbursement @ 8 days + 10 remittance days(RM360,000 X 6% X 18/365

1,065-21 -

SWIFT Charges 25-00 25-00

TOTAL CHARGES 1,810-21 745-00

Working Capital FinancingWorking Capital Financing

The money that is required to circulate within a business in order to finance its business/operating cycle. (It can also be used to settle LC)

Nature

•Short period – according to business/operating cycle

•Self-liquidating

•Financing relates to specific asset (eg stock, receivable)

Forms Overdraft Trust Receipt

- Document of trust signed by importer, the strength on with bank allows the

importer to obtain release of the merchandise but making payment at a later date. Bankers Acceptance (Import/Export)

- Usance Bill of Exchange drawn by client on the bank for acceptance/discount.

The proceeds will be utilised to finance the merchandise imported.

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Financing of Purchase/Import - Financing of Purchase/Import - MurabahahMurabahah

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BANK CLIENT

SUPPLIER

1. Bank appoints Client as Purchasing Agent

2. Purchase

Order

3. Supply of

goods

4. Payment

of Purchase

Price

5. Sale of Goods

6. Payment of Sale Price on Maturity

Sale Price = Cost + (Cost X Profit rate X Tenor) 36500

Islamic Accepted Bills (AB-i) Islamic Accepted Bills (AB-i) (Purchase/Import)(Purchase/Import)

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BANK CLIENT

SUPPLIER

1. Bank appoints Client as Purchasing Agent

2. Purchase

Order

3. Supply of

goods

4. Payment

of Purchase

Price

5. Sale of Goods

6. Payment of Sale Price on Maturity

Securitisation of Securitisation of the Debt : AB-i. the Debt : AB-i. Sale of AB-i to Sale of AB-i to another party is another party is under Bai’ Daynunder Bai’ Dayn

Financing oFinancing of Sales/Exports - f Sales/Exports - Bai’ Dayn Bai’ Dayn

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BANK CLIENT

SUPPLIER

2. Supplier

will pay on end credit

term

1. Client sells

goods

3. Sale of Debt

4. Payment via cash

5. On maturity, Client collect debt and pay to Bank

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BANK CLIENT

SUPPLIER

2. Supplier

will pay on end credit

term

1. Client sells

goods

3. Sale of Debt

4. Payment via cash

Islamic Accepted Bills (AB-i) Islamic Accepted Bills (AB-i) (Sale/Export)(Sale/Export)

Securitisation of Securitisation of the Debt : AB-i. the Debt : AB-i. Sale of AB-i to Sale of AB-i to another party is another party is under Bai’ Daynunder Bai’ Dayn

5. On maturity, Client collect debt and pay to Bank

AB-i (Purchase or Sale)AB-i (Purchase or Sale)

Transactions Allowed to be Securitised under AB-iTangible and non-haram goods (eg. raw materials, semi-finished goods or finished goods)Selected services – 1.Purchase of computer software licence,

2.Companies involved in trade-related logistic services such as warehousing, forwarding & shipping, or

3.Purchase of electricity such as Independent Power Producer

(Exemption given on case to case basis)

(Source: BNM AB-i Guideline)

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Working Capital FinancingWorking Capital Financing

Trust Receipt & Bankers Acceptance (BA)

Financing for Purchases/Imports & Islamic Accepted Bills (AB-i)

Tenor 30 – 180 days 30 – 180 days

Payment of Interest/Profit

UpfrontRequires Overdraft Facility

On maturity (in arrears)Coincides with operating cycleNot requires Overdraft FacilityLower effective rate

Financing Amount 100% under Trust Receipt

Round Down to nearest thousand for BA

100% of invoice amount

Acceptance Commission

Available under BA Facility None even under AB-i Facility

Cost Cost Comparison Comparison Between BA and AB-iBetween BA and AB-i

BANKERS ACCEPTANCE - CONVENTIONAL

Invoices RM384,429.00

Discount Rate / Accepted Commission 3.0%, 0.5%

Tenor 120 Days

Discounted Amount RM384,000.00 x 3.0% x 120/365 = RM3,787.40

Acceptance Commission Amount RM384,000.00 x 0.5% x 120/365 = RM631.23

OD Rate BLR + 1.5%

Upon Issuance BA Draft Amount = RM384,000.00

Current Account/ OD Debited RM631.23 + RM3,787.40 + RM429.00 =RM4,847.63

Up front Charges RM4,847.63

OD Interest RM4,847.63 x 7.5% x 120/365 = RM119.53

Upon Maturity RM384,119.53 (BA Amount + OD Interest)

Overall Charges RM388,967.16 (Upon Issuance + Upon Maturity)

Cost Cost Comparison Comparison Between BA and AB-iBetween BA and AB-i

ACCEPTED BILLS - ISLAMIC

Invoices RM384,429.00

Profit Rate 3.5%

Tenor 120 Days

Profit Amount RM384,429.00 x 3.5% x 120/365 = RM4,423.57

Upon Issuance BANK PURCHASE PRICE = RM384,429.00BANK SELLING PRICE = RM388,852.57

Upon Maturity RM388,852.57 (Bank Selling Price)

Overall Charges RM388,852.57 (Upon Issuance + Upon Maturity)

Islamic Export Credit Refinancing Islamic Export Credit Refinancing Scheme (IECR)Scheme (IECR)

Special government scheme to promote export of Malaysian

manufactured products, agriculture products & primary commodities via

participating commercial banks.

IECR Pre-shipment and Post-Shipment

AB-i uses the prevailing profit rate in the market while IECR allows

banks to resell the debt to EXIM Bank at a special rate. EXIM Bank will

notify the refinancing rate from time to time.

Uses the principle/contract of Bai’ Dayn.

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Islamic Trade FinancIslamic Trade Financing : ing : ProspectProspect

Trends in Islamic Trade Financing in Malaysia

In Malaysia, Islamic Trading Finance has gradually gained acceptance due to the distinct advantages.

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5000

10000

15000

20000

25000

30000

35000

Jan'02 Jan'03 Jan'04 Jan'05 Jan'06

Islamic BillFinancing

ConventionalTrade Bills

Source : BNM

GROWTH OF TRADE BILLS IN MALAYSIA

(in RM’Mil)

Islamic Trade FinancIslamic Trade Financing : ing : ChallengesChallenges

1. Differential in views of Islamic scholars on Bai’ Dayn

Scholars in the Middle East have different views on bai’ dayn.

2. Interest on Remittance Days of LC

Establishing LC where no interest is payable on remittance days.

3. Differential in Rates between BA and AB-I

Currently, AB-I rate is lower than BA rate due to the liquidity in Islamic Banking. The

position may be different in the future.

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