gif Islamic Finance Instruments
Simplified Process Flow of Tawarruq Transaction for Meeting Cash Needs
• Bank A is in need of Funds and Bank B has excess funds.
•
• Bank B buys a good from a Broker for USD. 100 and sells it to the Bank A on deferred payment basis (Murabaha) at USD110.
• Bank A immediately sells the good to the Broker for USD 100.
The end result of the transaction is that Bank A got funds, bank B lent the funds and got USD. 10 as return and the Broker got the good. This process is also called
monetisation of goods.
Reasons for Criticism of the Tawarruq Transaction
This practice (involving 3 parties) is said to be very much resembling buyback (involving 2 parties) which in turn is said to be an interest based (bay Inah) trans- action by a segment of scholars. To understand bay Inah lets consider that A (in need of funds) sells a good to B (having excess funds) for the cash price of USD 100. B turns around and sells the good to A for a credit price of USD. 110 payable in one month. The net result of both tawaruq and bay inah is the same the only difference being number of parties involved.
In this regard following extracts from Mahmud al Gamal’s work titled “ Limits and Dangers of Shariah Arbitrage’’ are very instructive:
“B sells a stapler to A, for the cash price of $100. A turns around and sells the stapler to B for a credit price of $105 payable in one year. This practice is called “bay` al-`ina” (same item sale-resale). Some jurists (e.g. the Hanbalis) forbade it based on Prophetic traditions, while others (e.g. the Malikis) forbade it based on the principle of sadd al-dhara’i` (prevention of stratagems to achieve illegal ends through legal means). However, some oth- ers (e.g. the Hanafi jurist Abu Yusuf and Al-Shafi`i) al- lowed the contract, ruling on each of the two separate valid sales separately. Provided that the second sale is not stipulated in the first, they reasoned, one can- not forbid the practice based on speculation about the contracting parties’ unobservable intentions.”
“C sells a stapler to A, for the cash price of $100. A sells the stapler to B for the credit price of $105 pay- able in one year. B sells stapler to C for the cash price of $100. This practice is called Tawarruq (literally, monetisation – of the stapler in this example). Abu Hanifa contemplated this contract as a variation on the previous one, with a third party serving as inter- mediary (muhallil). While he forbade the simple `inah (without a third party), he was more accommodative of Tawarruq. Most jurists considered Tawarruq invalid, defective or reprehensible. However, there were two reports on ibn Hanbal’s opinion on this contract, thus allowing a faction of the Hanbali school to approve the contract, which is quickly replacing Murabaha as the
46 Global Islamic Finance October 2010
favorite mode of financing in the GCC”. The AAOIFI is of the opinion that the transaction is only tolerable if it involves four parties (a purchaser, a seller, the pur- chaser’s broker and the seller’s broker) instead of a three party arrangement. This requirement seeks to avoid the concept of inah.
Key Shariah related issues emerge when the finances become available through these transactions to a con- ventional financial institution that is not dictated by any rules that require Shariah compliance as part of its operational procedures.
The practice is usually defended by arguing that being a Shariah compliant product there is no requirement for tracing the proceeds to know how they are used after the product is sold. It is even further argued that Shariah makes it illegal for identification of proceeds deployment under a sale of goods as the seller can- not influence the buyer on how the proceeds are to be used.
Lessons for the Regulatory Authorities
These transactions should be allowed only in case of extreme need (for which a criteria may be developed) and that too by fulfilling all the necessary Shariah re- quirements of each step in the multi layered structure of the transaction (for which regulatory and supervi- sory systems need to be placed) such as sale (e.g. possession, ownership etc.) and agency etc. Also the standards developed by AAOIFI will help in this regard. Since the Sukuk market is not that developed in many jurisdictions predominant recourse to these transac- tions open the door for letting the funds be utilised in the riba based sector. Therefore the Sukuk market needs to be developed so as to avoid the problems identified in case of these transactions.
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