Indranil Mandal

This article was originally published in the Financial Express: here.

Islamic finance has been defined as finance in consonance with the ethos and values system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic Shariah. “Shariah” means such rules and regulations as have their origin in the holy Qur’an and Sunnah to govern all aspects of human life.

Islamic finance is a concept denoting a number of financing instruments or operations, which avoid interest. It is not only to avoid interest-based transactions, prohibited in the Islamic Shariah, but also to avoid unethical practices and participate actively in achieving the goals and objectives of an Islamic economy. Financial institutions should have ‘halal’ income and depositors should also receive stable and ‘halal’ income.

Islam permits businesses including joint ventures based on sharing of risks and profits for all concerned for cash and credit transactions. Trade is permitted but prohibited Riba or interest charged on loan is prohibited. The performance of capital should also be considered while rewarding the capital. It is based on risk-sharing, owning and handling of physical goods, as well as involvement in the process of trading.

Profit has been recognised as ‘reward’ for use of capital and Islam permits gainful deployment of surplus resources for enhancement of their value along with the liability of risk of loss on capital rests with the capital itself, and no other factor can be made to bear the burden of the risk of loss.

Financial institutions (FIs) cannot undertake activities which are detrimental to society and its moral values and have to go through an exhaustive test of Shariah compliance. They are not allowed to invest in narcotics, casinos, nightclubs, breweries etc. This requires that the clients of Islamic banking must have business which should be beneficial for society, creating real wealth and adding value to the economy.

Islamic finance involves FIs as a partner in trade and has to concern itself with the nature of business and profitability position of its clients. To avoid loss and reputational risk, Islamic banks have to be extra vigilant about their clientele.

There is an alternative. Islamic trade finance may play effective role in promoting business. It is an effective trade financing methods and instruments to provide the traders with best pre- and post-shipping financing with compliance of Islamic rule.

The Islamic trade financing instruments provide working capital, pre-shipping and post-shipping financing such as Istisna’a, Murabahah, Ijarah Muntahia Bi al-Tamlik, Salam, Musharakah, Mudarabah, Installment Sale or Bay’ BithamanAjil (BBA). These Islamic financing modes depend on financing the product in kind, which is very different from debt financing that exists in the conventional banking system.

Some of these products are very convenient for financing global value chain (GVC). Murabaha sells a commodity as per the purchasing price with a defined and agreed-upon profit markup, which may be a percentage of the selling price or a lump sum. It is a purchase with a promise to buy submitted by a person interested in acquiring the goods through the institution, in which case it is called a banking Murabaha: i.e., murabaha to the purchase orderer. This may also be done through Bai-Murabaha. It is a contract between a buyer and a seller under which the seller sells certain goods permissible under Islamic Shariah and law of the land to the buyer at a price determined by charging agreed profit, margin or mark-up over the cost price. In this case, the buyer either makes cash payment to receive the goods or is allowed to make payment by installments or on a fixed future date. The profit mark-up may be fixed in lump sum or in percentage over the cost price of the goods.

In Bai-Murabaha method, the client requests the bank or agent to purchase certain goods for him. The bank purchases the goods as per specification and requirement of the client. The client receives the goods on payment of the price which includes mark-up profit as per contract. Under this mode of investment the purchase/cost price and profit are to be disclosed separately.

Sometimes the buyer make payment at an agreed later date. This transaction is called Bai-Muajjal.

It means sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on credit. It is a contract between a buyer and a seller under which the seller sells certain specific goods (permissible under Shariah and Law of the Country), to the buyer at an agreed fixed price payable at a certain fixed future date in lump sum or within a fixed period by fixed installments. The seller may also sell the goods purchased by him as per order and specification of the buyer.

In FI’s perspective, Bai-Muajjal is treated as a contract between the FI and the client under which the FI sells to the client certain specified goods, purchased as per order and specification of the client at an agreed price payable within a fixed future date in lump sum or by fixed installments.

Bai-Murabaha and Bai-Muajjal have become very relevant in the context of recent developments in global value chain (GVC). These changes have made value chain finance (VCF) an integral part of GVC. The buyers would like to delay paying cash for their purchases. They always search for pre-shipping financing which is necessary for them to acquire raw materials and pay for other pre-shipping trade activities. Likewise, the sellers or exporters also look for the best possible way to get short-term financing to settle their post-shipping expenses until they receive the payment for their goods and services.

VCF also facilitates the movement of capital and investment between countries through meeting financial need of both the buyer and the seller.

Many FIs  are active in VCF apart from local banks. Some of the local banks are also partners with overseas FIs. First Security Islami Bank Ltd (FSIB) and Agrani Bank Ltd entered into agreement with Prima Dollar, a British non-banking financial institution (NBFI) to provide VCF to exporters and/or importers. The mode of finance includes a tripartite agreement between buyer, seller and PrimaDollar for export of any products to buyers in overseas markets.  The buyer, seller and PrimaDollar made contract for certain quantities of products for a certain amount of transaction. The exporter in Bangladesh agreed to supply certain quantity of products at agreed price against contract or Letter of Credit. LC or a contract issued either from buyer or PrimaDollar.

The important features of the Bai-Murabaha mode of investment are (a) The client (buyer) requests the bank to purchase particular goods and promises to purchase the same from the bank at a price fixed by charging profit over the cost price. (b) Under the Bai-Murabaha mode of investment there is no scope to increase the price once it is fixed. (c) After buying the goods, the Bank has to bear all the risk until goods are actually delivered to the client. The credit extended by PrimaDolalr to the buyer also as per principle of Bai-Muajjal as the amount is fixed earlier by the contract between buyer, seller and PrimaDollar.

Bangladesh is a very good market for Islamic finance. VCF through Bai-Murabaha and Bai-Muajjal  may help promote the country’s active participation in global supply chain.

M.S. Siddiqui is Legal Economist.

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