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Different between Islamic Letter of Credit and Conventional Letter of Credit

Islamic Letter of Credit (ILC)


Letter of Credit (LC)
Definition :
Definition :
A Islamic letter of credit (ILC) is a
A letter of credit (LC) is a letter from a
letter from a bank guaranteeing that a
bank guaranteeing that a buyers
buyers payment to a seller will be
payment to a seller will be received on
received on time and for a correct
time and for a correct amount.
amount and must comply with the rules
and regulation and the Maqasi of
Shariah.
Types of ILC :
Types of LC :
a) Murabahah ILC
Revocable LC
Principle of Murabahah (cost plust
A revocable LC is one that may be
profit) where the customers is unable to
cancelled or amended by the issuing
pay the purchase price, the bank issues
bank or the applicant at any moment
the ILC and pays the purchase price to
and without prior notice to the
the exporter. The bank immediately
beneficiary.
sells to the customer at a mark up for a
Irrecoverable LC
deferred payment.
An irrecoverable LC is a definite
b) Musyarakah ILC
undertaking by the issuing bank to pay
Islamic bank issues the ILC and both
a certain sum of money to the
the bank and customer contribute to the
beneficiary provided he complies with
purchase price under ILC, and later
the term and condition of the credit.
share the profits of the business venture
This undertaking cannot be amended or
based on the pre-agreed profit-sharing
cancelled unless with the consent of all
ratio.
the parties concerned.
c) Wakalah ILC
Refer to agency relationship where
Bank act as agent on behalf of a
company/individual. For example,
customer authorizes the bank to issue
LC on his behalf to the bank of
exporter in return the bank receives
fees from the customer for the service.
Comparison :
Not subject to 2 tier interest rate
Cost only the opening commission.

Comparison :
Subject to 2 tier interest rate
Cost opening commission plus the 2

Reimbursement upon receipt of


complied documents at the counter of
the issuing bank.

tier interest rate.


Reimbursement from the nominated
reimbursing bank.

Features :
Features :
a) Murabahah LC
a) Revocable LC
Customer does not have required
The beneficiary to a trade
funds to finance purchase.
transaction naturally would like to
Bank issues LC to seller.
have a more definite undertaking
Bank makes full payment of
from his buyer before he ships his
purchase price to seller.
goods.
Bank immediately sells goods to
The negotiating bank if it has
customer (actual buyer) at a marknegotiated documents in full
up for deferred payment.
compliance with the credit before
receiving notice of amendment or
b) Musyarakah LC
cancellation of credit.
Customer and bank agree to profit
share.
b) Irrevocable LC
Bank issue LC to seller.
This undertaking cannot be
Bank and customer contribute to the
amended or cancelled unless with
payment of the purchase price.
the consent of all the parties
Proceeds of the subsequent sale are
concerned.
shared based on pre-agreed profit An irrevocable LC may or may not
sharing ratio.
be confirmed.
c) Wakalah LC
The clients inform the bank of his
LC requirements and request the
bank to provide the facility.
The client appoints the bank as its
agent for the purpose of executing
the transaction.
The bank requires the client to
place a deposit to the full amount of
the price of goods to be purchased,
which it accepts under the principle
of Al-Wadiah.
The bank established the LC and
makes payment to the negotiating
bank representing the counterpart,
utilizing the clients deposit.
The bank charges the client fees and

commission for its services under


the principle of agency fee or ujr.

Modus Operandi
1) Murabahah LC

2) Musyarakah LC

3) LC and Wakalah LC