Islamic Financing & UCP600 Article 12(b):

What Gives?
Editors Note: Since beginning his occasional column on Islamic
Financing in the Jan 2012
DCW
Issue, Mr. Nizardeens writing has prompted feedback and follow up
questions from readers. Here in this year-end issue, he addresses
multiple questions pertaining to UCP600 Article 12(b) that have been
received.
Questions:
What are the disadvantages and constraints encountered by Islamic
Banks with the introduction of UCP600 Article 12(b)? And what are the
solutions provided by the Islamic Banks to mitigate such situations?
Answer:
UCP600 Article 12(b) allows a nominated bank to prepay or purchase a
draft or a deferred payment undertaking incurred by the nominated bank
based on the issuing banks authorization. If an Islamic bank issues a
letter of credit then it will authorize any nominated bank to prepay or
purchase. If the nominated bank is a conventional bank, it will allow the
conventional bank to prepay or purchase a compliant presentation and it
will definitely involve interest. Dealing in any form of interest or
interest-based elements is prohibited under
Islamic Jurisprudence (Sharia). This will restrict the conventional bank f
rom financing LCs issued byIslamic banks with recourse to the Islamic
bank. As Islamic banks do not want to be the originator of interest-based
transactions, most Islamic banks are deleting Art. 12(b) from
their Usance LCs which bankers would observe when dealing with
Islamic bank LCs. As an issuer, here the Islamic bank is authorizing the
conventional bank to deal in interest-based transactions and Sharia does
not permit such transactions. If the nominated bank is an Islamic bank
and the financing is under an Islamic mode of financing, then
Islamic banks do not delete
Art. 12(b) to facilitate the financing under Islamic Sharia-compliant
financing with recourse to the Islamic bank. Introduction of Art. 12(b)
has sometimes put Islamic banks under tremendous pressure by

conventional banks as they look forward to discount or prepay bills

which are issued under Islamic bank LCs and request Islamic Banks not
to delete Art. 12(b) or to reinstate Art. 12(b) to enable them to finance.
This is one of the major constraints facing Islamic banks today.
However, in such situations, nominated banks may need to seek
exceptional approvals in order to facilitate the business requirements or
the beneficiary to seek financing with recourse (to the
beneficiary), based on the acceptance from the issuing bank (Islamic
bank) with the fraud exception. As every coin has two sides, sometimes
this works to the benefit of Islamic banks as well. Such restrictions may
lead the beneficiary to opt for Islamic financing directly from the Islamic
bank(issuing bank) against the Islamic banks own acceptance at a
competitive rate instead of seeking financing from the nominated bank.
Some Islamic banks are actively involved in this business of making
maximum use of the situation. With awareness of the limitations and
constraints faced by Islamic banks and financing options available with
Islamic banks, we also have observed over a period of time that a
growing number of conventional banks have opted to finance bills
issued under Islamic banks LCs, even though Art. 12(b) is deleted to
surmount such situations. This is mainly due to business competition and
to have the market niche, a growing number of conventional banks are
discounting or prepaying bills of Islamic banks based on the standing
of the Islamic bank and the customer. Some are even going to the extent
of providing financing under Islamic Financing. K. Nizardeen, Head
of Trade & Corporate Services, Al Hilal Bank (Abu Dhabi, UAE)