CONTROVERSIAL DEBTBASED FINANCING PRODUCTS

I. Tawarruq (Monetization, Tripartite Sale)

Tawarruq is a combination of two separate sale transactions
whereby an individual in need of funds purchases a
commodity from a seller on a deferred payment basis and then
sells the same on spot basis in order to realize cash to a party
other than the original seller.
Tawarruq is a financing product that is cited as a classical case
of hiyal, or legal tricks, but has been permitted by mainstream
scholars under certain conditions.

In modern Islamic banking practice, the bank usually performs

all the transactions needed as it first buys the commodity under
its own name, then sells it to the customer on credit, and finally
sells it on behalf of the customer to a third party for its cash
value.

The procedures of tawarruq as a financing product involves the

following steps:
1. Client approaches Bank with a specific need for cash;
2. Bank purchases commodity X of value equivalent to the Clients
need, (say P) from a Seller.
3. Bank sells X to Client on a deferred basis for P+I.
4. Bank as Agent of Client sells X in the open market or back to
Seller for P* on cash basis
5. The three transactions occur within a short time period between
each other
6. In practice, the bank often acts as an agent on behalf of the
customer (in the customers transaction with the commodities
broker)

General rules to legitimate the tawarruq

transaction:
Scholars have permitted tawarruq since it fulfills a genuine for
funds. It is permitted as long as it does not violate the norms of
Shariaa. Hence, all care should be taken to ensure that it does
not involve riba.

For the sale transaction to be acceptable,

1.The buyer should fully possess the goods before selling them for
the second time, in order to expose the buyer to the risk associated
with holding the commodity and storing it.
2. The second sale should be separate from the first sale to avoid
complexity and not to fall in gharar.
3. The good should not be sold to the same person it was originally
bought from. , The client must sell the commodity in the market
place to a third party. Otherwise, it would be a case of bay'-aleinah.

4. There must be a time gap between the first sale by the bank to
client and sale by the client in the market. This is in addition to
the time gap between the purchase by the bank and its sale to
client as in case of all permissible murabaha.
5. Another condition of a valid and permissible tawarruq is the
absence of any pre-arrangement between the three parties.
In tawarruq, therefore, one needs to exercise extra care and
subject the product to an additional investigation before
accepting it as Sharia compatible

II. Bay'-al-Einah (Buy-back sale, Repurchase)

A very popular mechanism used by Islamic banks in South East
Asian countries is based on repurchase or bay'-al-einah.
A murabaha can change into bay'-al-einah if the identity of the
seller is not different from its client.
Bay Al-Einah represents the purchase of a commodity on
deferred basisand the commodity is then sold for cash on a spot
basis, at a price lowerthan the purchase price, back to the original
seller.
The rate of profit in this case is indistinguishable from prohibited
riba on a conventional loan.

You may note that bay al-einah involves a mere debt creation
exercise;there is no sale in the real sense, as the commodity does
not move fromthe client to the bank or vice versa.
The market price of the commodity, under bay'-al-einah, need not
bear any relationship with the amount effectively borrowed.
There is no genuine trade and exchange in bay'-al-einah; and the
cash sale in bay'-aleinah may be for the amount that the client
needs to borrow. The deferred repurchase may be for the loan
amount plus interest.
There is a consensus among Muslim scholars that bay al-einah is
not permissible.

III. Bay'-al-Dayn (Sale of Debt Bill Discounting,

Bill Factoring)
Islamic Sharia allows selling on credit as in murabaha on
deferred payment terms. The ongoing debate is whether Sharia
allows the selling of debt!
Much of todays business is conducted on credit. Businesses
that sell commodities on credit tie up their financial resources
in the form of IOUs. Thus, liquidity may become a business
concern

A bill of exchange originates with a sale or purchase. The seller

draws a bill of exchange asking the buyer to pay a certain
amount (value of purchase plus interest) after a certain time
period called maturity. When the buyer accepts the bill of
exchange, it becomes a valid financial instrument that can be
traded in the market. The seller now has two options.
1. He may wait until maturity and realize the full maturity value
-value of his sale plus interest for the maturity period. In this
case the seller nances the working capital requirement of the
buyer;
2. He may go to the market (such as a commercial bank) and
sell the instrument at a discount to the maturity value. The
discount is determined by the rate of interest and the time
between date ofpurchase of the instrument by the bank and the
maturity date.

* When the bank buys the instrument, it effectively engages in

lending at interest.
* Mainstream Islamic scholars have put a plug on the possibility
of earning interest by insisting that any sale of debt (bay'-al-dayn)
or transfer of debt (hawalat-al-dayn) must be at par. This means in
the above case, when the bank buys the instrument of debt from
the original buyer, it is not entitled to any discount.
* Riba is avoided by disallowing any difference between what it
pays (purchase price of the instrument) and what it receives on
maturity (its maturity value).
* Notwithstanding the clear verdict against such transac=on,
some Islamic banks have been oering Islamic bill discoun=ng
products. They essen=ally treat debt as any other physical asset
that can be traded at a nego=ated price.

Another similar financial product that involves bay'-al-dayn is

factoring in which a company transfers its selected accounts
receivables to a bank (factor). The bank is now assigned the
accounts receivables and entrusted with the task of collecting the
receivables. Against these receivables, the bank provides
financing. While an Islamic bank may legitimately charge a fee
for its collection activities, it cannot accept interest on the loan
extended.