ISLAMIC TRADE FINANCING

ISLAMIC TRADE FINANCING

by amirul hafiz

​International Trade refers to the exchange of products and services from one country to another. In other words, imports and exports. International trade consists of goods and services moving in two directions: 1. Imports – flowing into a country from abroad.

​Meaning of International Trade

​TRADE FINANCE

​Trade finance represents the financial instruments and products that are used by companies to facilitate international trade and commerce. Trade finance makes it possible and easier for importers and exporters to transact business through trade. Trade finance can help reduce the risk associated with global trade by reconciling the divergent needs of an exporter and importer.

​FOREIGN EXCHANGE

​CORPORATE FINANCE

i. ​Corporate finance is the subfield of finance that deals with how corporations address funding sources, capital structuring, accounting, and investment decisions.

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ii. Corporate finance is often concerned with maximizing shareholder value through long- and short-term financial planning and the implementation of various strategies

​PRODUCT & SERVICES OF TRADE FINANCE

​i. Accepted bills-i

​ii. Bank guarantee-i

​iii. Export credit refinancing

​iv. Letter of credit-i

​v. Shipping guarantee-i

​vi. Trust receipts-i

​ISLAMIC LETTER OF CREDIT

​MODUS OPERANDI LC

​ISLAMIC LETTER OF CREDIT (CONTRACT)

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​AL-WAKALAH (AGENCY)

​i. Al-wakalah refer to any agency relationship where a Bank acts as an agent on behalf of a company. While a conventional LC may involve a temporary loan based on interest.

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​ii. An Islamic bank may extend a facility in the following manner using the mechanism of wakalah.

​1. The client informs the Bank of his LC requirements and requests the bank to provide the facility.

​2. The client appoints the bank as its agent or wakil to execute the transaction.

​3. The bank requires the Client to place a deposit to the full amount (100%) of the price of goods to be purchased/imported under wakalah LC.

​4. The bank establishes the LC and makes payment to the negotiating bank representing the counterpart, utilizing the client's deposit. The pertinent document are released to client.

​5. The bank charges the client fees and commissions for its services under the principles of agency or ujr.

​6. The benefit under these contract are to ensure buyers receive merchandise on time and payment made upon receipt of complied documents.

​PROCESS OF WAKALAH LC

​AL-MURABAHAH LC

​Al-Murabahah refers to the sale of a good at a price, which includes cost plus as agreed by both seller and the buyer. This is a contract where the commodity exchanged for is delivered immediately and the price is paid in a lump sum later.

​The features under this contract:

(a) Undertaking to pay by the Bank:

(b) The Bank appoints the customer as purchasing agent;

(c) Upon the arrival of the complied documents, the Bank pays the negotiating bank by utilizing its funds;

(d) The bank sells the goods to the customer (purchasing agent) at a selling price comprising its cost and profit margin. Settlement by customeon deferred payment; and

(e) Bank provides financing.

​The benefits under this contract:

(a) Purchase goods on credit and enjoy the cash price from the supplier;

(b) Obtain financing from the Bank;

(c) Pays the bank on the deferred term, ar

(d) Rebate may be given on early settlement.

​AL-MUSHARAKAH LC

​Musyarakah is defined as a joint venture on profit/loss sharing between a bank and customer hereby the customer has to contribute part of the capital in a joint venture project. The profit derived from the project shall be distributed at a profit ratio as agreed between the bank and the customer.

LC under the principle of Al-Musharakah is adopted as follows:

1. The customer is required inform the bank of his LC requirements and negotiate the terms of reference for Musharakah​ financing.

​2.The customer places with the bank a deposit for his share of the cost of goods imported which the bank accepts under the principle of al-wadiah.

​3. The bank then issues the LC and pays proceeds to the negotiating bank utilizing the customer's deposit as well as its finances, and subsequently, releases the documents to the customers.

​4. The customers take possession of the goods and dispose of them in the manner stipulated in the agreement. Profits derived from this operation are shared as agreed. The Musharakah principle is also followed for project financing.

​MURABAHAH WORKING CAPITAL

​The customer may approach the bank to provide financing for his working capital requirements to purchase stocks and inventories, spares and replacements, or semi-finished goods and raw materials. Al-Murabahah is a "cost-plus" sale contract. It is a facility granted to customers for financing their short-term working capital requirement by way of lump sum deferred payment cost plus profit.

​The features under this contract:

(a) Undertaking to pay by the Bank:

(b) The Bank appoints the customer as purchasing agent;

(c) Upon the arrival of the complied documents, the Bank pays the negotiating bank by utilizing its funds;

(d) The bank sells the goods to the customer (purchasing agent) at a selling price comprising its cost and profit margin. Settlement by customeron deferred payment; and (e) Bank provides financing.

​FACTORING

​Factoring is a financial transaction whereby a business sells its accounts receivable (.e.. invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. Firstly, the emphasis is on the value of the receivables (essentially a financial asset), not the firm's creditworthiness. Secondly, factoring is not a loan - it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

​It is different from forfeiting in the sense that forfeiting is a transaction-based operation while factoring is a firm-based operation - meaning, in factoring, a firm sells all its receivables while in forfeiting, the firm sells one of its transactions. Factoring is a word often misused synonymously with invoice discounting. Factoring is the sale of receivables whereas invoice discounting is borrowing where the receivable is used as collateral.

​The three parties directly involved are the one who sells the receivable, the debtor, and the factor. The receivable is essentially a financial asset associated with the debtor's liability to pay money owed to the seller (usually for work performed or goods sold). The seller then sells one or more of its invoices (the receivables) at a discount to the third party, the specialized financial organization (aka the factor), to obtain cash. The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights and risks associated with the receivables.

​BAI AL-DAYN FINANCING

​Dayn is a debt that exists because of any other contract or credit transaction. It is incurred by way of either rent or sale or purchase in any other way, which leaves it as debt or another. Debts bought to be returned without any profits since they are advanced to help the needy and meet their demands and therefore, the lender should not impose on the borrower more than what he had given on credit. The Islamic debt market will be enormously enhanced through the securitization of such debt and the creation of an institutional framework for trading in such debt instruments.

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Refers to debt financing. It means a contract that involves the sale and purchase of securities or debt certificates that conform to Shariah principles. A debtor issues debt certificates to a creditor as evidence of indebtedness. Bai Al-Dayn is usually a short-term facility with a maturity of a year or less. On the other hand, Factoring is quite commonplace in conventional banking. 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 period called maturity. When the buyer "accepts" the bill of exchange, a valid financial instrument can be traded in the market.

​The seller now has two options. One, he may wait until maturity and realize the full maturity value of his sale plus interest for the maturity period. In this case, the seller finances the working capital requirement of the buyer as presented in the figure below. Two, he may go to the market - 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 the date of purchase of the instrument by the bank and the date of maturity. When the bank buys the instrument, it effectively engages in lending at interest.

​ISLAMIC ACCEPTED BILL

​The previous working capital financing under Al-Murabahah, which gives rise to debt, or Al-Dayn may indeed be securitized. In that instance, the bank draws a bill of exchange on and to be accepted by the customer. This bill of exchange will be drawn for the full amount of the bank's selling price on the maturity date of the financing.

​Accepted Bills-Islamic (AB-i) AB-i is a bill of exchange, which is either.

i. drawn by the Bank and accepted by the importer/purchaser - underlying Shariah concept is Murabahah.

ii. drawn by the exporter/seller and accepted by the Bank- underlying Shariah concept is Al-Dayn.

​LETTER OF GUARANTEE

​The bank may provide the facility of a Letter of Guarantee to its customer's purposes under the principle of Al-Kafalah. The Letter of Guarantee may be provided in respect of the performance of a task, the settlement of a loan, etc. As common practices that a customer often requires the bank to act as an intermediary in certain kinds of transactions to ensure an atmosphere of security and confidence for both parties.

​In such mediation, the bank merely acts, as a guarantor of its client's liability towards the latter's customer or counterparty. There is no cash outflow involved in the initial phase of the contract for the bank. However, in the event of subsequent default by the client, the liability may fall on the

bank as the guarantor and the bank may be required to pay up the amount guaranteed. The outcome is a temporary loan by the bank to its client.

​The facility may involve the following steps.

1. The Letter of Guarantee may be provided in respect of the performance of a task, settlement of a loan, etc.

2.The Client may be required to place a certain amount of deposit for this facility, which the Bank accepts under the principle of wadiah wad dhamanah.

3.The Bank charges the Client a fee for the services it provides. Islamic banks have been providing such facilities in the areas of trade finance, construction, project-related finance, shipping, and other activities.

​KAFALAH SHIPPING GUARANTEE

​This is a guarantee provided by a person (the Bank) to the owner of goods, who had placed or deposited his goods with a third party, made under the concept of Al-Kafalah or Al-Dhamanah whereby any subsequent claim by the owner for his goods must be met by the guarantor and the third party.

​Kafalah Shipping Guarantee is a facility granted by the Bank to importers for clearance of goods at the port without producing the original Bill of Lading. It should only be issued for documents drawn under the Bank's LC or customers with approved these contract facilities for collections documents.

​KAFALAH BANK GUARANTEE

​This is a surety is given by the Bank (made under the concept of Al-Kafalah of Al-Dhamanah) whereby agrees to guarantee the liability of a customer/applicant in case of the latter defaults in fulfilling his obligation. There are several types of guarantees issued by the bank depending on the needs of the customers.