Tawarruq Trade Financing Quiz

Which of the following best explains why Tawarruq is widely used in Islamic Trade Financing?

• It provides fixed interest rates for financing products

• It allows for unrestricted trade of commodities, including prohibited items

• It enables Shariah-compliant liquidity through deferred sales of commodities

• It eliminates the need for any profit margin or markup in financial transactions

AAOIFI prohibits the creditor from retaining late payment penalties for personal benefit. How should these penalties be accounted for in financial records?

• They are recorded as income in the period they are received

• They are recognized as a reduction in Murabaha receivables

• They are credited to a Charity Payable account and must be transferred to an approved charity

• They are treated as deferred income and amortized over the financing term

Which feature of Commodity Murabahah Trade Financing ensures compliance with Shariah principles?

• Interest is calculated using the effective interest rate method

• Profits are derived from a fixed markup on an asset-based trade

• Penalties for late payments are retained as administrative income

• Transactions are recognized as loans receivable at principle value

What does it mean when the Hanbali School claims to prohibit Tawarruq due to its resemblance to Riba?

• It means that Tawarruq is prohibited because it creates a debt through a series of transactions

• It means that Tawarruq is only prohibited if it involves trading in commodities that are not permissible in Islam

• It means that Tawarruq is prohibited because it involves the use of interest rates that are higher than market rates

• It means that Tawarruq is allowed as long as the costs are kept low and there are no losses involved

Answer explanation

Tawarruq is prohibited because it closely resembles Riba by creating a debt through a series of transactions that lead to higher costs (eg: transaction costs, involving multiple parties) and potential losses (due to market risks), undermining the principles of fairness and justice in Islamic Finance.

Why is Tawarruq considered more flexible compared to other Shariah-compliant contracts in financing?

• It allows for the purchase and resale of commodities without the customer's involvement

• It provides both immediate cash flow and deferred payment options

• It eliminates the need for documentation in trade financing

• It allows the customer to bypass commodity trading entirely

In the context of Murabahah, what does 'Ibra' refer to?

• Early settlement rebate

• Deferred profit

• Late payment penalty

What is the formula for calculating late payment charges? (Ta'widh)?

• Outstanding Principal x Islamic Interbank Money Market Rate x Days in default/365

• Principal x Profit Rate x Days in default/365

• Outstanding Principal x Bank Profit Rate x Days overdue

How do the Shariah Governance mechanisms address the specific risks of Tawarruq Trade Financing?

• AAOIFI standards focus on standardizing accounting practices for Islamic banks and have little relevance to the operational risks of Tawarruq transactions themselves.

• The governance mechanisms rely on conventional insurance policies to mitigate risks in Tawarruq Trade Financing. Shariah principles are only considered after a loss has occurred to determine if the insurance claim is permissible.

• AAOIFI's Islamic Insurance standard directly addresses risks by providing Shariah-compliant risk transfer mechanisms. BNM's Takaful Operational Framework ensures robust oversight and effectiveness in mitigating the risks.

• These governance mechanisms focus on mitigating credit risks by requiring strict collateralization of Tawarruq transactions. Operational and physical risks related to the goods are the sole responsibility of the trader and are not directly addressed by these frameworks.

In the Tawarruq framework illustrated, Islamic Bank A purchases a commodity from a Supplier. This commodity is then sold to Client/Islamic Bank B, who immediately sells it on (a)   . This process allows the client to obtain financing while adhering to Shariah principles.

Why was the Bursa Suq Al-Sila created?

• To provide a platform for trading conventional financial derivates, allowing Islamic banks to hedge their risks in the same way as conventional banks

• To serve as a centralized clearinghouse for all Islamic financial transactions in Malaysia, including Islamic bonds (Sukuk)

• To avoid "organized Tawarruq', where the subsequent buyer is pre-arranged, resembling a disguised loan. The platform connects clients with anonymous counterparties, ensuring a genuine sale

• To facilitate Shariah-compliant commodity transactions by providing a transparent and efficient marketplace by offering a regulated platform