UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for March, 2011

Bai’ Al ‘Inah In Islamic Finance

Bai’Al ‘Inah is a transaction which involves the sale and buyback of an asset by the seller:

1.The seller will sell the asset to the buyer on a deferred basis and later will buy back the same asset on a cash basis at a price, which is lower than the original selling price.

2. Alternatively, it could also be where a customer offers to sell some of his inventory to a bank for an immediate cash payment.  He then buys back the inventory on an installment basis, but at a higher price than the price he sold to the bank earlier.  The difference between the purchase price by the bank and the sale price by the bank is the bank’s profit.

It is generally known as a sale based on the transaction of Nasi’ah (delay):

  • The prospective debtor will sell to the prospective creditor some object for cash, which is payable immediately, the debtor then immediately buys simultaneously the same object for a greater amount for a future date.  The difference between the two prices represents the profit.”  (The Law and Practice of Islamic Banking and Finance (2003) by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; Megat Hizaini Hassan)

Government Sector (Bank Negara Malaysia)

According to Bank Negara Malaysia, “the Bai’ Al ‘Inah contract is defined as two transactions entered between two parties whereby one party (the Government) undertakes to sell an asset to successful participants on a cash basis and subsequently will purchase back the same asset at a higher price, which is normally at par on a credit basis.”

Private Sector (Bank Negara Malaysia)

“A contract, which involves selling and buying of an asset where a seller will sell the asset to a buyer on a cash basis and subsequently will buy the same asset on a deferred payment basis at mark up price. It can also be applied when a seller sells the asset to a buyer on a deferred basis and will later buy back the same asset on a cash basis with a price, which is lower than the deferred price.

Application:

1) Issuance of Bank Negara Negotiable Notes (BNNN).

2) Issuance of Profit-based GII.

Acceptability:

1) Bai’ Al ‘Inah is not acceptable by the Middle Eastern countries, however, is practiced in Malaysia.

2) Some of the scholars regard Bai’ Al ‘Inah as part of Interest-based transactions and therefore, conclude that this is unacceptable under Sharia’h law.” (Bank Negara Malaysia)

 

According to Wikipedia,Bai’ al ‘Inah is a financing facility with the underlying buy and sell transactions between the financier and the customer.

  1. The financier buys an asset from the customer on spot basis.  The price paid by the financier constitutes the disbursement under the facility.
  2. Subsequently, the asset is sold to the customer on a deferred-payment basis and the price is payable in installments. The second sale serves to create the obligation on the part of the customer under the facility.
  3. There are differences of opinion amongst the scholars on the permissibility of Bai’ al ‘Inah, however, this type of sale is practised in Malaysia.” (Wikipedia)

‘The Maliki and Hanbali jurists feel that this method of sale is illegal as it constitutes a legal device to obtain a loan with interest, which is not allowed under the Sharia’h.’  They based their opinion on the Prophet’s Sunnah, in which he was reported to have said:

‘And when men become filled with greed towards money (Dinar and Dirhams) and transact through Ainah, and leave out jihad, remember that calamity will strike them until they turn back to their religion.’’

 

‘However, the Shafi jurists concluded that such transactions were allowed under the Sharia’h because according to them contracts are valid by the external evidence that they were properly concluded and that the unlawful intention of the parties is immaterial.  It does not invalidate their act unless expressed in that act.  The intention of the parties is, therefore, taken into account when the invalid intention is explicitly mentioned in the contract.’  (The Law and Practice of Islamic Banking and Finance (2003) by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; Megat Hizaini Hassan)

* Based on Information from The Law and Practice of Islamic Banking and Finance (2003) by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; Megat Hizaini Hassan, Bank Negara Malaysia, and Wikipedia/

Types of Instruments on the Islamic Interbank Money Market (SBBA) (Bank Negara Malaysia)

http://iimm.bnm.gov.my/index.php?ch=4&pg=4&ac=22

Issuing Procedures for Islamic Treasury Bills – the Bai’ Al ‘Inah Concept (Bank Negara Malaysia)

http://iimm.bnm.gov.my/view.php?id=33&dbIndex=0&website_id=14&ex=1194300189&md=iY%0F%9B%0D%D8%F8Qm+%86%DA%26sQ%C6

Bai’ Al ‘Inah Downloads

http://www.96147.com/no/bai%20al%20inah%3Bpdf.html

Tawarruq in Islamic Finance

 

 

Tawarruq means converting an asset into ‘wareq’ or money.  It is a financial product structured to satisfy customer cash needs in accordance with Sharia’h.  In this structure, the bank purchases certain goods on spot basis from local or international markets and sells them to the customer on credit on a cost plus basis.  The customer in turn sells the goods to a third party for cash.  Therefore, the customer has in effect turned an asset into cash using a bank as an intermediary and the bank has usually made a profit.  In some instances, the bank will also act as agent in selling the asset for the customer.

In other words, the bank purchases commodity from a Trader (Trader A) in the commodity market on a cash basis.  The bank then sells the commodity to the customer at a deferred price (cost price plus profit margin) payable in a lump sum or installment basis.  The customer may appoint the bank as his agent to sell the commodity to another Trader (Trader B) on cash basis in the commodity market; and the bank then sells the commodity as agent of the customer to Trader B on a cash basis in the commodity market.

According to Mohammad Netajullah Siddiqi, in Tawarruq, ‘The client  – the mutawwarriq – buys X on deferred payment from the International Financial Institution (IFI) and sells X for a cash amount less than the deferred price to a third party.  Also, tawarruq enables the IFI to guarantee a pre-determined percentage rate of return to its term-depositer, buying XX from him/her on deferred payment then selling XX for cash, the deferred payment being larger than the cash price… therefore, allowing the bank to make a profit.’   (Mohammad Netajullah Siddiqi, The Economics Of Tawarruq, 2007)

According to http://finance.practicallaw.com/5-367-4016, Tawarruq is “a method where the financial institution either directly or indirectly will buy an asset and immediately sell it to a customer on a deferred payment basis.  The customer then sells the same asset to a third party for immediate delivery and payment, the end result being that the customer receives a cash amount and has a deferred payment obligation for the marked-up price to the financial institution.  The asset is typically a freely tradable commodity such as platinum or copper.  Gold and silver are treated by Sharia’h as currency and cannot be used.”

According to Salah Al-Shahoob, “the bank specifies the market, which is the international market, and the type of commodity which is, normally, a metal. Then, the bank indicates the contract, which is offered to the client, which is a mark- up sales (bay‘ al-murabaha). This means that they indicate the cost of commodities to the client and the amount of profit and the price must be paid within a certain period of time. This transaction might be under the concept of deferred sales (al-bay‘ al-mu’ajjal) if the payment is a single transaction or installment sales (bay‘ al-taqsit) if the payment is by more than one installment.  The role of the institution may not end after selling the product to the client, but the bank can also offer to the client their services as an agent to sell the commodity on his behalf and receive the price, which is credited to the client’s account.

Al-Mushaiqih defines the organized tawarruq as a contract where the financial institution arranges to sell a commodity to a client by deferred payment then becomes an agent on behalf of the client to sell the commodity to a third party whereupon the institution pays the price to the client. Then, al-Mushaiqih elaborates on the procedure. He says that the institutions buy commodities, normally minerals, specifically zinc, bronze, nickel, tin and copper, every week. They choose these minerals because they are common in daily exchange in the international market. In the contract, clients apply to buy a specific mineral, which they specify and the contract is based on installment sales. The commodities are normally in another country, such as Bahrain. Then, the institutions sell the minerals in many units according to the wishes of the clients. After the client buys a unit, he empowers the institution to receive and sell his commodity in the international market and credits the price of it to his account. The clients have the power to change the price, so they might sell their commodities for the same price or a different one. The clients also have the right to receive their commodities in the place where they are normally delivered. In addition, Al-Mushaiqih also indicates that the financial institutions engage in an agreement with some brokers to obtain the metals.”

Al-Shaloob concludes that “organised tawarruq is a sales contract, the purpose of which is to finance people in accordance with Islamic law.”  He says that, “The process begins in the international or local market where the financial institutions buy commodities for immediate payment and obtains a certificate, which proves their ownership of the commodity. The financial institutions then offer the commodities to their clients and the clients buy the commodities as an installment sale.  The financial institutions also often indicate the original price (al-thaman), which has been paid. The clients then enter into another agreement to empower the financial institutions or a third party to sell the commodities in the market, although they normally avoid selling the commodities to the traders who originally sold them to the financial institutions. However, in some cases the financial institutions and clients enter into the contract before the financial institutions obtain the commodities. At the end, the financial institution credits the price to the account of the client.”

According to Mohammad Netajullah Siddiqi, “the harmful effects (mafasid) of Tawarruq include:

• It leads to creation of debt the volume of which is likely to keep increasing.

• It results in exchange of money now with more money in the future, which is unfair in view of the risk and uncertainty involved.

• Through debt proliferation, it leads to gambling like speculation.

• Through debt finance, it leads to greater instability in the economy.

• In a debt-based economy, as the money supply is linked to debt, there will be a tendency towards inflationary expansion.

• It results in inequity in the distribution of income and wealth.

• Through debt finance, it results in the inefficient allocation of resources.

• By consolidating debt financing, it leads to the raising of anxiety levels and destruction of the environment.”

(Mohammad Netajullah Siddiqi – Economics of Tawarruq)

According to Saleh – Shaloob, “Tawarruq is not accepted by the Maliki School, however, is more accepted with the Hanbali, Hanafi, and Shafi Schools.  According to Islamic Finance WIKI, the 5th decision of the Muslim World League on Tawarruq considered it permissible as the technique is derived on two sales contracts with the ultimate buyer being not the same as the initial seller.  However, the OIC Fiqh Academy Ruled Organized Tawarruq Impermissible in 2009.  Other Scholars believe that permission should be granted on a case-by-case basis.”

Saleh Al-Shaloob states that “The Islamic Fiqh Academy, which belongs to the Islamic World League, has issued two separate and different resolutions on the contract of tawarruq in the traditional form and the contract of organized tawarruq.

According to the Islamic fiqh academy, the traditional form of tawarruq is permissible (In the Circle 15th, Makka,1998) whereas the new form of tawarruq, which is called banking tawarruq (al-tawarruq al-masrafi) or organised tawarruq (al-tawarruq al-munazam) is prohibited (In the Circle 19th, Makka, 2003).

According to proponents of this view, there are three differences between the two forms;

The first difference is that the role of agency, which is played by the financial institutions changes the nature of the contract, bringing it close to the form of ‘ina sales, which is prohibited in Islamic law according to the majority scholars, whether the agency of the financial institution is indicated as a condition of the contract or is very common in this type of contract.

Secondly, this kind of contract, in many cases, does not reflect the concept of possession in Islamic law.

Thirdly, the reality of this type of contract is to finance the client (al-mustawriq) who applies for some money and to charge him extra;

The financial institute arranges the procedure of the contract by obtaining the commodity and selling it in the market on behalf of the client in order to achieve this purpose. However, that is not the real form of tawarruq, which has been indicated in the traditional fiqh and previously premised by the Islamic fiqh academy. The traditional form of tawarruq is a contract in which the seller sells a commodity, which is normally under his ownership and belongs to his business, to the buyer for deferred payment and the seller delivers the commodity to the buyer to be under his full possession and responsibility. Then, after the commodity is received by the buyer, he sells it to a third party who is not the seller for immediate payment.” (Salah Al- Shahoob)

Conditions of Organized  Tawarruq

1- Ownership of the commodities.

The seller must own the commodity before selling it to the buyer.

2- Commodity is specified.

The seller has to explain the details of the commodity to the buyer.

3- Possession of commodities.

The commodities, which are normally used in the contract of organized tawarruq, can be transferred from place to place and this kind of commodity is called a transferable commodity (manqulat).  Examples include metals, cement, rice and cars.

4-Avoiding ‘ina sales.

As has been mentioned, the majority of jurists consider that ‘ina sales are prohibited according to Islamic law. Therefore, financial institutions avoid buying the commodities again from the client because they have already sold them to the client by installment payments for more than what they normally pay to acquire the commodities. Consequently, if they were to buy the commodities from the clients for less than what the client had paid, the contract would be an ‘ina sale.

5- Details of the time of payments.

The contract between the financial institution as the seller and the client as the buyer is based on the contract of installment sales or deferred sales in general and one of the conditions of the both contracts is that it must explain in detail the manner of payment.

6- Avoiding usury.

The contracting parties have to be careful not to deal with commodities, which it is not permissible to exchange for deferment, otherwise, they would be involved in the usury by way of deferment (riba al-nasi’a).

7- Delivery is immediate.

As indicated previously, the contract of organized tawarruq is based on deferred or installment payment so if the delivery is deferred, the contract would then be a sale of debt –for- debt and this kind of sale is prohibited in Islamic law. “(Salah Al- Shaloob)

http://kantakji.com/fiqh/Files/Markets/o111.pdf

http://www.siddiqi.com/mns/Economics_of_Tawarruq.pdf

http://finance.practicallaw.com/5-367-4016

http://wiki.islamicfinance.de/index.php/Tawarruq

https://eprints.kfupm.edu.sa/14894/1/organised_tawarruq_in_Islamic_law_(Conf_23_Apr_2007).pdf

http://www.azmilaw.com.my/archives/Article_9_Tawarruq_00093603_.pdf

http://www.isra.my/fatwas/topics/commercial-banking/financing/tawarruq/item/340-deposit-and-financing-products-based-on-tawarruq.html

http://www.isra.my/fatwas/topics/commercial-banking/financing/tawarruq.html

http://etic.itsr.ir/Admin/Files/maghalat2/78.pdf

http://www.islamic-banking.com/glossary_T.aspx

http://www.scribd.com/doc/38181141/Issues-on-the-Permissibility-of-Tawarruq-Contracts-Draft-1

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance