Are more and more Islamic banks shunning Tawarruq?

LONDON, May 25, 2009 (Arab News - McClatchy-Tribune Information Services via COMTEX) -- FISI | Quote | Chart | News | PowerRating -- The Islamic finance market has welcomed the recent resolution passed by the International Council of Fiqh Academy, which is an organ of the Organization of the Islamic Conference (OIC), on the contentious contract of Tawarruq, which is used as a cash management instrument by some Islamic banks. Some Islamic bankers and others providing such services, especially in Europe and Asia, are keen for further clarification as to whether the resolution merely applies to Tawarruq per se or also to commodity Murabaha contracts as they are currently practiced.

Shariah resolutions can have a direct -- and sometimes negative unintended impact -- on the Islamic financial market. The statement by the Shariah Committee of the Bahrain-based Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI) in February 2009 relating inter alia to ownership rights and guaranteeing of principal in Musharaka and Mudaraba Sukuk, for instance, unwittingly caused confusion in the market, especially relating to retrospective application of the ruling.

Some Sukuk arrangers confirmed that it partly contributed to the slowdown in the market, which was already being affected by the fallout of the credit crunch and the global financial crisis.

Another major decision relating to Shariah issues was the ruling in April 2009 by the Malaysian Appeal Court that the Al-Bai Bithaman Ajil (BBA) deferred payment contract as practiced in Malaysia is a valid Islamic sale contract. The appeal court overturned a ruling earlier by a lower court that it was not a valid Islamic contract and is tantamount to a loan, which is Riba (interest) and therefore not permissible.

The earlier judgment caused considerable anxiety amongst Islamic financial institutions in Malaysia for fear of potential increases in defaults in their BBA contracts and uncertainty as to the validity of BBA agreements. The Malaysian Appeal Court ruled that BBA agreements were valid and binding in Malaysia; these agreements must not be compared to loan agreements as the BBA contracts are sale transactions and not money lending transactions.

In the recent case of Tawarruq, the International Council of Fiqh Academy at its 19th session held in Sharjah at end of April, passed a Resolution 179 (19/5) outlining the classical concept of Tawarruq, which is permissible, and agreeing on the practices which are not acceptable under Fiqh Al-Muamalat (Islamic law relating to financial transactions).

Badlishah Abdul Ghani, CEO of CIMB Islamic Bank, stressed that the classical case of Tawarruq is acceptable under Shariah principles. It is certain applications of Tawarruq that has caused concern in the market. He would like further clarification between the so-called organized Tawarruq and reverse Tawarruq on the one hand and the classical commodity Murabaha contract.

In the classical Tawarruq the third party has to be identified and cannot have any link with the financier or bank. In a commodity Murabaha this is not necessarily the case.

According to the International Council of Fiqh Academy ruling "technically, according to the Fiqh jurists, Tawarruq can be defined as: A person (mustawriq) who buys a merchandise at a deferred price, in order to sell it in cash at a lower price. Usually, he sells the merchandise to a third party, with the aim to obtain cash. This is the classical tawarruq, which is permissible, provided that it complies with the Shariah requirements on sale."

However, in recent years the practice of organized Tawarruq has emerged. This is defined -- "when a person (mustawriq) buys merchandise (commodity) from a local or international market on a deferred price basis. The financier arranges the sale agreement either himself or through his agent. Simultaneously, the mustawriq and the financier execute the transactions, usually at a lower spot price. Reverse Tawarruq, is similar to organized Tawarruq, but in this case, the (mustawriq) is the financial institution, and it acts as a client."

It is the latter two -- organized and reverse Tawarruq that have been proscribed from a Shariah point of view. The rationale is that "it is not permissible to execute both Tawarruq (organized and reversed) because simultaneous transactions occurs between the financier and the mustawriq, whether it is done explicitly or implicitly or based on common practice, in exchange for a financial obligation. This is considered a deception, i.e. in order to get the additional quick cash from the contract. Hence, the transaction is considered as containing the element of Riba."

Tawarruq is practiced in most countries where Islamic finance is provided except perhaps in Qatar where the Shariah scholars have discouraged its use per se. However, more and more Islamic banks in countries including Saudi Arabia are now shunning Tawarruq, even the accepted form, as a matter of principle or perhaps to avoid market confusion.

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