By Yousuf Ibnul Hasan, Program Consultant Islamic Banking & Applied Finance, IQRA University, Karachi, Pakistan*
We thank Yousuf Ibnul Hasan for sending his very interesting articles on Islamic Finance and the riba issue to islamicworld.it. This is his third contribution on the subject: the other ones have been published on May 14th and 27th of the current year.
Man and Economics
Before we go into direct discussion to the respective question we have to understand about the Islamic economics which is a system that defines the available resources blessed by Almighty Allah to the mankind. How these resources are utilized and distributed by man keeping in it the social justice and seeking best of these in participation and cooperation by applying the knowledge, experience, ability and efforts through the power of the pen and book granted by Almighty Allah to men in confirmation of “Unique among Creations” and “Custodian” to all the resources that Almighty Allah owns it alone and absolute.
According to Islamic economics, resources are unlimited and human efforts are limited as a result needs and wants do not effect on the supply or resources because availability of resources are dependent on efforts that develop the affordability of human being in satisfying the needs.
Nations were putting their efforts in achieving knowledge and seeking their rights in the economic system are the leaders of economic growth. A nation that merges the economics growth with social development develops the communities. Social economics development converts peoples into the nations. The nations having one identity and recognize that “all wealth belongs to Almighty Allah and man being is the trustee of the wealth. Hoarding of wealth is prohibited and wealth must be in circulation at all time, categorized as Ummah”.
Man, Money and Commodity as factor of production
Islamic economics define clear function of man money and commodity as the basic factor of production and all the economic activities must revolve around these three factors of production. Money is considered in volume against the value of the commodity and services and money cannot act in value because it is a medium of exchange and not the commodity. The use of money for various means and mode has been divided into four basic activities for which money function as a bridge between need and satisfaction. These methods are classified as: Modaraba for ability finance, Musharka for equity finance, Morabaha for commodity finance and Ijarah for property finance. Islamic finance does not have any fifty purpose of money and all four purposes are only and only act into by keeping social justice and social development in the economic growth.
Financial instruments as input and output methods
The four modes of financing in particular Modaraba, Musharka, Morabaha and Ijarah are considered as Output items for exchange, industry, administrations and business and the budgetary sources are assembled through the Input strategy which is delegated Sukuk. All the four items can be blended between one another for single reason exchange for which monetary sources are equipped by Sukuk as the commitment from backers as value, organization as a speculation and open as cooperation through funds. The participators to the over four yield strategies are lenders by method for Sukuk or investor as an issue or first part and ambitious person, gathering of the second part in Modaraba, while broker in Morabaha, accomplice in Musharka and Sarif (client) in Ijarah who go about as to produce financial action by keeping need of Social thought that take out Riba from the exchange that is embraced through man, fund and thing/ administrations. In all such exercises man could be client of fund, financial specialist, supplier or accomplice.
Exchange related exercises could be embraced in each of the four system for financing gave the organizing to the exchange is attempted with appraisal for reason, individual, value, probability, process, items, period, precautionary measures and benefit estimation. These systems for financing are not hand crafted items however these are considered as appropriately customized as indicated by the estimation and needs of the exchange which is workout on the notoriety and capacity of the players of the exchange.
Wakulla is the term utilized like a lawyer or for the benefit of one who demonstrates and one who designates to act. Regularly in the keeping money the Trader who needs the products applies for the financing and financing is conceded and given to the broker to get the merchandise of business need. On one side Trader is the accomplice who acts and on the flip side, Trader is delegated as Agent to the obtainment.
My individual experience and comprehension is, it is an aggregate infringement of the essential standards of the Morabaha that don’t permit trusts to be given at the transfer of working accomplice and the bank must utilize its aptitude to secure and supply to merchant. Fundamentally when merchandise are acquired by the Trader himself the costing and valuing to the buy and offer can’t impact straightforward. However bank can make Wakulla once the merchandise are conveyed to the Trader and permit him to enter into exchanging accord to the deal cost which was pre-agreed before the exchange and can’t be increment until the aggregate products are sold. Any increment in the merchandise cost over to the concurred value prompts the holding of products to the enticement of the benefit which come about the loss of lender as Morabaha takes a shot at shorter is the exchange higher is the benefit and more is the exchange lower is the benefit.
Product innovation in Islamic trade finance to meet the needs of buyers and suppliers in emerging markets?
Money related matters in a post Islamic period were usually drilled on the premise of social needs and Prophet (Sall-La-Ho-Wa-Alay-Wassalam) excessively was included in business and budgetary exercises considering social commitments in monetary matters. It is confirmed by documents of the Islamic world that with the presentation of financing and tossing loaning structured the most compelling group advancement on the premise of social improvement in the first Islamic state under the direction of Prophet Muhammad (Sall-La-Ho-Wa-Alay-Wassalam) in the standard of four Caliphs.
The monetary framework was presented in the time of Prophet (Sall-La-Ho-Wa-Alay-Wassalam) with the presentation of the idea of Money fit as a fiddle of Dirham and Dinnars as the medium of trade in all business exercises. The exchanges under certification result were changed over into an examination system as precommercial technique for estimation of result. Rehen (Collateralization) against the utilization of fund was denied and Arboon (Equity support by client of fund) was presented that give the right of fund manager to be the accomplice in the exchange with all the rights and authorization to impart and act in the exchange was presented and all the budgetary items were honed with security inside the organizing of the exchange.
Morabaha mode of financing for Trade and commodity
Before we go into further detail, let us see the technique connected of all exchange related exercises and title as Morabaha and evaluate its application and essentialness: Morabaha is a financing mode for exchanging exercises on the premise of offer for benefit. In fact, it is an agreement of offer in which vender pronounces his expense and benefit. It is an aged practice which was seen in the files preceding skyline of Islam. Its application is as per the following:
Morabaha Application
A dealer needs merchandise and methodologies agent to get the obliged products or things through financing. In premium based framework, fund is arrived on enthusiasm to the borrower who would go and purchase the obliged ware from the business sector. This alternative is not accessible in Morabaha. Fund can’t be loaned straightforwardly to Trader and financing against the acquirement of products or merchandise specifically paid to supply as per appeal of Trader.
The appeal of dealer (Local Purchase Order) must be in composing with clear determination of products needed alongside the supplier distinguishing proof and costs proclaim by the supplier. Lender independent from anyone else or through specialists enters into a buy manage the supplier of the Trader and arranges the cost to a base conceivable level. Supplier last cost and Trader proclaim value if varies this distinction is a piece of gaining for Financier as exertions include to be adjusted. A broker can’t guarantee a piece of this winning, however Financier as great motion can diminish the benefit on the thing that he add on acquired cost announce by Trader.
Broker after accepting the products from supplier issue an acknowledgement affirming the quality and amount of merchandise got from the supplier and issue subtle element of stock kept set up. Agent can likewise delegate its Moqqadum (operators) who is permitted to get the conveyance of merchandise and products for Rab-al-Maal. Macadam (specialists) may keep the products and wares under his control and discharge upon the conveyance request issued by Financier to the Trader either upon the installment or under contrasting installment terms. It is necessary that merchandise exchange from Financier to Trader ought to be on the pre-agreed value which was consolidated in the Morabaha Financing Contract underpinned by Local or Foreign Purchase Order properly marked by Trader.
Not every country produces all required commodities useable and consumable and dependence remain active among the countries. Morabaha is the products that merge with all other financial products in respective manner and in according to the need of the goods and commodities. Morabaha if applied in a real spirit it can develop inter-commodity trade and supply market which was accepted in a Conference on Islamic Banking held at Dubai in 1979 endorsed the terms & condition of contract between two parties of Morabaha as:
“This conference concluded that the Morabaha transaction comprises a promise to purchase on behalf of the Morahib according to condition agreed upon and promise by the financier to conclude the sales after purchasing the commodity based on the decided condition”.
All the financial products can be innovative according to the transaction as every transaction is tailor made and structure according to the requirement.
Financial risks in Morabaha
In conventional trade finance banks work with credit insurers and ECA’s which assume some of the risks of non-payment etc. Islamic trade finance providers taking advantage of these risk management tools in Morabaha practice that is developed in the Islamic financial system with guidance of Islamic Shariah as a financing technique that involves a request by the Morahib (trader) to the financier (Rab-al-Maal) for the purchase of a certain goods or equipment for him. The financier after the appraisal of the price and cost estimates its profit over the cost which is settled at a purchase price in advance. The financier pays on behalf of the Trader and delivers the goods after taking acceptance of receiving the goods as per request.
The framework supports danger imparting, advances business, disheartens theoretical conduct, and underscores the holiness of agreement. The essential schema for Islamic money related framework is requirement of the guidelines for treatment of monetary, social, political, and social normal for Islamic social orders.
The budgetary contract was presented as opposed to concurring and all unwritten terms and condition were neglected and does not have any lawful validation rather than which terms of conditions must be pre-agreed, predefine, obviously comprehended and undertaking is embraced in the vicinity of two witnesses. The update is composed by outsiders and it is perused before two witnesses before it is marked by the accomplices of the exchange.
Firstly, the Morahib demands the financier to embrace a Morabaha exchange and guarantees to purchase the product tagged by him. The guarantee is not a lawful tying and Morahib may retreat on his guarantee and the Financier goes out on a limb of the sum financed. In this circumstance the Arboon sum is kept as the stake of Morahib, along these lines is utilized to cover the value edge where Financier can offer the products by lessening the cost to draw in the purchaser.
Also, Morahib buys great obtained by financier on an agreed installments premise and consents to an installment plan for different dates. On such courses of action the productivity of financier might not be change and pre-agreed cost of resale of merchandise between the two gatherings of Morabaha contract should stay steady.
Morabaha deal contracts permit the thing sold it to the Morahib or in the event that if these are declines to buy by Morahib then financier can offer purchase at the best suitable value exploiting Arboon (edge, value or forthright commitment).
Financier cannot enter into any transaction of Islamic finance product if the reputation of operating party is not to the satisfaction. The ability and capability come to second which link to the experience. In the same case operating party have to be careful on the funds that are used for the financing and it must be carefully examined that the financier have the ability to manage his inflow and outflow of funds which should be clean and not Riba funds.
The goods are the risk coverage and the margin contributed by the operating party is over and above to the best actual purchase price. The margin is used to cover the shortfall in revenue in case of force liquidation of goods or sale to cover the principle financing amount.
Development of Islamic trade finance market and its capacity to support the demand
Beyond any doubts the Islamic block is one of the largest populated communities of the world and around 49 active Islamic countries are available on inter-trade activities under the Organization of Islamic Countries with the greater role of Islamic Development Bank that can play an important role as the Central Bank of OIC.
With the blessings of Almighty Allah the Islamic block has abundant resources of useable and consumable. Every country importing and exporting the products could explore the possibility to have inter-trade between member countries by taking the advantage of the major currencies of the Islamic block consist of Dirham or Dinar. As a common assessment and keeping the trade volume of major Islamic countries the Islamic Trade and Supply market could be minimum Euro 5 trillion a year. This volume will not only decrease the inflation but also brings the prices to affordability level to common person living in the community.
Let us take the Pepsi consumption in Saudi Arabia which is the highest in the world and equal to the total consumption of Europe in a year. Why this drink rule the beverage market in the Islamic block when traditional drinks are available and acceptable.
Pakistan produces the best quality of Rice and Cotton and exporting it to the various markets which exploit Pakistan into the real value of the products due to geopolitical condition. The Islamic commodity market can overcome this situation and Pakistan can fulfill the basic material demand that ultimately converted into value added in the importing country. The price and cost of procurement could be reduced in such trade which ultimately benefits the importing country in reducing the product price for the end user.
There are many examples in which inter trade and financing transaction have proved to be successful and some can be checked from the record available on net. Like Syndicate Financing of Bahrain base banks to Pakistan Cotton Export Corporation and Rice Export Corporation from 1986 to 1992 for over US $500 million. Similarly commodity export of Denim cloth procured by Faisal Finance Institution of Turkey through Faisal Islamic Bank Pakistan which was manufactured in Siddiq Sons Pakistan and exported to Turkish importers. We can name many such transactions and the future indication as growth in case trade barriers are easing which is strictly due to political disturbance by the developing countries to keep the underdeveloped countries involve in the struggle for peace and not to look for socio economic growth. Single currency transaction that is executed between Iran and Pakistan to a level of over US $500 million under the barter trade system, but employing the value of the commodity in exchange of commodities. Both countries use the base currency as the volume for the value of exchange and fund the export bill in their respective currency at their respective location instead of sending the documents for collection.
Scope for syndications in the Islamic trade finance
The Islamic financial system provided an excellent opportunity of syndications trade related financing. One such transaction was witnessed in 1986 when Massraf Faysal Al Islamic Al Bahrain (now Shamil Bank of Bahrain) structure the US $500 Million financing syndication financing for Pakistan two organizations. This transaction successfully initiated and executed with excellent result. Such transactions are common among the Islamic countries and can be structured under Musharka for Ijarah need or Modaraba for Morabaha transaction. There are many examples of issuance of specific Sukuk to structure the capital base of trade related transaction. Such contribution is routed through Morabaha by employing margin amount participated by Trader and the balance finance by Sukuk contribution that give the opportunity of small and medium saver of the bank to participate with their savings amount for Halal profitability. In case Trade transaction is structured by employing funds on Modaraba basis then the risk factor is taken as prime important which normally avoided in initiating.
In the trade related markets the Islamic finance is provided for leasing and Ijarah transaction when the useable goods are procured under Morabaha and offloaded on Ijarah. We can take the application as Sukuk is taken for contribution of capital which is used for the procurement of useable asset and then Sukuk are discharged by way of Ijarah financing and assets remain under Rental in ownership base.
If we look into the present market trend on such transaction we will find the market is still considered as virgin and scope to accommodate such transactions which mention in above is higher than the interest base lending. The equity participation from the user is the strongest aspect of risk cover that mortgage does not cover if we see the case of Lehman Brothers incident.
Growth in trade between OIC countries, and Islamic financial institutions to meet the increasing demand for Islamic trade finance
After the 9/11 and the role of US in regard to the Islamic block resulted the tremendous growth of Islamic Banking and financial markets. The market players were not only Islamic but large parts of conventional banks have opted to open a window under Islamic finance and banking. This develops the link between the market financiers instead of lenders and conventional started looking into possibilities to introduce the best quality of monetary services.
The financial growth is seen noticeable but human resource on the Islamic system lack in these institutions which created a kind of mistrust among customer and business communities who desire to opt the Islamic way rather to go on the Riba base system. Few banks hired the Religious Supervisory members to prove the transparencies to the transaction and the Islamic banking system but in the application and support they fail to create trust as the application of the Islamic financial institutions were not different than the conventional system.
The OIC had given a status to one and only bank which is based in Saudi Arabia and known as the Islamic Development Bank which is seen “look busy and do nothing”. The transactions seen and highlighted by IDB do not appeal to those who know the system in true spirit. On the other end the respective Central Banks of Islamic countries are keener to implement conventional banking regulation as they believe that four hundred years old banking system on the Interest base is much secured rather to opt for newly introduce the Riba free system. These banking regulators prefer to apply Rate to the principle amounts rather to go for Ratio on the financial participation. It is common understanding that financing is still a liability rather to act as Equity where as lending is a liability which price by the application of Rate.
The emerging Islamic financial institutions can bring the change in money market and can convert the market from the money market where money is bought and sold to financial market where money is an investment is the prime practice by equity participation for commodity exchange and trading. OIC history does not specify any significant transaction that can be classified as a move towards the development of trading market through financial system instead of lending practices. Islamic financial institutions have been well placed now and almost all the countries where Islamic banking and finance have a scope or growth prefer to remain under correspondence arrangement with conventional banks which give a relief to the Islamic bankers for security to their wealth as well as effective role in terms of wealth investment.
Beyond any doubt the demand is there, scope is visible and infrastructure is development but consideration, thinking, confidence and spirit lacks and as a result of this lacking the growth is seen in all kinds of Islamic financial and banking activities, but without an Islamic way of system.
Conventional banks leverage from emerging markets and Islamic finance plug the gap in terms of financing trade in emerging markets
It is evident that any conventional bank can avoid the Islamic financial market as due to petrol dolor influence in the money market and this influence largely occupied by the Islamic countries, the banking sector whether conventional or Islamic will struggle to take their share of liquidity volume and for this they go on to serviceability and not the interest rate. No doubt that the conventional banks have more products to offer and much better relationship with their customer on the basis of their standing in the banking market that develop the confidence among customers, client and savers for conventional banks which Islamic financial institution do not have though internal working of the Islamic banks are much better and more than the conventional banks still edge remain over by conventional bank to Islamic financial institutions.
Islamic banks are operating within their own system and the gap is shared between the two banking system in normal banking activities and we cannot classify the specific banking system filling the gap or covering the shortfall of any nature in trade financing activities and transaction. We must understand that they still the Islamic banking need to be modest and exclusive in its application that brings the change in the banking industry with products, purpose and proficiency. Still Islamic banking is accused of using the same methods and modes as practiced by the conventional banks and both the banking institutions exchange the funds on the basis of supply and demand by using simply the word Profit instead of Interest. Interbank lending and borrowing are based on location’s IBOR fixation, but the method is different as conventional bank use the straight line method of charging the cost of lending at Rate and Islamic bank go through SWAP deals which is commonly known as Parallel Sale and Purchase of Currency and Commodity, which is a kind of Riba.
In my experience it indicates that every institution is playing in the market on the basis of their liquidity and not through their banking. Why I comment such openly and without any hesitation, because I observed and noticed through extensive study in the banking market which clearly portrait one way that involve interest and not any other way of charging and rewarding on transactions. The size of the institution allocates the room in the world trade finance market. There are syndications and consortium for the trade transaction capital structuring and issuance of Sukuk which is also a kind of syndication in which size of participation is uniform is commonly seen and in Sukuk application the participation is contributed according to the purpose of the project or the transaction.
Islamic trade finance become the preferred choice for emerging markets such as Turkey, Indonesia, Malaysia, Qatar, Saudi Arabia and the UAE
Preferred and emerging markets for Islamic trade finance are Pakistan. The country which prepared a comprehensive document for Islamic economics system in participation of over 500 leading personalities of various trades and presented this document at the OIC which was appreciated unanimously by member countries of the OIC and then developing the Modaraba Ordinance for the small medium enterprise concept of declaring Modaraba mode of finance as Modaraba institution and giving the status of Non Banking Financial Institution (NBFI). This develops an international market for trade and industry and finally the concept of Modaraba was awarded a Nobel Prize in Bangladesh where germane concept becomes the example for prosperity and socio economic growth through Islamic finance.
We cannot ignore the Malaysian contribution in the relative field which was followed by Indonesia and Iran. Turkey ranks among those countries which follow the secular system and the means of lifestyle have to be secular and not portrait of any religion. The trade market does exist in Turkey but Islamic finance in Turkey has not much been. Whereas Middle East including Saudi Arabia are practicing the trade finance but the application is not specific.
Pakistan, Iran, Malaysia, Indonesia, Egypt, Sudan, Iraq and some of the Central Asian Republics could be the emerging markets but due to political unrest in the major countries the economic activities are at risk but in a good return on the simple formula of “Opportunities lies in the crises” Middle Eastern states are consuming market where financing are available on an individual basis which have investment opportunities of the specific transaction. USE is perhaps the classified market where bulk trade is seen and trade financing is highest in volume among other Middle Eastern countries.
Islamic trade finance is one of the key engines for growth in the $1.6 trillion Islamic finance industry
No doubt it could be the key engines provided the trade financing is applied and conducted in the true spirit and on strong footing. It needs to have a better show of result with risk calculated on the basis of rational appraisal of the transaction; it’s costing and its profit sharing. Once the better profit result yields in the transaction the contribution of the financial resources will grow which ultimately develop a strong fund base and better turnover trading transaction. As the high volume growth and developments in the Islamic trade finance the industrial growth develops and inflation reduces with the introduction of new industrial flow and better supply in quality and quantity with affordable cost of product at end user level.
