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Tawarruq plays a crucial role in Islamic finance and serves as a fundamental pillar, offering an alternative to conventional interest-based transactions while strictly adhering to Shariah principles.
It facilitates short-term financing and liquidity management without resorting to interest-bearing loans, providing individuals and businesses with access to cash in a Shariah-compliant manner.
Islamic finance is experiencing continuous growth worldwide. However, the development of Shariah-compliant financial products remains a key area of innovation.
It is essential to evaluate these products to understand their dynamic factors and their impact on the industry.
Tawarruq sometimes involves a combination of two contracts signed within a single contracting session, which violates Shariah principles.
Additionally, organized tawarruq, where financial institutions prearrange transactions, also contradicts Shariah compliance. To prevent engaging in non-compliant forms of tawarruq, a comprehensive understanding of its overall process is necessary.
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Monetization is the process of purchasing the commodity for a deferred price determined through a Murabaha (mark-up sale) or Musawamah (bargaining) and selling it on a cash to the third party to obtain the liquidity.
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When there is a need for quick cash and the client cannot obtain it from a conventional financial institution due to the interest factor, monetization serves as the best Shariah-compliant loan alternative, provided that all its terms and conditions are met.
Classical monetization which is known as in Arabic (Tawarruq ghair munazzam) is defined as, it is the process of purchasing the commodity on deferred payment and selling it to the third party other than the seller without the involvement of the first seller in selling it to the third party.
To ensure that a tawarruq transaction is Shariah-compliant, the following terms and conditions must be adhered to:
i- The contractual requirements for Murabaha (markup sale) and musawamah (bargaining) must be properly fulfilled.
ii- There must be a real commodity that the seller owns before selling it.
iii- The commodity must not be gold, silver, or currency, as deferment in these forms is not permitted under Shariah.
iv- The commodity must be clearly identified and distinguished from the seller’s other assets. This can be done by separating it physically or recording its identifying documents, such as storage certificates.
v- If the commodity is not physically available at the time of the contract, the client must be given its full description and storage location to ensure that the contract reflects a genuine transaction rather than a fictitious sale.
vi- The buyer must take actual or constructive possession of the commodity, without any future conditions or delayed procedures for receiving it.
vii- The deferred payment contract for purchasing the commodity and the spot price contract for selling it to a third party must not be linked, as this would deprive the client of their right to receive the commodity. Such linking of contracts, whether through stipulation, acceptance, or market norms, is prohibited.
viii- The client must not delegate the institution (or its client) to sell the same commodity that was purchased from the institution. However, if regulations prevent the client from selling the commodity independently, they may delegate the institution only after taking actual or constructive possession.
ix- The institution must not arrange a third-party proxy to sell the commodity on behalf of the client.
x- The client must sell the commodity independently or appoint an agent other than the institution to sell it on their behalf.
If all the required terms and conditions are met, the tawarruq transaction will be considered Shariah-compliant, according to the majority of scholars.
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Organized monetization is the process of purchasing a commodity from the local or international market at a deferred price and then selling it at a spot price to a third party, while the overall transaction is managed by the original seller.
This type of tawarruq is impermissible from a Shariah perspective as it closely resembles Bai' al-Inah or, in some cases, results in the commodity returning to the original seller.
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According to AAOIFI, Bai' al-Inah is defined as the process of purchasing a commodity at a deferred price and then selling it back to the same party at a lower spot price from whom it was originally purchased.
If someone approaches a conventional financial institution for a loan, the institution will only provide it on an interest basis. In bai al-inah, the commodity is merely included to make the transaction appear as a sale contract,
whereas, in reality, the commodity returns to the seller, and the buyer pays an excess amount, effectively resembling an interest-bearing loan. According to the majority of scholars, bai al-inah is a Shariah-impermissible contract.
Islamic banks use monetization techniques to finance individuals and SMEs, particularly when they need liquidity. Since Islamic banks cannot extend loans on an interest basis, they engage in commodity Murabaha with the client.
The bank purchases a commodity on cash from the commodity market based on the client’s cash requirement. After taking possession of the commodity, the bank sells it to the client on a deferred payment basis.
The client then resells it to a third party, other than the bank, at a spot price to obtain liquidity. The client repays the amount in instalments. This is the overall process of monetization in Islamic banks.
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References:
Dewaya, M. A. (2024). Innovation in Islamic finance: Review of organized banking Tawarruq. Review of Islamic Social Finance and Entrepreneurship, 199-211.
https://aaoifi.com/ss-30-monetization-tawarruq/?lang=en
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
