Tawarruq Issue and Challenge PDF

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TAWARRUQ: ISSUE & CHALLENGEBy: Shochrul Rohmatul Ajija, Mia Fathia, and Agusdiwana Suarni 1ABSTRACTCommodity tawarruq financing has been the most widely used form of liquidity management instrument to date, due to its ease of execution and wide acceptability among IFIs and banks. In recent y...

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TAWARRUQ: ISSUE & CHALLENGE By: Shochrul Rohmatul Ajija, Mia Fathia, and Agusdiwana Suarni1

ABSTRACT Commodity tawarruq financing has been the most widely used form of liquidity management instrument to date, due to its ease of execution and wide acceptability among IFIs and banks. In recent years, however, some of the IFIs have been reluctant to use commodity tawarruq instruments due to their disapproval of the concept of tawarruq. Therefore, analysis about tawarruq is very essential and many studies have been done on it. Nevertheless, study about the comprehensive review of tawarruq according to scholar‟s view and analysis of tawarruq in practice is limited and this paper attempt to fill this gap. Using literature analysis, this paper attempts to provide the views and verdicts of jurist regarding tawarruq in the banking system. Furthermore, it will also critically provide their textual evidence and rational arguments in order to reach a final juristic judgment. Key words: Tawarruq, Scholar‟s View

1.

Introduction

In the name of Allah, the most Beneficent the most merciful All praise for Allah, may peace and blessing be upon the messenger of Allah Muhammad, the last messenger of Allah, his household, his companions, and, those who follow and support him. One of the most widely discussed topics of the Islamic banking system in recent times has been that of tawarruq which was invented on 1421 H, by several banks in Saudi Arabia fallowed by other banks in Bahrain, Kuwait, Qatar, and United Arab Emirates. That is because Islamic banks have employed this financial instrument extensively. They do so because they believe it ensures that depositors will continue to do business with them and because it provides the liquidity that is considered to be their lifeblood. (Bouheraoua, 2009)

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Juristic views about it are divided. Some scholars permit it, based on the legality of sales founded on mutual consent, as well as the presence of a third party that excludes it from the form of the prohibited „inah sale. Others stipulate certain conditions for its acceptability; while others prohibit this type of transaction altogether, considering it a ruse by which Islamic banks provide legal sanction for riba (usiry/interest), which is unanimously agreed to be prohibited. (Bouheraoua, 2009). Therefore, this paper attempts to provide the views and verdicts of jurist regarding tawarruq in the banking system. Furthermore, it will also critically provide their textual evidence and rational arguments in order to reach a final juristic judgment. The structure of the paper is as follows: Section 2 provides the definition and form of tawarruq. Section 3 analyzes the similarities and differences between tawarruq and „inah. Section 4 attempts to tackle tawarruq in practice used case study of Bank Islam Malaysia. Section 5 discusses the scholar‟s view and evidence in tawarruq, and the last section is conclusion and recommendation.

2.

Definition and Forms of Tawarruq

2.1.

Definition of Tawarruq

2.1.1. Literal Meaning of Tawarruq According to Bouheraoua (2009) tawarruq comes from “masdar” the verb taqarruqa is said Tawarruq al-hywan which it means the animal at the leaves. Khayat (2006) also mentions that tawarruq comes from the word wariq as it mentions in surah AlKahfi: 9

‫فابعثوا احدكم بورقكم ىذه الى المدينو‬ “So send one of you with this silvery coin of yours to the town.” Which it means Dirhams made of silver. However, there are two different accents in the Arabic language (wariq-warq). Furthermore, Tawarruq and the verb derived from al-warraq are not directly traceable in the Arabic language; linguists mention only variable nouns, as an al-Iraq (which applied to become rich) and alistiraq (which applied to a man who is seeking Dirham or money). So the term tawarruq is invented by the scholars for the one who may be pressure himself on how to obtain “al-wariq.”

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2.1.2. Technical Meaning of Tawarruq Dusuki (2008) defines tawarruq technically as the purchasing of a commodity on credit by the mutawarriq (seeker of cash) and selling it to a person other than the initial seller (3rd party) for a lower price on cash. Actually, tawarruq is a sale contract, whereby a buyer buys an asset from a seller on deferred payment and subsequently sells the assets to the third party for cash, with a price lesser than the deferred price. This transaction is called tawarruq, mainly because when the buyer purchases the asset on deferred terms, it is not the buyer‟s intention to utilize the benefit from the purchased asset, rather to facilitate him to attain liquidity (waraqh maliah). Khayat (2006) explains that according to Malikis, tawarruq means selling something on deferred basis and then buying it back in cash, albeit at a lower price than the deferred price. For example, someone sells his commodity at a price that is already known to be paid by the deferred payment. He then buys it at a lesser price than the deferred price. It is known because of obtaining the money for sahib al-inah. This is because al-ain is the present property from the money. This is one of the practices of the Hanafis. According to the Shafi‟is, tawarruq means selling something on deferred payment, and then buy it back in cash, albeit at a lower price than the deferred price. Furthermore, the Hanbalis said in kitab Syarh Muntaha Al-Iradat, known as Daqaiq Awla An-Nahyu Li syarhi Al-Muntaha that bai‟ al-„inah by the name of tawarruq is the need for cash, buying the equivalent of thousands and more to expand its price and there is nothing wrong with that and it is known as tawarruq. In Muntaha Al-Iradat Fi Jam‟i Al-Muqni‟ Ma‟a At-Tanqih Wa ziadat, “If someone bought something on credit or he did not pay the price, it then becomes forbidden and the sale is invalid to its buyer by cash purchase less than the first price, and it is a tool to the second, except change its feature and it is known as the problem of „inah, because the commodity of the buyer in deferred is taken instead of it. 2.2.

Forms of Tawarruq

According to Bouheraoua (2009), the kinds of tawarruq are two. Those are classical tawarruq (Al-Tawarruq at-Fardi) and organized tawarruq (Al-Tawarruq alMunazzam). Classical tawarruq is defined as the purchase of a commodity possessed owned by the seller for a delayed payment, whereupon the buyer resell the commodity for cash to other than the original seller in order to acquire cash (al-wariq). 3

Whereas, Fahmy et.all (2008) mentioned that the contemporary definition on organized tawarruq is the transaction that a person (mustauriq) buys commodity from local or international market at a deferred price. Simultaneously, he (mustauriq) will ask the financier in his own capacity or through his agent or by special agreement with mustauriq to rearrange the sale transaction usually at a lower spot price. 2.3.

Modus Operandi of Tawarruq

Modus operandi of classical tawarruq is shown as following picture: Figure 1: Classical Tawarruq 1. Purchase commodity on cash Trader A

Islamic Financial Institution

2. Transfer commodity ownership

Trader B

4. Transfer commodity ownership

5. Sell commodity * on cash

3. Sell commodity on deferred price (Cost + Profit) 6. Transfer ownership Counterparty

*In practice, the Counterpart will appoint the bank as his agent to sell the commodity to Trader B on cash basis in the commodity market Source: Fahmy et.all (2008)

According to Fahmy et.all (2008), the modus operandi of classical tawarruq is: 1. The Islamic Financial Institution (IFI) purchases commodity from Trader A in the commodity market on cash basis; 2. Ownership of the identified commodity will then be transferred to IFI; 3. Thereafter, the IFI sells the commodity to the Counterparty (e.g. other Islamic financial institutions, or client) on deferred price, i.e. cost price plus profit margin); 4. The ownership of the commodity will be transferred to the Counterparty; 5. The Counterparty will then sell the commodity to Trader B on cash basis in the commodity market;

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6. Finally, the ownership of the identified commodity will be transferred to Trader B. In addition, the most important thing that must be underlined is that in the classical tawarruq structure, each transaction shall be independence. Nevertheless, in practice, to achieve cost effectiveness, IFI will be appointed as an agent to sell the commodity to third party on behalf of the Counterparty; that is called organized tawarruq.

Figure 2: Organized Tawarruq 1. Deliver warrants Islamic Financial Institution

2. Sell warrants

1. Pay Spot

3. Appoint IFI as agent to sell warrant

Trader A

3. Sell Warrant as Agent

5. Pay Deferred Trader B

Counterparty

Note: Majority of commodity Murabahah transactions use London Metal Exchange (LME) base metals as an asset since they meet all criteria for a commodity (i.e. no-perishable, freely available and can be uniquely identify) and are easily identifiable via warrants. Source: Fahmy et.all (2008)

The organized tawarruq is usually practiced on the commodity murabahah which is the most commonly used liquidity management instrument by IFI. This is because IFI can get a fix return from this instrument. Furthermore, following figure illustrates how organized tawarruq works in the case of commodity Murabahah when an IFI provides funds to its counterparty to earn profit. The description of organized tawarruq is as following steps: 1. IFI purchases warrants from Trader A and pay spot. 2. IFI will then sell the warrants to the Counterparty. The Counterparty accepts the offer from the IFI to purchase warrants on a deferred payment basis, where the mark-up and the repayment date are pre-agreed.

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3. The Counterparty appoints IFI as an agent to sell warrants on its behalf. The IFI now acts as an agent to sell the warrants at spot to another Trader B. Alternatively; the Counterparty could sell the warrants in the open market. 4. Payment made to the Counterparty; ownership of warrants transfer to the end buyer. In most of the case, whether the Counterparty requests the IFI to sell the warrants on its behalf or arrange to sell to third party by itself, the Counterparty will be paid the spot counter value of the warrants. 5. Deferred payment will be made by the Counterparty to the IFI. This payment takes place at a pre-agreed time in the future and consists of the principal of the original purchase plus a pre-agreed mark-up. The net result of the above movements of warrants and cash is that the counterparty now holds an amount of money against an offsetting payment to the IFI for a pre-agreed principal plus a mark-up at a pre-agreed future date, thus creating a synthetic deposit. From that explanation, the tawarruq process seems to be very simple. However, extra care should be taken while undertaking such transaction, and it should be ensured that the transaction does not become a mere exchange of papers between two brokers, and one or two financial institutions. IFI needs to understand that tawarruq arrangement should be used in extreme cases where no option is available to avoid interest. Widespread use of this tawarruq is harmful to the industry in the long run. Therefore, Shariah Board needs to strictly monitor all tawarruq based transaction which includes the commodity Murabahah.

3.

The Similarities and Differences between Tawarruq and ‘Inah

The similarities and differences between tawarruq and „inah must be known especially there are many scholars that claim tawarruq as „inah which is prohibited by many scholars. Bouheraoua (2009) describes that tawarruq and „inah are congruent in terms of the purpose behind them, which is to acquire cash. In addition, they are also congruent in that they result in the payment of a greater amount of immediate cash in consideration of the delay. Generally, the modus operandi of „inah is as following picture:

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Figure 3: Modus Operandi of ‘Inah

How can I borrow RM100,000 to get married?

RM 150,000

RM100,000

Source: Dusuki (2008)

However, tawarruq and „inah differ in terms of the return of the commodity sold. The requester of „inah will return the commodity back to the seller, whereas the mutawarriq in the individual form of tawarruq will sell the commodity to a new buyer other than the first buyer with neither the arrangement nor the knowledge of the first seller. However, in organized tawarruq he arranges with the first seller to sell it to a third party or return it to its first seller.

4.

Tawarruq in Practice: Case Study of Bank Islam-Malaysia

Firoozye (2009) mentions that tawarruq in practice has become an institution and as in many institutional frameworks, has been streamlined and risk managed. The actual goal of securing finance for a fixed term is emphasized over all else, since classical tawarruq has too many moving parts and risk managers the world over could complain. The result is that the bank plays the intermediary in all transactions, the client having essentially no ownership (nor interest in actual or legal sense) in the underlying asset. The end result is called organized tawarruq. Moreover, Dabu (2008) stresses that the goal of tawarruq actually is to get cash which is clearly stated in the notices of Islamic Banks and their brochures. The major reason that prompts the said banks and financial institutions to practise

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tawarruq is that in most cases, is to free from the constraints of the balance sheet, as the financial accounting rules take into account the principle of capital adequacy, and provision for managing bad debts (doubtful debts), which would hinder the activities of finance in general, slow down the circulation of capital and reduce the profitability of the Bank. In this case, tawarruq is considered an appropriate substitute, due to the fact that it can rotate part of the liquid assets for tawarruq of non-liquid assets that guarantee the bank‟s debts to the other person, without an increase of risks to the bank that is without any need for a special supervision in the general budget. One example of bank that practices tawarruq in Malaysia is Bank Islam. According to Bank Islam (2009), in regards to Murabahah Commodity, Bank Islam is executed to serve house and fixed asset financing, vehicle financing and personal financing. Moreover, step by step process flows of tawarruq practiced in Bank Islam are explained on this following picture:

Figure 3: Tawarruq Structure Diagram of Bank Islam

Source: Bank Islam (2009)

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Descriptions: 1. The costumer applies financing product based on tawarruq concept from the bank. Bank obtains tawarruq transaction documents from the costumer. 2. Bank will buy the commodity at LME through broker 1. 3. Under the murabahah contract, bank then sells the commodity to the costumer at bank‟s selling price (principle profit) on deferred payment term. 4. Under the wakalah contract, costumer requests bank to sell the commodity in the market. 5. Acting as the appointed sale agent for the costumer, bank sells the commodity to broker 2. 6. Bank then credits the wariq (proceed) from the sale of commodity to the costumer‟s account. 7. Finally, costumer pays amount due to the bank (principal + profit) by way of agreed installment method. Furthermore, to ensure the product is inline with Shariah, Alhadad (2003) mentions that there are some conditions that must be met by Bank Islam in carrying out the above transaction: 1. The contract of deferred sale should be Shariah compliant, either by negotiation or murabahah and make sure that the commodity exists and possessed by the seller before he sells it. In case of binding promise, the promise should only be from one party. Moreover, the subject matter should not be gold, silver or currencies; 2. The commodity must be precisely determined, either by possessing or by serial number of its documentation, such as the serial numbers of warehouses certificates; 3. If at the time of concluding the contract, the commodity does not exist, then the seller must provide full information regarding the description, quantity and the place the commodity is stored to the client, in order to ensure that the sale is genuine not nominal. Preferably, the transaction should use local commodities; 4. There should be real possession of the commodity, and there should not be any obstacle that prevents the client to hold the commodity;

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5. The commodity should be sold to a third party, and not to the first seller, so that sale of „inah is avoided. Additionally, the first seller should not get back the commodity by any condition, collusion or through customary practices; 6. There should not be any link between the contract of purchase at deferred price and the contract of sale at cash price, by a way that forbids the client to hold the commodity, either the link is stated in the contract or due to customary practices or by the nature of the procedures; 7. The client should not appoint the company (which deals with the international markets of commodities) or its agent to sell the commodity that the client has bought. However, if the system in the market does not allow the client to sell the commodity by himself, the client can assign the company as his agent to sell the commodity, on condition that the sale should be done after the client has held the commodity; 8. The company should not appoint another agent to sell the commodity (which was sold by the company – first seller) on behalf of the client; 9. By taking other provisions into account, the client should sell the commodity himself or through another agent (not the company); and 10. The company should provide full information, in order to enable the client to sell the commodity, either by himself or through his agent.

5.

Scholar’s View and Evidence in Tawarruq

There are two scholarly views on tawarruq. The first view is that tawarruq is permitted, either by absolute permission or disapproved permission and the second view is that tawarruq is prohibited. 5.1.

The Scholars that Permitted Tawarruq

In regard with the prohibition of tawarruq by some Muslim Scholars or jurists such as Umar bin Abdul Aziz, Ibn Taymiyyah, Ibn Alqiyym and Mohammed bin Allasan Alshaibani, conversely, some of Muslim jurists agree to the implementation of tawarruq. The evidences that are used to allow real tawarruq are as follows: Firstly, tawarruq is form of trade or sale which is permissible by Shariah. It is included in the general commandment of Allah that said: “Allah has allowed trade and has prohibited riba.” (Surah: Al-Baqarah: 257). So, the tawarruq is kind of trade that permitted except there is statement from source of Islam that prohibit it. It is clear

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that tawarruq sale is legally permissible, because the basic ruling on sales is al-ibaha (legalization) as mentioned in the previous surah, al-Baqarah 257 and there in no trace of a riba in this type of sale, whether deliberately or ostensibly, and because it is the need that calls for that for refunding of debt, or marriage and so on and so forth. It was reported by Abu Said al-Khudri and Abu Hurayrah (R.A) that the Messenger of Allah (peace be upon him) appointed a man as his agent in Khaybar. He brought some junayb dates to the Prophet (peace be upon him), who asked him, “Are all the dates of Khaybar like this?” The man replied, “No, I swear by Allah, O Messenger of Allah; we exchange a s...