Tawarruq declared impermissible by the OIC Fiqh Academy

Analysis on Islamic Banking, June 2009

As the key product in the Islamic banking industry is declared impermissible and attention turns to AAOIFI - the industry standards body - for direction, Islamic Banker investigates the ruling and its repercussions.

Tawarruq, also known as Reverse Murabaha or Monetization, is a widely used instrument to obtain cash immediately.

As shown by the below diagram, Tawarruq is essentially very similar to the standardMurabaha structure, with one additional leg. The standard part of the structure involves the Bank buying the commodity from the "Goods Supplier", paying £100. The bank then sells the commodity to "UK Purchasing Company" on a deferred basis, that is, the bank charges "UK Purchasing Company" £110 due in, say, five years time. The final step involves UK Purchasing company selling the commodity to the "Goods buyer" for an immediate cash payment of £100.

Source: Tax Adviser; Mohammed Amin Islamic Finance Blog,

What makes this contract popular with the bankers? Tawarruq is not only easy to use, but it is also flexible. In an industry that is very short on Sharia compliant products that provide cash "today", the Tawarruq contract was seen as an alternative. Secondly, it is also possible to roll over the contract, hence providing additional funding.

OIC Fiqh Academy Ruling

According to the Fiqh Academy there is a real distinction between "classical" and "contemporary" practice ofTawarruq. The cash obtained in the classical Tawarruq is determined by market forces, whereas, in the contemporary version the contract is "arranged"... that is "simultaneously, the mustawriq ("UK Purchasing Company") and the financier executes the transactions, usually at a lower spot price".

With this in mind, the Fiqh Academy has thrown its weight behind the classical version of the Tawarruq contract, whilst declaring the widely used contemporary version impermissible.

Are there any other alternatives? The Fiqh Academy suggests that the market should embrace Qard Hasan(benevolent or interest free loans) and "institutions are encouraged to set up special Qard Hasan Fund."

One thing is for certain - the ruling by the Fiqh Academy is certainly brave and the implications of this announcement might be huge. In an industry, where the vast majority of transactions are "arranged" rather than left to market forces, many practitioners will be worried about other products coming under the Fiqh Academy's radar, including the ubiquitous Murabaha contract.

This point can be cemented further - AAOIFI standards 2/1/3, for Murabaha, state: "... it is permissible to prepare a single set of documentation to include both the customer's stated wish that the institution should buy the item from the supplier and a promise to buy the item from the institution, which the customer signs..."

Indeed, speaking at the Utrujj foundation in the UK, Shaykh Nizam Yaqubi, a leading scholar and a member of the AAOIFI Sharia' board, expressed disappointment that a compromise was not reached.

In particular, Shaykh Nizam rejected the idea of Qard Hasan as a solution arguing that Islamic banks were socially responsible banks that had to deliver returns to their shareholders.

The need for cash...

Ultimately, this boils down to one question: what do you say to an individual/institution that wants cash immediately? Should they be referred to the conventional system (where there is universal agreement on theimpermissibility) or should Islamic banks come up with solutions?

We can deal with the question head on, by asking: why does the individual need cash immediately? Certainly, Islam encourages people to live within their means and simply placing emphasis on credit will cause long term damage. However, in reality, the vast majority of people choose to live beyond their means, with the banking industry facilitating this process.

As attention turns to AAOIFI, there is no doubt that the OIC Fiqh Academy's ruling will be a wake-up call to many market participants. To the idealists in the industry, it is hoped that the focus will shift from debt to equity. However, the realists continue to argue that as long as the industry remains in the "nascent" stage, it has no choice, but to replicate conventional products.

Notes:

1. Mohammed Amin, et al., (Sept. 2008), Islamic finance: the tax adviser's role, Tax Adviser

2. Mohammad Nejatullah Siddiqi (Feb. 2007), Economics of Tawarruq

3. AAOIFI (2008), Sharia Standards for Islamic Financial Institutions,

4. Mohammed Amin, (Feb. 2007), Foreign investors applying Shariah compliant finance when investing into the United Kingdom, Islamic Finance Blog

5. ISRA (Apr. 2009), OIC Fiqh Academy Ruled Organised Tawarruq Impermissible

Link: http://www.islamicbanker.com/tawarruq-fiqh-academy-aaoifif.html