Executive Summary
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Tawarruq is a financing method used by most Islamic financial institutions in the world.
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It consists of a sale contract whereby the client buys a commodity from the bank for deferred payment and then sells it to a third party for cash at a price that is lower than the deferred price. The result being that the bank’s client gets an immediate liquidity without having recourse to prohibited interest-based loans.
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This mode has long been accepted by many shariah scholars as a way of acquiring liquidity.
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However, the indiscreet use of this practice, created many shariah risk issues due to some specific structures that derived from it.
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This has pushed many scholars, initially favorable to this mode, to call for a reassessment of its validity.
Introduction
At a time when the global Islamic finance industry is gaining increasing acceptance from both Muslim and non-Muslim investors, many challenges emanating from the lack of harmonization have yet to be overcome. The fact of the matter is that the Islamic financial market is still witnessing inconsistencies in nomenclature from one region to another, with certain products considered as halal (permissible) by some scholars and declared haram (impermissible) by others.
One of these financial products that create confusing situations in Islamic finance is tawarruq, also known as “commodity murabahah.” Tawarruq is a mode of finance that involves a tripartite sale contract whereby one party buys an asset from a vendor for deferred payment and then sells it to a third party for cash at a price that is lower than the deferred price.
This mode is very popular with bankers as a rapid and flexible way of acquiring liquidity. In fact, by using tawarruq bankers avoid constraints related to capital adequacy and allay the provision for managing doubtful debts. Tawarruq can also be used in more complex structures, such as Islamic foreign exchange swaps, where it helps to hedge against currency rate fluctuation risks. These kinds of contract combinations, replicating interest-based loans in the form of a deferred liability, have been practiced by many Islamic banks for more than three decades. However, there has never been a consensus on their permissibility, and there are even some shariah scholars who were initially open to such practices but later called for a reassessment of the product in order to avoid opening the door of riba (usury).
Before going into the arguments put forth by the proponents/opponents of the practice, it is relevant to differentiate between the different types of tawarruq. The first type is “real tawarruq,” which occurs when a person that needs cash (referred to as a mustawriq) buys a commodity from a bank at a deferred price and subsequently sells it to another party or bank for cash and hence gets his or her needed cash. The second type, “organized tawarruq,” also called “banking tawarruq,” is practiced when a person buys a commodity from a bank on a deferred-price basis and the bank arranges the sale agreement either itself or through an agent. The mustawriq and the bank execute the transactions simultaneously, usually at a lower spot price. The difference between the two types of tawarruq is that the customer in the organized tawarruq does not receive the commodity and is not engaged in selling it, while the customer of the real tawarruq has the choice to either keep the commodity or sell it himself. Most organized tawarruq involve international commodities such as minerals. There is also a third type of tawarruq, called “reverse tawarruq.” Its form is similar to organized tawarruq, except that the mustawriq is the Islamic bank and it acts as a client. The same shariah rules apply to both organized and reverse tawarruq.
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