As discussed in our previous articles, Islamic banks solve customer needs through number of ways. All Islamic banking contracts entail buying or selling of goods or services.
But what if the customer needs liquid cash for his miscellaneous personal use? Remember that money is not a commodity which can be bought or sold.
And what if the customer wishes to pay off debt in another bank? Remember that a debt cannot be bought or sold unless it is done at cost.
This is where Tawarruq contract comes in. Tawarruq means converting an asset into ‘wareq’ or money.
Simply put, it is liquidating of an asset in order to satisfy customer needs for liquid cash in accordance with Sharia’h principles of Islamic finance. Tawaruq is also reffered to as Commodity Murabaha, Reverse Murabaha or Monetization.
It is a financial instrument in which the buyer purchases commodity from the seller on a deferred payment basis, and sell the same commodity to a third party on a spot payment basis. He is able to obtain cash which he can utilize for his financial needs.
Tawarruq is a murabaha with additional leg. Whilst in Murabaha the customer purchases the item on differed payment for use of consumption, in Tawarruq the item which is also purchased on differed payment is sold immediately by the buyer on cash. Remember that the aim of the arrangement is to help the customer get immediate cash.
- Customer applies for facility e.g. to pay of debt
- The facility is approved under Tawaruq
- Bank Purchases a fast moving commodity such as oil.
- The bank sells the commodity at cost plus profit to the client on differed payment.
- Bank and customer enter into agency agreement.
- The commodity is sold on behalf of the client on cash.
- The cash is then put in the customer’s account
- Customer repays the bank at cost plus profit over agreed period of time.
There is a scholarly dispute with regards to Tawarruq. Those opposed to the product say that the process simply circumvents Riba because the intention of the commodity purchases is not for use of the commodity but acquire cash. They argue that there is no real economic activity but just steps meant to circumvent riba.
Scholars who accept Tawarruq contract as valid note that it is based on two valid legal contracts, murabaha and sales. That the bank sells the commodity to the customer through Murabaha which is a valid contract and then the customer sells the same to realise instant cash.
Despite the controversy, however, leading Islamic banks, including the United Arab Bank, QNB Al Islamic, Standard Chartered of United Arab Emirates, and Bank Muaamalat of Malaysia, use Tawarruq.
Legitimacy of Tawarruq
The legitimacy of the Tawarruq arrangement is derived from the Quran and Sunnah of Prophet Muhammad ﷺ. Quran chapter 2 verse 275 implies the general permissibility of sales contract including Tawarruq; “…whereas Allah has permitted trading and forbidden usury”.
There is no direct juristic authority from the Sunnah of the Prophet ﷺ regarding the legitimacy of the Tawarruq. It is deemed permissible based on the general permissibility of sales in Islamic law.
The 5th decision of the Muslim World League on Tawarruq considered it as permissible as the technique is derived on two sales contract with the ultimate buyer being not the same as the initial seller (un-organized Tawarruq).
Types of Tawarruq
There are two types of Tawarruq; organized and un-organized Tawarruq.
In organized Tawarruq, there are only two parties, i.e. no real, unconnected third party. There is concealed buy back-ina, the transaction is a ‘trick’ with an embedded fixed return. In 2003 the Muslim World League declared it as impermissible while some scholars permit it on case by case.
In unorganized Tawarruq, the client sells the commodity either himself or through an agent appointed by himself to a third party. At the very most, the bank should provide the client with the information needed to sell the commodity.
Tawarruq with the involvement of a third party is seen by the Maliki School as reprehensible but accepted by the Hanbali, Hanafi and Shafi schools of thought.
Tawarruq as a Deposit taking instrument in Islamic Banks
Customer makes a fixed deposit placement say of USD.100,000 with an Islamic Financial Institution for a 90 day period. Upon this request, the Islamic Bank executes the Tawarruq arrangement.
The Customer who is the depositor becomes or acts as a seller; He purchases certain commodities on spot basis from local/ international commodity market e.g. for USD. 100,000 and sells these commodities to the Bank on deferred payment basis (for a period of 90 days) on a cost plus margin basis of USD.100, 000 + USD. 20,000 (profit).
The Islamic Bank in turn sells the goods to a third party for cash on spot, hence meeting its need for liquid cash for placement purposes. Therefore, the Islamic Bank has in effect turned the commodities/asset into cash using an intermediary/ a commodity platform.
The Customer will receive a return that is USD. 120,000. (Purchase price + sale price) after the agreed period of placement 90 days. In other words, the customer becomes financier here.
Key Shari’ah Requirements That Make a Tawarruq Transaction Shari’ah Compliant
- Ownership of the commodities – the seller (customer/depositor) must own the commodity before selling it to the buyer (Islamic bank) on differed terms.
- Commodity is specified – the seller has to explain the details of the commodity to the buyer, size, quantity, amount etc to avoid Gharar.
- Possession of commodities – the commodities which are normally used in the contract of Tawarruq can be transferred from place to place and this kind of commodity is called a transferable commodity (manqulat). Examples include metals, cement, rice and cars.
- Avoiding ‘ina sales – ‘ina (Sale and buy back) sales are prohibited according to Islamic law. This entails the selling a commodity to someone at cash then buy the same item back to be paid on differed payment. To avoid the commodity being sold back to the seller, there has to be a third party who purchases from the buyer who is now the seller in the second transaction i.e. the transaction needs three parties to make a Shari’ah compliant Tawarruq.
- Details of the time of payments – the contract between the financial institution as the buyer and the client as the seller is based on the contract of installment sales or deferred sales in general and one of the conditions of the both contracts is that it must explain in detail the manner of payment.
- Avoiding usury – the contracting parties have to be careful not to deal with the six riba commodities such as gold, silver, dates, salt etc. Doing so means they will have been involved riba al-nasi’a.
- Delivery should be immediate – as indicated previously, Tawarruq is based on deferred or installment payment so if the delivery is deferred, the contract would then be a sale of debt for a debt and this kind of sale is not Shari’ah compliant.
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