TAWARRUQ — THE ‘NEW KID’ IN IS­LAMIC BANK­ING

The au­thor­i­ties, how­ever, need to put cer­tain pa­ram­e­ters and lim­i­ta­tions in the use of the con­cept

New Straits Times - - Opinion - mah­bubi@iais.org.my The writer is a re­search fel­low at the In­ter­na­tional In­sti­tute of Ad­vanced Is­lamic Stud­ies (IAIS) Malaysia

IS­LAMIC fi­nan­cial prod­ucts have evolved from sim­ple and straight­for­ward struc­tures to highly so­phis­ti­cated and mul­ti­fac­eted in­stru­ments. Dur­ing the 1980s and 1990s, Is­lamic fi­nan­cial prod­ucts were dom­i­nated by de­posits and sav­ings, syn­di­cated project fi­nanc­ing, syariah-com­pli­ant stocks and mu­tual funds.

The last decade has wit­nessed the un­veil­ing of more com­pli­cated struc­tures, in­clud­ing var­i­ous sukuk mod­els, de­riv­a­tives, Is­lamic struc­tured prod­ucts, Is­lamic hedge funds, and oth­ers. Most, though not all, of them are re­verse-en­gi­neered repli­ca­tions of con­ven­tional prod­ucts, splic­ing to­gether nom­i­nate con­tracts from the Is­lamic fiqh legacy with a few mod­i­fi­ca­tions to sat­isfy le­gal re­quire­ments and be “syari­ah­com­pli­ant”.

Tawarruq, a fi­nan­cial in­stru­ment in­volv­ing a se­ries of sale con­tracts con­ducted in suc­ces­sion — a per­son pur­chases a com­mod­ity from a seller on de­ferred ba­sis and sub­se­quently sells it to a party other than the orig­i­nal seller on a cash ba­sis for the pur­pose of ob­tain­ing liq­uid­ity — is “the new kid on the block”.

It has fa­cil­i­tated the launch of un­prece­dented and so­phis­ti­cated Is­lamic fi­nan­cial prod­ucts, rang­ing from de­posit and fi­nanc­ing in­stru­ments, to liq­uid­ity man­age­ment and debt re­struc­tur­ing, sov­er­eign and pri­vate sukuk struc­tur­ing, and risk man­age­ment and hedg­ing in­stru­ments. It is well ac­cepted by mar­ket play­ers due to its flex­i­ble na­ture that al­lows Is­lamic fi­nan­cial in­sti­tu­tions (IFIs) to pro­vide cash with pre­de­ter­mined fixed in­come, just like its con­ven­tional coun­ter­part.

As a case in point, tawarruq, pop­u­larly known as com­mod­ity muraba­hah, has be­come a new phe­nom­e­non in the Malaysian Is­lamic bank­ing sys­tem. This is par­tic­u­larly af­ter the is­suance of a 2012 Bank Ne­gara Malaysia cir­cu­lar on bay’ inah (sale and buy­back), which sub­stan­tially tight­ens the syariah re­quire­ments for it. This, in turn, cre­ates prac­ti­cal dif­fi­cul­ties when ap­ply­ing bay’ inah in the mod­ern fi­nan­cial land­scape. Since then, Malaysian Is­lamic bank­ing sys­tem has started to ac­tively use tawarruq as an al­ter­na­tive to bay’ inah. Some have even phased out bay’ in­ah­based prod­ucts from their port­fo­lios.

The re­sult is ob­vi­ous. Tawarruq has evolved as a dom­i­nat­ing con­cept in Malaysian Is­lamic banks. A sur­vey I con­ducted in 2015 re­vealed that tawarruq rep­re­sented more than 80 per cent of the to­tal fi­nanc­ing port­fo­lio in three Malaysian Is­lamic banks, be­tween 61 per cent and 80 per cent in six Is­lamic banks; and be­tween 40 and 60 per cent in two Is­lamic banks. The rest ap­plied tawarruq in rel­a­tively smaller por­tions, con­sti­tut­ing less than 40 per cent of their to­tal fi­nanc­ing port­fo­lio.

Nev­er­the­less, the ex­ten­sive use of tawarruq in IFIs has stirred a plethora of con­tentious queries from both syariah schol­ars and Mus­lim economists. The fact that tawarruq is de­signed to merely mimic the char­ac­ter­is­tics of con­ven­tional prod­ucts chal­lenges the claims of Is­lamic fi­nance pro­po­nents that IFIs of­fer a gen­uine al­ter­na­tive to con­ven­tional fi­nance. As a re­sult, the prospects that IFIs can of­fer solutions to the eco­nomic prob­lems caused by the con­ven­tional fi­nance are dim­ming. The In­ter­na­tional Is­lamic Fiqh Academy, a sub­sidiary or­gan of the Or­gan­i­sa­tion of Is­lamic Co­op­er­a­tion, in its 19th meet­ing — held in Shar­jah, the United Arab Emi­rates in 2009 — re­solved that the mod­ern prac­tice of tawarruq is im­per­mis­si­ble.

This is mainly due to the ab­sence of a true and gen­uine trans­ac­tion — a se­ries of trans­ac­tions be­tween the bank and the cus­tomer is ex­e­cuted si­mul­ta­ne­ously in ex­change for a fi­nan­cial obli­ga­tion. The ar­range­ment has been de­signed to of­fer quick cash to the cus­tomer for a higher amount in the fu­ture, which is con­sid­ered to con­tain the el­e­ment of riba. The Ac­count­ing and Au­dit­ing Or­gan­i­sa­tion for Is­lamic Fi­nan­cial In­sti­tu­tions, in its Shariah Stan­dard No. 30, Para­graph 5/1, 2008, clearly states that tawarruq should only be em­ployed as a last re­sort when an in­sti­tu­tion faces a liq­uid­ity short­age that could harm its sus­tain­abil­ity. It should not be used as a mode of in­vest­ment or fi­nanc­ing for the pur­pose of profit mak­ing.

Dusuki et al. (2013) sum­marised four ma­jor con­cerns raised by syariah schol­ars on the mod­ern prac­tice of or­gan­ised tawarruq.

FIRSTLY, many com­modi­ties used in the prac­tice are junk and de­fec­tive.

SE­CONDLY, the tawarruq le­gal doc­u­ment is em­bed­ded with the clause that the cus­tomer is re­stricted from tak­ing de­liv­ery of the com­mod­ity pur­chased. This is par­tic­u­larly true in the case of tawarruq trans­ac­tion con­ducted via the Lon­don Metal Ex­change.

THIRDLY, the com­mod­ity rarely gets phys­i­cally trans­ferred from the seller to the buyer.

FOURTHLY, the in­clu­sion of agency in the tawarruq ar­range­ment makes the con­tract sim­i­lar to the pro­hib­ited ‘inah (a fic­ti­tious, ma­nip­u­la­tive trans­ac­tion for ob­tain­ing cash in­volv­ing a com­mod­ity which is re­turned to the same seller for a lower price).

On the op­er­a­tional side, tawarruq as­sumes a rel­a­tively high de­gree of syariah non-com­pli­ance risk as com­pared with other con­tracts mainly be­cause it in­volves a se­ries of sale con­tracts that are con­ducted in suc­ces­sion.

A proper re­view and due dili­gence is cru­cial be­fore the con­tract ex­e­cu­tion. Ex­treme care should be taken to en­sure that the ar­range­ment does not re­flect a mere ex­change of pa­pers.

As such, the Malaysian reg­u­la­tors and syariah com­mit­tees have to put cer­tain pa­ram­e­ters and lim­i­ta­tions in the use of tawarruq . This is for a num­ber of rea­sons:

FIRST, the prac­tice of tawarruq in IFIs is dis­puted among syariah schol­ars across ju­ris­dic­tions. This in turn im­pedes the in­ter­na­tion­al­i­sa­tion of Is­lamic fi­nance as pro­mul­gated by the Malaysian gov­ern­ment;

SEC­OND, the over­whelm­ing use of tawarruq does not sub­stan­tially add to the IFI value prepo­si­tion and eco­nomic growth due to debt na­ture in­her­ent in the con­cept; and,

THIRD, tawarruq re­quires more pru­dent risk mit­i­ga­tion be­cause it is prone to ex­po­sure to a large vol­ume of syariah non-com­pli­ance events.

The fact that ‘tawarruq’ is de­signed to merely mimic the char­ac­ter­is­tics of con­ven­tional prod­ucts chal­lenges the claims of Is­lamic fi­nance pro­po­nents that Is­lamic fi­nan­cial in­sti­tu­tions of­fer a gen­uine al­ter­na­tive to con­ven­tional fi­nance.

FILE PIC

‘Tawarruq’ has be­come a new phe­nom­e­non in the Malaysian Is­lamic bank­ing sys­tem, par­tic­u­larly af­ter the is­suance of a 2012 Bank Ne­gara Malaysia cir­cu­lar on ‘bay’ inah’ (sale and buy-back).

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