ISLAMIC TRADE FINANCING

GROUP ASSIGNMENT OF ISLAMIC TRADE FINANCING

1.0 INTRODUCTION

Trade was recognized to be an important tool in the economy

activities. It was creating many jobs and demands for trade

financing including for import and export purpose. According

to the World Trade Organization, trade financing is a vital to

the economy by supporting almost of the global trade.

However, although the international trade was exist for

centuries, the trade finance also developed to support the

requirement and needs of exporter and importer in their

relation. Trade financing can be defined as financing for

trade which concerns for both domestic and international

transactions which involved a various activities of lending,

factoring, insurance, issuing letters of credit and export

credit.

The trade financing would help to support by providing a

various tools such as the letter of credit which is to

guarantee the payment of importer to the exporter which

functioning to maintain the contract without can be cancel in

the future. By this way, it can remove the risk from importer

who may refuse to make payment for purchasing goods as agreed

before.

Besides, an Islamic Trade Financing (ITF) activities was

increase rapidly among the members of business around the

world. It was benefitted in the form of Syariah compliant

practices in the business which would support the development

in Islamic economy and finance. It is because, ITF provided a

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strength financing supports and offers many special products

which providing more benefits to the users.

As to support the ITF, the International Islamic Trade

Finance Corporation (ITFC) was established and commenced its

operation in 2008. It is an autonomous entity within the

Islamic Development Bank Group who together encouraged intra-

trade among the Organization of the Islamic Conference (OIC).

This corporation helps the member countries such as Saudi

Arabia, Bahrain and Malaysia to gain a better access in ITF by

providing them the necessary tools to compete in the global

market.

On the other hand, various intermediaries such as banks and

financiers, importers and exporters, besides service providers

will play a big role to run this trade financing by follow the

Syariah guidelines in their activities. Islamic banks and

Islamic financial institutions will help to support the

transactions by giving trade financing parallel to the

syariah.

Normally, the importer may wish to reduce risk when

purchasing exporter goods especially for unknown exporter, so

it is necessary to ask exporter to document the good that have

been shipped, while the importer required to prepay for goods

shipped. So, the Islamic bank may provide a various forms of

ITF products such as an Islamic bank guarantee to built a

confident to the exporter.

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It is important for global economy because most countries

will rely to each other to support their necessity such as be

an importer to get the raw material which the cost would be

cheaper than local price.

So, in this assignment, we would like to discuss and

explain more about Islamic trade financing process which used

among the members in economy activities and tools involved

such as letter of credit, bank’s acceptance, shipping

guarantee and documentary collection.

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2.0 METHOD OF TRADE SETTLEMENT

Settlement (finance) of securities is a business process

whereby a securities or interest in securities are delivered

usually against in simultaneous exchange for money, to fulfill

contractual obligation, such as those arising under securities

trades. As part of performance of delivery obligations

entailed by the trade, settlement involves the delivery of

securities and the corresponding payment. On top of that,

settlement at the various custodian is increasingly moving

towards the DvP method ( the simultaneous and irrevocable

exchange of security and cash), in order to minimize the

seller’s and buyer’s risk of delivering one asset without

receiving the contra asset at the same time. This is sometimes

referred to as dependent deliveries of security or dependent

payments of cash. In other words, the delivery of security

will not be affected without simultaneous payment of cash and

vice versa.

So, in order to succeed in today’s global marketplace

and wins sales against international trade presents a spectrum

of risks which causes uncertainty over the timing of payments

between the exporter (seller) and importer (foreign buyer).

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For exporters, any sale is a gift until payments is received.

Therefore, exporters want to receive payments as soon as

possible, preferably as soon as an order is placed or before

the goods are sent to the importer. For the importers, any

payment is a donation until the good are received . Therefore,

importers want to receive the goods as soon as possible but to

delay payment as soon as possible, preferably until after the

goods are resold to generate enough income to pay the

exporter.

2.1 Type Of Method Trade Settlement For Islamic Bank

The movements of cash and securities can occur in

different ways such as cash in advance (advance payments)

or prepayments, documentary credits, documentary

collections, and open account.

2.1.1 Cash in advance/ Advance payment

( prepayments)

Under this term of settlement, the importer will

pay to the exporter the goods before the exporter

delivers them. Although full payment in advance is

obviously most desirable for the exporter, he will

only be able to obtain such terms when there is a

seller’s market or occasionally when such terms

are customary in that particular trade.

In fact, this is a credit granted by the

importer to the exporter. Being a credit, the

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importer can ask the exporter the payment of an

interest. This term is very useful for the

exporter. It is quite common for a sale contract

to require partial payments in advance. For

example, the contract could stipulate, say, 20%

payable on the signing of the contract with the

remaining 80% payable, after dispatch of the goods

under one of the other means of payments.

The risks of the exporter is the goods of

received can be specialized goods and if the

importers cancel the order before the payments is

made, the exporter cannot sells these goods

easily. Meanwhile, the risk that will be faced by

the importer is sometimes the exporter does not

send the goods, the documents can be wrong, and

the goods are sent with a delay or to a wrong

destination. Even though this terms give the risk

to the importer, but it also give advantages to

the importer, such as, the importer has the

control over the timing of settlement and the

method by which funds are remitted, the

inspections of the goods is usually possible

before the payments is made and a few arrangements

have to be made other than ensuring that funds are

available to meets payments when they are due.

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With cash-in-advance payments terms, the

exporter can avoid credit risk because payment is

received before the ownership of the goods is

transferred. Wire transfer and credit cards are

the most commonly used cash-in-advance options

available to the exporters. However, requiring

payment in advance is the least attractive option

for the buyer because it creates cash-flows

problems. Foreign buyers are also concerned that

the goods may not be sent if payment is made in

advance. Thus, the exporters who insist in this

payments methods as their sole manner of doing

business may lose to competitors who offers more

attractive payments terms. Last but not least,

this method of settlement is also used between the

old partners with a long business relationship.

Another method of advance payment can be “ 30% of

the value in advance and 70% of the value will be

paid upon the delivery”.

2.1.2 Open Account

Generally, an open account transaction is a sale

where the goods are shipped and delivered before

the payment is due which is usually in 30 to 90

days.

When a buyer and a seller agree to deal an

open account term, it means that the seller will

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dispatch his goods to the buyer and will also send

an invoice requesting payment. The seller loses

control of the goods as soon as he dispatches

them. He trust that the buyer will pay in

accordance with the invoice.

Open account is the simplest method

settlement. However, because the exporter is

delivering the goods without payments or some

other absolute means of insuring that payment is

received, this method presents the greatest risk.

Despites all of this, the majority of

international trade transactions continue to be

settled this way. Open accounts settlements also

have some advantages that make them more

attractive, for the exporter and importer but

there are also disadvantages for this type of

terms. Obviously, this option is the most

advantageous option to the importer in term of

cash flows and cost but it is consequently the

highest risk option for the exporter.

Because of intense competitions in export

markets, foreign buyers often press exporters for

open account terms since the extension of credit

by the seller to the buyer is more common abroad.

Therefore, exporters who are reluctant to extend

credit may lose a sale to their competitors.

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However, the exporter can offer competitive open

account terms while substantially mitigating the

risk of non - payment by using of one or more the

appropriate trade finance techniques, such as

export credit insurance.

2.1.3 Documentary Collection ( Drafts/ Bills of

Exchange )

A documentary collection (D/C) is a transaction

whereby the exporters entrusts the collection of a

payment to the remitting the banks (exporter’s

bank), which sends documents to a collecting bank

(importer’s bank), along with the instructions for

payments. Funds are received from the importer

and remitted to the exporter through the bank

involved in the collection in exchange for those

documents.

D/Cs involve using a draft that requires the

importers to pay the face amount either at sight

(documents against payment) or on a specified date

(documents against acceptance). The draft gives

instructions that specify the documents required

for the transfer of title to the goods. Although

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banks do acts as facilitators for their clients,

D/Cs offer no verifications process and limited

recourse in the event of non- payments. Normally,

drafts are generally less expensive than letter of

credits.

Futhermore, this type of method settlement

provides some comfort to the exporter, who will

ship the goods and then arrange for the documents

of title and collection instructions. The

documents may include a bill of exchange drawn by

the exporter on the importer for the amount of

the invoice and payable at the sight or at a fixed

or future determinable time

( under British Law).

2.1.4 Documentary Credit

The documentary credit also called as a letter of

credit which it is a conditional guarantee payment

in which is an overseas bank takes responsibility

for paying you after you ship your goods, and it

will provided you to present all the required

documents such as documents of titles, insurance

policies, commercial invoices and regulatory

documents. Besides that, documentary collection

also can be defines as international trade

procedure in which the credit worthiness of an

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importer is substitute by the guarantee of a bank

for a specific transactions.

Under documentary credit arrangement, a

bank usually undertakes to pay for a shipment,

provide the exporter submits the required

documents within a specific period. In US, this

arrangement is called “ commercial letter of

credit”. On top of that, the documentary of credit

is actually a separate contract from an export

contract. The parties to a documentary credit

deals with documents not the goods that the

documents relate to.

The main steps in a typical documentary

credit transaction are consists of five steps.

Firstly, after finalizes the export contract, the

buyer arranges with a bank to open the documentary

credits in the buyer favour. The foreign bank

(issuing bank) will check the buyer credit

worthiness. Next, The issuing bank sends the

documentary credit to an Australian Bank (advising

bank). The advising bank verify the authenticity

of the documentary credits and forward it to the

buyer (beneficiary). Third step is when the

documentary credits set out the documents, the

buyer must present to receive the payments. When

the buyer had ship the goods and compiled all the

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necessary documents, the buyer lodge with

negotiating bank. Then, the negotiating bank

checks the documents to ensure the terms of the

documentary credits have met and send the

documents to the issuing bank with a request

payment. Lastly, if the issuing bank is satisfied

with the necessary documents that provided by the

buyer in the exact form of documentary credit, it

will forward the payment to the negotiating bank,

which in turn pays to the buyer. Then, the

documentary credit will state whether you receive

payment “at sight” or at an extended term.

3.0 DOCUMENTARY COLLECTION

3.1 Definiton of Documentary Collection

Documentary collection is the collection by a bank of

funds due from a buyer against the delivery of

documents. The bank, acting as agent for the seller12


(exporter), presents documents to the buyer (importer)

through that party's bank and in exchange receives

payment of the amount owed, or obtains acceptance of a

time draft for payment at a future date. The liability

of the bank under a documentary collection is primarily

restricted to following the seller's instructions in

forwarding and releasing documents against payment or

acceptance.

Islamic documentary collections typically based on

wakalah. In the case of a seller, for example, he

nominates the bank as an agent to act on his behalf to

collect payment.

3.2 Different Between Documentary Collection an Letter

Credit or Open Account

Unlike a letter of credit, the bank does not

assume any liability to pay if the buyer does not want

or is unable to pay. Compared to open account sales,

the documentary collection offers more security to the

seller, but less than a letter of credit.

3.3 The Use of Documentary Collection

Numerous criteria are applied by businesses when

determining which payment instrument to offer as a term

of sale. However, in general, a documentary collection

would be appropriate where:

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The seller and the buyer know each other to

be reliable.

There is no doubt about the buyer's

willingness or ability to pay.

The political and economic conditions of

the buyer's country are stable.

The importer's country does not have

restrictive foreign exchange controls.

3.4 The Advantages of a Documentary Collection

There are several advantages of Documentary

Collection that will give the benefit to the users and

the applicant. Firstly, the Documentary Collection are

simple and inexpensive to handling compared to the

letter of credit which is has more expensive price.

Secondly, Documentary Collection also offer

faster receipt of payment compared to the open account

terms which has many procedures to be handle in

receiving the payment and the applicant or the users

also need to wait for a longer time to receiving the

money.

Thirdly, Documentary Collection also give the

seller retain title to the goods until the payment is

or the acceptance is made by the buyer. Thus, it will

give opportunity to the seller to keep the title of the

goods more longer.14


3.5 The Disadvantages of Documentary Collection

The Documentary Collection also has its own

disadvantages which is involve with the payment. If the

buyer refuses or is unable to pay, the seller has three

options, which could be expensive:

Find another buyer.

Pay for return transportation

Abandon the merchandise.

3.6 The Parties Involved

In Documentary Collections, there are several

party that involved in its management:

Firstly is the principal.Generally, for the principal

part, it will manage by the exporter, seller, remitter,

drawer of the draft.

Second is the Remitting Bank.For the remitting bank,

usually the exporter's of the bank will handling the

collection

Thirdly is the presenting or Collecting Bank.For the

presenting or the collecting bank, it will be handle

usually by the buyer's bank.

Lastly is the Drawee. For the drawee, it will be handle

and manage by the importer, buyer, payee.

3.7 Types of Documentary Collections 15


Generally, there are several types of the

Documentary Collection which is:

Firstly is the Documents against Payment (D/P)

also known as "Sight Draft" or "Cash against Documents”

(CAD). Through this, the buyer must pay before the

collecting bank releases the title documents.

Secondly, is the Documents against Acceptance

(D/A). In this document, the buyer accepts a time

draft, promising to pay for the goods at a future date.

After acceptance, the title documents are released to

the buyer.

3.8 The Steps in Documentary Collection

There are several steps in the Documentary

Collection that need to be follow by the applicant and

also the users.

Firstly, the buyer (importer) and seller (exporter)

agree on the terms of sale, shipping dates and that

payment will be made on a documentary collection

basis.

Secondly, the exporter, through a freight

forwarder, arranges for the delivery of goods to the

port or airport of departure.

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Thirdly, the forwarder delivers the goods to the

point of departure and prepares the necessary

documentation based on instructions received from the

exporter.

Fourthly, the export documents and instructions

are delivered to the exporter's bank by either the

exporter or the freight forwarder.

Fifth, is following the instructions of the

exporter, the bank processes the documents and forwards

them to the buyer's bank.

Sixth, is the buyer's bank, on receipt of

documents, contacts the buyer and requests payment or

acceptance of the trade draft.

Next, after payment or acceptance of the draft,

documents are released to the buyer, who utilizes them

to pick up the merchandise.

Then, the buyer's bank remits funds to the

seller's bank or advises that the draft has been

accepted.

Lastly, on receipt of good funds, the seller's of

a bank credits the account.

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4.0 LETTER OF CREDIT

Letter of Credit (LC) play an important role in international

trade and can be said as the lifeblood of international

commerce. Issued by banks, transacted through banks and

largely funded by banks, the banking sector across the world

is directly involved in financing international trade through

LC.

The LC is one of the payment mechanism used in international

trade. It is used widely, especially in trade transactions

where the seller and the buy do not reside in the same

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country. A far distance between both parties may invites worry

because it is very difficult to trust each other. Both parties

involves in this transaction will be reluctant to give any

commitment unless they are assured that their positions are

protected. So, the LC play on important tool to overcome the

problem of trustworthiness between such person. Thus, LC play

role and functions as to provide efficient payment through the

bank as reliable paymaster for advance payment. The seller is

directly paid once he presents to the bank documents which

strictly comply with the credit requirement, and the buyer

will only have to pay when all the documents required under

the LC have been declared in conformity with the term and

condition of the LC. This mechanism is used in Malaysia by

many trades and the business community especially when involve

with international trade.

4.1 Islamic Letter Of Credit

A Letter of Credit can be said as an instrument of

international trade and it is one of the most secure method

for seller to be paid. Normally, Letter of credit is used in

business practise for long distance trade and particularly

important commission earning service for any bank. ISRA

(2003) defined Islamic Letter of Credit (ILC) is written undertaking given by

the Islamic Bank (IB) ,to the seller (the beneficiary) at the request and on the

instructions of the buyer (the applicant), to pay at sight or at a determinable

future date, a stated sum of money withiin a prescribed time limit and against

stipulated documents which must comply with terms and conditions. There

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are several contract used by IB to offer ILC such as Wakalah

(agency), Murabahah (cost-plus profit) and Musyarakah

(Partnership).All this three concept can exist at the same

time in one single ILC transaction.

4.1.1 Wakalah Islamic Letter of Credit

Through the principle of Wakalah the IB act as the

agent of the customer, the customer will ask the bank

to issue the ILC by providing a written instruction to

the seller. Then, the bank will ask the customer to

place the amount of the price of the goods in place the

amount of the price of the goods in the bank as

security. Next, the bank create the ILC in favour of

the exporter and collects its commission and other

charges involved. After negotiation of the document,

the issuing bank will pay the negotiation bank

utilising the customer’s deposit. Later, the bank

release the document to the buyer and charge fee for

its services under the principles of Ujrah (fee).

4.1.2 Musyarakah Islamic Letter of Credit

Through principle of Musyarakah, the IB issues the

ILC and both the financier and customer involves to the

purchase price under ILC. Next, the will share the

profit of the business venture based on the pre-agreed

profit sharing ratio. But, losses are borne

proportionate to the capital contribution. Likewise, to20


the Wakalah ILC, the first procedure involve in

establishing the Musyarakah ILC begins with the

customer informs the IB of his ILC requirement and

negotiates the term of Musyarakah financing for his

requirement. Then, the customer deposit enough money

with the bank for his share of the cost of good to be

purchased or imported as per the Musyarakah agreement

which the IB accepts under the principle of Wadiah Yad

Dhamanah. Later, IB create the ILC and pays the

proceeds to the negotiating bank, Utilising the

customer’s deposit as well as its own shares of

financing. After that, IB release the documents to the

customer. Lastly the customer take possession of the

goods and disposes of these in the agreed manner.

4.1.3 Murabahah Islamic Letter of Credit

Under this principle the IB will provides a

financing facility to customer that unable to pay the

purchase price to the exporter. Then the bank will

resells the good at a higher price agreeable to the

customer. The new price will include mark-up of certain

profit. In summary, the procedure start when the

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customer informs the IB of his ILC requirement and

request the IB to purchase or import the good by

executing an aqd in writing. The customer be appointed

by IB as an agent to purchase the required goods.

Later, the IB will sells the goods to the customer at a

sale price comprising its cost and profit margin under

the principle of Murabahah for settlement on a deferred

time.

4.1.4 Difference between Murabahah Letter of Credit and

Musyarakah Letter of

Credit Operation

Trade transaction can be carried either by

Murabahah or Musyarakah principles. The role, or

involvement, of a bank in a particular business venture

would determine whether Murabahah or Musyarakah is

applied. For example, if the bank contributing to the

capital investment jointly with the buyer, then it said

that the principle of Musyarakah exists. However, if

the bank is not one of the parties in a particular

trade carried out by the buyer, the principles of

Murabahah is applied. The banker-customer relationship

in Murabahah transacting is best described as seller-

buyer relationship.

Murabahah is a credit business transaction where

the amount of purchases, or ‘deb’, is paid after the

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goods are sold to the final buyer. The bank would

acquire the goods from the exporter for its customer.

This is done through issuing a guarantee for payment

instrument to the exporter, which is an LC. In

Murabahah LC the bank has no management right and only

benefits from the total capital invested where it earns

some profit. The Bank is not liable for any loss in

business venture and only customer is responsible to

honour the selling price to the bank on the agree date.

In contrast, Musyarakah witnesses the investment

of the bank in a particular business venture carried

out by the buyer with both capital investment and roles

played by the bank. The bank will involve in the

business venture with capital will be invested in an

agreed proportion. Through this investment, the bank

jointly own the business with its customer. Currently

the bank provide consultation and advise on the

management of funds and the customer runs the daily

business operations. Both parties will sharing the

profit in accordance to the ratio of the invested

capital. In both transaction, the LC is used as the

payment mechanism. But, under the Murabahah trade

transaction, the bank does not have any control over

the business venture, the type of good involved is

restricted to inventory and stock, such as, sugar,

flour, spare parts and commodities. This is to make

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sure that they are disposed of within the shortest time

period. On the other hand, in Musyarakah, the bank has

some power to control the business venture.

5.0 TRUST RECEIPT

This Mechanism is a written legal document between a bank and a

person borrowing from that bank. On the document shares that the

bank will give merchandise to the borrower but bank will still

retain the little to the merchandise and can repossesses it if

the buyer does not uphold the terms decided upon in the trust24


receipt. At the same time, borrower must keep the merchandise and

any profits made from that merchandise separate from normal

business expenses and if the bank repossesses the items, the

borrower will return the items or the money made from selling the

merchandise. In daily transaction, item used in trust receipts

are large items with social numbers that are easy to record and

keep track of. For instance, radios, refrigerator, television,

large appliances and trailer can all be given to a borrower by

signing a trust receipt. Then, the borrower promises to pay the

loaner back an amount of money worth the property loaned to him.

Concept of trust receipt can be said as similar to a loan

where the borrower provides a type of collateral to the bank or

other business loaning him the money. However this type of loan

is considered a secure loan because an item, known as the

collateral, is listed as part of the arrangement. In case, the

borrower does not repay the loan, the lender has the right to

take the collateral item and sell it to cover the money the

borrowed owed him. But, the difference between a trust receipt

and a standard loan is that in a trust receipt the items being

borrowed, and any money made from selling them also serve as the

collateral for the loan.

5.1 Islamic Trust Receipt

It is one of mechanism to help finance domestic or

international trade document drawn against ILC or Wakalah

inward bills for collection. Islamic Trust Receipt ( ITR) is

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issued by IB to the customer based on the concept of

Murabahah for financing the purchase of goods. ISRA (2003)

assert, it is document of trust signed by the customer (importer):, the strength on

which the Islamic bank allows the customer (importer) to obtain release of the

merchandise but makes a lump-sum payment at a later date.

The first procedure involve in modus operandi of ITR is the

customers must first have an approved ITR line. The request

for financing must include submission of relevant documentary

evidence of the underlying transactions and compliance to

the terms of the facility.Secondly, the customer informs the

bank of his letter of credit requirement and request the bank

to purchase the goods. Thirdly, The Islamic bank retains the

legal title to the goods but relinquishes physical possession

to the buyer or importer. Then, the IB appoints the customer

as its agent to purchase the good that the customer requires

on behalf of the IB. Next, upon delivery of the goods, the

Islamic bank pays the exporter /supplier for the cost of the

goods based on the invoice value. The IB will resell the

goods from the customer at invoice value and resell them to

the customer on deferred payment terms at a price inclusive

of the IB’S profit margin. If the IB appoints the customer as

its agent, then the IB cannot purchase from the customer. The

deferred payment terms of sale of goods granted to the

customer constitutes a creation of debt. This is securitised

in the form of a bill of exchange drawn by the IB and

accepted by the customer and payable on maturity. Lastly, the

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IB holds the customer’s ITR executed by him. This is to

signify his holding of the goods in trust pending the sale of

goods and the customer undertakes to settle the Selling Price

on the expiry date.

6.0 BANKER’S ACCEPTANCE (BA)

It is countersigning (endorsement) of a bill of exchange by the

buyer’s/importer’s of bank. A bill of exchange drawn by importer

to their order, payable on a specific future date and then, bank

will accept it for financing trade transactions such as import,27


export or domestic. Bankers acceptance establishes that payment

of the bill on its maturity date is now guaranteed by the

endorsing bank. If bank felt confident with buyer’s financial

strength and stability, and on payment of the acceptance fee. So,

bank will agree to counter sign a bill of exchange.

According to the 1930 convention providing a uniform law

for bill of exchange and promissory notes held in Geneva, a bill

of exchange must contains the term bill of exchange, an

unconditional order to pay a determinate sum of money, the name

who is to pay(drawee), a statement of the time of payment, a

statement of the place where payment is to be made, a statement

of the date and of the place where the bill is issued, the

signature the who issues the bill (drawer).

Usually, the banker’s acceptance provides a short -term

financing for 30, 60,90, 120, 150 or 180 days. Moreover, the

maximum financing is always less than a year. Whereas the 30

to 90 day periods are the most common financing periods, and the

180 days and above period are rare.BA available for exporter on

document against payment(D/P ),since it takes more than 21 day.

BA also available for exporter /seller who export/sell

goods under document against acceptance (D/A).

Features of banker’s acceptance:

BA is governed by the “Guidelines on Banker’s Acceptance”

issued by BNM

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Minimum period of financing is 21 days, and maximum is 365

days

Minimum amount of financing is RM 50,000

Bunching of documents to reach the minimum of RM50 000 is

allowed

Separate bunching for domestic sales and foreign sales.

Usance draft drawn by the buyer or seller and discounted by

the bank

As a conclusion,the banker acts as intermediary in

connecting the exporter, importer and the investor.As

intermediary,the banker accepts,on behalf of his importing or

exporting customer,the obligation to repay the investor on

maturity date of BA.Hence,financing transaction is code-named

Banker’s Acceptance.

6.1 Islamic Banker’s Acceptance

Islamic banker’s acceptance well known as accepted

bills-i. Accepted bills-I ( AB-i) previously known as

Islamic accepted bill (IAB) were introduced in 1991 through

this islamic financing mechanism can encourage and promote

both foreign and domestic trade. AB-I is a bill of

exchange,which is drawn by bank and excepted by

importer/buyer creating a debt owing to the bank .

The AB-i formulated based on 2 shariah concepts

consists of Bai’ dayn (debt trading) and murabahah(cost

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plus). As our information,Bai’ dayn refers to the sale of a

debt arising from a trade transaction in the form a trade

transaction in the form a trade transaction in the form of

a deferred payment sale.While, Murabahah refers to the

selling of goods at a price based on cost plus profit

margin agreed to both parties.

There are 2 types of financing under the AB-I facility:

Imports and local purchases

Exports and local sales.

Under import and local purchases an applicable

mechanism under this type of financing is the working

capital financing under murabahah. The bank will appoints

customer then purchases the required merchandise from the

seller on behalf of the bank. Then, bank will pay the

seller and resell the merchandise to the customer at a

price, comprehensive of a profit margin. In additions, upon

maturity of the murabahah financing, the customer can pay

bank the cost of goods plus the bank’s profit margin.

Moreover,the good news is customer is allowed a deferred

payment term of up to 365 days.

The sale of goods by the bank to the customer on

deferred payment term constitutes the creation of debt. The

debt is securitised in the form of a bills of exchange

drawn by the bank(drawing bank) on and accepted by the

customer(acceptor) for the full amount of the bank’s

selling price payable at maturity. If the bank decides to

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sell the AB-i to a third party, AB-i will be sold under the

concept of bai’ dayn.

Under Export and Local Sales . They uses the type of

financing facility bai’ dayn comply with the shariah

concept. The customer prepares the sale documents as

required under the sales contract or letter of credit. Next

the sale documents are sent to the purchaser’s bank. The

customer draws on the bank a new bill of exchange as a

replacement bill that represents the AB-i. The bank will

purchase the AB-i at a mutually agreed price using the

concept of bai’ dayn and the proceeds will be credited to

the customer’s account.

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7.0 SHIPPING GUARANTEE (SG)

Shipping guarantee is a form of bank guarantee made available for

the importers. It is not a form of loan. Bank does not give any

money, just a guarantee which is a commitment to pay. SG a

document that allows a customer to take possession of shipped

goods before the shipping company receives the bill of lading,

indemnifying the shipping company from any loss in case the

customer fails to pay. SG is typically arranged by banks, which

require a cash margin or other assurance of payment from

customer.

With SG, bank certifies that the importer is the

rightful/legal owner of the goods. Remember, the importer cannot

prove himself to be the rightful owner, since he has no bill of

lading and other shipping documents to show. So, the bank’s SG

the shipping company(or the custom authority or any other

parties to whom the SG is addressed to)will allow the importer to

take delivery of the goods.

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Nevertheless, importer must have a line of Trade Finance

Facilities to obtain SG. Moreover, SG does affect the Basel

CAR, such as bank needs to have sufficient capital in order to

cover the risk/potential loss due to issuing the SG. However, the

risk is minor, and, being off-balance sheet item, the impact on

capital under Basel CAR too is minor. In fact, if the SG is

given to the high-rated customer, the risk under Basel CAR is

treated as zero which means the impact of SG on capital too is

zero. As we know SG comes in the pre-printed form, so immediately

available on request.

7.1 Islamic Shipping Guarantees (ISG)

Islamic shipping guarantees well known as Shipping

Guarantee-I is one of facility that the Islamic trade

financing provided. This facility is a document issued by

the bank to the shipping company that allows the

importer/buyer to collect the goods from that shipping

without the presentation of the original Bill of lading. It

is issued under the Kafalah contract. It can defined as a

surety provided by a party to the owner of the goods,who

deposited his goods with the shipping company, whereby any

subsequent claim by owner for his goods must be met by the

guarantor(the bank).

As we all know under kafalah ,in case default is

function as a contract of performance or financial guarantee

given by one party to set free liability of third

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party.There are several advantages when using shipping

guarantees-I product such as it will make clear goods

without having to wait for a complete sets of import

documents. Of course,this brilliant facility make

importer/buyer felt comfortable and cosy because enables

they to sell the goods without delays. Moreover,it will

helps you avoid any demurrage or other port charges.So, we

don’t have worried about the good conditions and the charges

is affordable to importer.

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8.0 BANK GUARANTEE (BG)

Bank guarantee (BG) is a promise by a third party to carry out

obligation owed by one person to another in the event of default.

It is performed by a bank and also can be from other lending

institutions which to use it as to cover the loss if any default

on loan or payment by a borrower or applicant.

BG is actually an undertaking or promise given by a bank on

behalf of their applicant to the beneficiary. The bank performs

their responsible after agreed to the applicant if he failed to

fulfill his obligation to beneficiary caused of problem in

financial or performance as agreed with the beneficiary before.

The bank who act as guarantor of applicant (guarantee) will make

payment according to the amount agreed upon receipt of claim by

beneficiary. This BG’s applicant, enable and benefits him

proceeding the purchase and expand entrepreneurial activities

once the company had problem to perform it.

According to Agasha Mugasha (2003), the developments of bank

guarantees in particularly England and other common law countries

where there were no terminological restrictions, the function of

standby letters of credit was performed by similar instruments

issued by banks which is known as BG. BG means a guarantee

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issued by banks which may be performance bond or guarantee, a

repayment or tender guarantee. The bank will pay money to

beneficiary if the terms of guarantee are complied with. It is

useful when the bank’s customer or applicant failed to perform

his contract with the beneficiary which then the bank will

present for it.

Even BG’s characteristics look same as the letter of credit,

there are some different things that make their functions not

used in the same purposes. BG will ensure the liabilities of

debtor will meet if their applicant failed to settle the debt

while for letter of credit, the bank pays the amount to

beneficiary once the obligation of production documents on the

fulfillment of contract. So, before making any contract, the

applicant must recognize and identify about the actual functions

and for what purpose of the letter of credit and bank guarantee

will perform for.

As the conclusion, BG plays a big role for the applicant and

bank economy performances especially in import and export

activities because it is a way to help the unable applicant

proceeding their payment due to their financial constrains.

8.1 Islamic Bank Guarantee (IBG)

Islamic bank guarantee (IBG) is a special guarantee

which created to replace the functions of conventional bank

guarantee based to its specifications. According to ISRA

(2013), “Under a Syariah, and in accordance with the principal of kafalah, an

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Islamic bank may issue, at the request of the customers, an Islamic Bank

Guarantee (IBG) to a beneficiary named by customers”.

Basically, IBG is an irrevocable written obligation

which involved Islamic Contract known as Kafalah. The Islamic

Bank will assure the payment in case of demand by

beneficiary and act as guarantor to the customers. The

benefits of IBG are it is widely acceptance besides can be

leveraged to enhance the applicant reputations. It is also

capable to unlock the applicant capital from required any

deposits or payment in the future.

The kafalah principles used in IBG is actually a surety

given by an Islamic Bank who agree to bears a liability of

beneficiary in the case of the applicant or the bank’s

customers are default in fulfill their obligations to the

beneficiary. The applicant is required to place certain

amount in the Islamic Bank as deposit for this facility

which is under the Islamic principles of wadiah (safe-

custody). IBG also may fall into some categories such as

performance guarantee, guarantee of sub-contract and

guarantee of exemption of custom duties.

Although most of Islamic Banks tend to charge some fee

for their service of issuing letters of guarantee, some of

Syariah scholars believe this charge is actually against the

Syariah. These scholars stated that this facility is an act

37


of guarantee so no need to impose any fee when issuing the

letter.

Table 1 : Comparative of Islamic Bank Guarantee and Islamic

Letter of Credit

Islamic Bank Guarantee Islamic Letter of

CreditDefinition A legal instrument

executed by Islamic bank

on behalf of its

customer or applicant to

the beneficiary in

connection with the

contract entered between

the applicant and

beneficiary.

An instrument issued by

Islamic bank on behalf

of and for the account

of the buyer of goods.

Feature Two types of guarantee :

Financial Guarantee

Performance

Guarantee

Islamic bank undertake

the bills of exchange

and trade documents of

seller when drawn or

presented according to

the terms of the credit

document will be duly

honoured.Sources of

Fund

Islamic bank fund will

not tied-up and the

Wakalah Islamic

Letter of Credit

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liability is contingent

upon the failure of

applicant’s obligation.

(fund is from the

customer to the

buyer)

Murabahah Islamic

Letter of Credit

(fund is from

Islamic bank via

financing)Syariah

principle

Kafalah (guarantee)

Wakalah Bi Al-Istihmar

(investment agency)

and kafalah

(guarantee)

Wakalah (agency)

Murabahah (Cost

plus profit sale)

(Source: ISRA 2013)

8.2 Example Process

Company A which is a small and unknown company would

like to purchase RM 3 million of kitchen equipment from

Company B who is the beneficiary. To build a confident by

Company B, Company A comes to the Bank Islam by showing a

contract with Company B to apply for Bank Guarantee-I (BG-

i).

After checking the contract of Company A, Bank Islam

issues the (BG-i) and forwards it to the Company A. Company

A then forward the original guarantee to the Company B. If

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the Company A is able to settle the payment, Company B will

send back the (BG-i) to the Company A so that Company A can

cancel the guarantee from Bank Islam.

However, if the Company A defaults in the payment, Bank

Islam will take action to fulfill the obligation on behalf

of Company A to company B according to the claim amount

before.

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9.0 INCOTERMS

9.1 Definition of The Incoterms

Incoterms is an abbreviation of International

Commercial terms. In term of definitions, terminology

incoterms is a series of those used in international

trade transactions. Incoterms is a set of rules issued

by the institution of private trade, the International

Chamber of Commerce (ICC). Thus the positions of this

incoterms are independent, because it is not a product

of the government of any country. Historically,

Incoterms were first published in 1936 after the First

World War. Later in the journey, several times amended.

These changes are always made by the ICC in

order to adopt trade practices most updated. The first

change was made in 1953, known as incoterms1953.

Further changes were made on a regular basis, so it is

known incoterms versions in accordance with the

amendments, namely: incoterms 1967, incoterms 1976,

incoterms 1980, incoterms 1990, 2000, and the last is

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incoterms 2010, which came into effect from 1 January

2011. Incoterms provides a set of terms of trade clause

that essentially three things: cost (cost), risk (risk)

and the responsibility for the maintenance task

(responsibility). In general terms, Incoterms regulate

matters relating to the CRR (cost, risk and

responsibility).

9.2 Four Basic Categories of Incoterms

There are several basic categories of the

Incoterms that need to be know by the applicant:

Firstly, is the E terms, which is used when the

seller will make goods available to the buyer on the

seller’s own premises. Secondly is the F terms, and it

will be used when the seller will be required to

deliver goods to a carrier appointed by the buyer.

Thirdly is the C terms, that will be used when the

seller will be required to contract for carriage, but

will not assume risk of loss or damage to goods, or of

additional costs that may occur after shipment and

dispatch. Lastly is the D terms, which is require the

seller to bear all costs and risks needed to bring

goods to the place of destination.

In general, incoterms base the interpretations

on the party who is the best equipped to handle the

task. 42


9.3 Rules for any mode of transport

There are several rules for the transport that have

different types of mode which are :

1) Ex Works (EXW)

2) Free Carrier (FCA)

3) Carriage Paid To (CPT)

4) Carriage and Insurance Paid To (CIP)

5) Delivered at Terminal (DAT)

6) Delivered at Place (DAP)

7) Delivered Duty Paid (DDP)

9.3.1 Ex Works

Ex Works Seller delivers when it places the goods

at the disposal of buyer at the seller’s premises

or another named place for example works, factory,

and warehouse. Seller does not need to load the

goods on any collecting vehicle, nor does it need

to clear the goods for export, where such

clearance is applicable.

9.3.2 FCA

Free Carrier is a seller delivers the goods to the

carrier or another person nominated by the buyer

at the seller’s premises or another named place.

Seller does clear goods for export; import

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formalities are buyer’s responsibility. Seller may

contract for carriage at buyer’s expense and risk.

9.3.3 CPT

Carriage Paid To Seller delivers the goods to the

carrier or another person nominated by the seller

at an agreed place (if any place is agreed between

the parties) and the seller must contract for and

pay the costs of carriage necessary to bring the

goods to the named place of destination.

9.3.4 CIP

Carriage and Insurance Paid To Seller delivers the

goods to the carrier or another person nominated

by the seller at an agreed place (if any such

place is agreed between the parties); seller must

contract for and pay the costs of carriage

necessary to bring the goods to the named place of

destination.

9.3.5 DAT

Delivered at Terminal is a seller delivers when

the goods, once unloaded from the arriving means

of transport, are placed at the disposal of the

buyer at a named terminal at the named port or

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place of destination. “Terminal” includes any

place, whether covered or not, such as a quay,

warehouse, container yard or road, rail or air

cargo terminal.

9.3.6 DAP

Delivered at Place is a seller delivers when the

goods are placed at the disposal of the buyer on

the arriving means of transport ready for

unloading at the named place of destination. The

seller bears all risks involved in bringing the

good to the named place.

9.3.7 DDP

Delivered Duty Paid is a seller delivers the goods

when the goods are placed at the disposal of the

buyer, cleared for import on the arriving means of

transport ready for unloading at the named place

of destination. The seller bears all the costs and

risks involved in bringing the goods to the place

of destination and has an obligation to clear the

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goods not only for export but also for import, to

pay any duty for both export and import and to

carry out all customs formalities.

9.4 Benefits of using Incoterms rules.

Firstly, the benefit of using the Incoterm is it

will  standardize how you do on the business. This is

because, by using the incoterms, the applicant or the

users will have the knowledge on how to standardize the

business and the applicant also know types of standards

that need to be place for the business which can make a

greater and many profit for the business as well.

Secondly, the benefit for using the Incoterm is,

it will  strengthen internal control. Through this, if

the applicant use the Incoterm for their business and

management which is it will provide security for the

internal business as well as for the applicant and the

users itself.

Besides that, the benefit for the applicant and

the users in getting involve with the Incoterm is can

avoid the delay that caused by the documentation

problem. This is because, the Incoterm will provide the

security to the users from any problem or mistake which

can affect the efficiency of the business and

management.

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Futhermore, the other advantages of using the

Incoterm is, it will prevent the disputes over the

payee that is “ who pays for what”. Through this, the

Incoterm will protect the payee or the buyer that buy

the goods from other country in receiving their goods

which give more secure for the goods itself and also to

avoid the buyer from pay something for that they not

receive.

On top of that, by using the Incoterm, it also can

protect the applicant or the user ability in getting

involve with the business. In this case, by using the

Incoterm, it will give security for the applicant that

want to create a business internationally which is

selling the goods to other country.

Lastly, the advantage for using the Incoterm is,

it will declare the correct value for makes the

differences in imports and exports for the first time

and between success and failure. This is because, the

mistake or miscorrect in the difference of the value in

import and also export will cause a big mistake to the

business and also management of the company. Thus, it

will definitely cause a loss to the company and also

for the users and applicant.

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11.0 CONCLUSION

Islamic Trade Financing (ITF) was plays a big role in

supporting the development and strength of international trade

activities. Besides offers many special products which

providing more benefits to the users, it was benefitted in the

form of Syariah compliant practices in the business which

would support the development in Islamic economy and finance.

There are various intermediaries who help in running this

type of trade financing by follow the Syariah guidelines in

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their activities such as banks and importers and they are

interdependencies among each others as to maintain their

interest in this trade besides to achieve profit based from

the shariah guidelines. For example, in Islamic Bank Guarantee

(IBG), the Islamic bank agreed to bears the liability if the

applicants were default in fulfill their obligations to the

beneficiary while the applicants of the Islamic bank would be

benefiting to proceed the business and run their trading

activities with the beneficiary during their financial

constrains.

Besides, the most vital functions of ITF are to provide the

smooth and efficient shariah compliance of international trade

financing. As the increment of Muslim traders around the

world, the existence of ITF would help to achieve the maqasid

shariah and help them to choose the financial products and

involved in activities that allowed by shariah. The Islamic

Letter of Credit (ILC) for example, is not only islamic

instrument of international trade used in business practise

for long distance trade and particularly important commission

earning service for any bank, but it also provide the shariah

type of contract which mean surely valid and applicable based

from Islamic perspectives such as ILC of Wakalah (agency) and

Musyarakah (Partnership).

The last one is, ITF is a dynamic and flexible of trade

financing. It is not only specialized for muslim traders,

however the non-muslim also welcomed to apply this ITF

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products as to helping to run their business. ITF which

concerns about the public interest would be able to attract

the non-muslim customers with the multi-financial products

besides also applicable to use in the local and international

trade. Islamic Trust Receipt (ITR) is one of mechanism to help

finance domestic or international trade document drawn against

ILC or Wakalah inward bills for collection while Banker

Acceptance (BA)

As a conclusion, ITF brings a bright future for the local

and international trade financing. Malaysia should be proud

because aggressively providing and offering a variety of trade

financing products to help the effectiveness of business

activities around the world. This keen offer at the same time

will improve and strengthen the Islamic economy of Malaysia

globally.

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12.0 REFERENCES

12.1 Book

International Shari’ah Research Academy for Islamic Finance

(ISRA) (2013) “Islamic Financial System, Principles & Operations”, Kuala

Lumpur, Malaysia, pg 343-349

Agasha Mugasha (2003) “The Law of Letter of Credit and Bank Guarantee”,

The Federation Press, pg 46&47

Adiwarman Azwar Karim (2005) Islamic Banking Fiqh and Financial Analysis,Jakarta : Indonesia, pages 113-124

A. K. Daud Vicar(2010), Islamic Finance: Understanding its Principles and Practices.Marshall Cavendish International Asia Pte Ltd. pg257-258.

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J. S. Sak Onkvisit(2008), International Marketing: Strategy and Theory Taylor & Francis. pg506.

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