Islamic finance : Tawarruq at a glance

In a time when the global Islamic finance industry is getting more and more acceptance from both
Muslim and non non-Muslim investors, many challenges related to the lack of standardization are still
to overcome. As a matter of fact, we are still witnessing some product names having utterly different
meaning from a region to another, and we still can see some products considered as Halal by some
scholars and declared impermissible by others.
One of these financial products that are creating confusing situations in Islamic finance nowadays 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 within bankers as a rapid and flexible way for acquiring liquidity. In fact, by using Tawarruq,
bankers could avoid many constraints related to capital adequacy and provision for managing doubtful
debts. Tawarruq can also be used in more complex structures, such as Islamic FX swaps where it
helps hedging against currency rate fluctuation risks. This kind of contract combinations, replicating
interest-based loans in form of a deferred liability, has been practiced by many Islamic banks for over
three decades. However, there had never been consensus on their permissibility, and there are even
some Shariah scholars who were open to such practice but who called later for a reassessment to
avoid opening the door of Riba.
Before taking a look at the arguments of defenders and opponents of that practice, we should first
differentiate between different types of Tawarruq. The first type is the “Real Tawarruq” which happens
when a person (Mustawriq) buys a commodity from a bank at a deferred price; and subsequently sells
it to another party or bank for cash, in order to get his needed cash. The second type is “Organized
Tawarruq”, also called “Banking Tawarruq”, which is practiced when a person buys a commodity from
a bank on deferred price basis; and the bank arranges the sale agreement either itself or through an
agent. The Mustawriq and the bank execute, simultaneously, the transactions, 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 keeping the commodity or selling it himself. Most organized
Tawarruq run on international goods, like 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. Same Shariah rules apply for both Organized and Reverse
Tawarruq.

Real Tawarruq
Most of jurists allow the Real Tawarruq provided that it complies with the Shariah requirements on
valid sale. For example, in case the customer appoints the bank as an agent to sell the commodity on
behalf of him, the agency contract should be independent from the sale contract and it should be
made after the agreement with the bank has been signed. Among the scholars who allow the Real

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Tawarruq are the Council for Fiqh, under the League of Islamic World and the permanent Committee
for Research and Fatwa in Saudi Arabia. The scholars of these institutions consider Tawarruq as
permissible as the technique is derived on two sale contracts with the ultimate buyer being not the
same as the initial seller. The permission is also justified by the fact that this process allows rotating
part of the liquid assets to replace conventional credits. In addition, in an industry that remains in the
embryonic stage, Tawarruq helped many institutions starting from scratch, under severe regulatory
constraints, to subsist and later to initiate a shift from debt to equity.
At the opposite, other scholars interpret Tawarruq as similar to Bai‟ „inah; since the only objective of
the buyer of the commodity is to get cash. They also consider that the process makes the client sell
what he has at a loss, for reasons of necessity, which take in the transaction as a forced sale. And
given that Islam does not illegalize a least harm and legalizes a major one, they argue that the whole
transaction is disliked and sometimes prohibited.
However, the intention of the contracting parties cannot be used as an argument to justify prohibiting
Tawarruq. In fact, evidence could be found in a hadith that shows that it‟s permitted to change the
form of a contract from haram to halal, while keeping situations the same. The hadith says that a man
brought the Prophet Mohamed (saws) a good date from Khaybar, called janiib. The Prophet (saws)
asked the man, {Are all dates of Khaybar like this?}. The man said: {O you the messenger of Allah,
we take a sa‟a of this with two sa‟a and two sa‟a with three}, the Prophet (saws) replied, {Do not do
that, sell the bad dates; then use the cash to buy the good ones}. This shows the sold commodity is a
means for this purpose.

Organized Tawarruq
There are different views concerning the ruling of Organized Tawarruq. According to scholars of the
Islamic Fiqh Academy, financing by this form of Tawarruq is not permissible because simultaneous
transactions that occur between the financial institution and the Mustawriq are Haram in Islamic law.
They support their view with the fact that the Prophet (saws) said: {The condition of a loan combined
with a sale is not lawful, nor two conditions relating to one transaction, nor the profit arising from
something which is not in one‟s charge, nor selling what is not in your possession}. However, some
scholars interpret the two conditions relating to one transaction in the above hadith as referring to a
seller who indicates two prices in the contract without a decision upon one of them; while other
scholars interpret the hadith as referring to a transaction between two people who deal with the same
commodity, by selling it the first time by deferred payment, and in the second time for immediate
payment. The contract of Organized Tawarruq is clearly different from these two interpretations, as
the transactions are separate, even though they are at the same time for the same commodity.
Other opponents of Organized Tawarruq compare it to a form of Bai‟ „inah as it involves an exchange
of money for money with an extra sum. They argue that the financier organizes the contract from the
beginning until the end; and that the client only receives money in his account, without being really
involved in the arrangement of the contract. In addition, when the financial institution sells the
commodity to the client, it does it on a larger scale for many clients and does not distinguish the share
of every client. Hence, it is considered that the client does not have the complete possession of
ownership of the goods bought from the bank, to sell them again in the market.
Conversely, the AAOIFI scholars tried to find a compromise on the validity of Organized Tawarruq by
setting a number of conditions controlling this type of contracts. The reformed standard aimed at
enabling using this structure as a quick-fix to urgent and extreme financing needs; and to avoid falling
in Bai‟ „inah, AAOIFI‟s Shariah Standard 30 stresses that commodity, subject to the organized
Tawarruq, should be sold to a party other than the party from whom it was purchased on a deferred
payment basis. This implies that the bank or its agent should not sell the commodity on the customers
behalf if the customer initially bought that commodity from the bank neither should the bank arrange
a third party to sell this commodity; the client should, instead, sell the commodity either himself or

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through his own agent. The ruling also requires the seller to explain the details of the commodity to
the buyer, when the buyer does not see it; and that the delivery should be immediate.
Although these conditions dramatically reduce profitability and feasibility of organized Tawarruq for
banks, they were judged as insufficient in the eyes of many Shariah scholars, and the structure is still
widely criticized as no genuine trade really occurs throughout it; and as only stocking of commodity
takes place, which makes it similar to retaining collateral against an interest-based loan.

Controversy
Despite all debates on the permissibility of some forms of Tawarruq, a significant number of Islamic
banks conduct a large volume of Tawarruq transactions on a regular basis in relation to their treasury
operations. Shariah boards of these banks authorize operations based on these contracts. And since
the opinion of Shariah boards does not have to take into account the ruling of Islamic finance
organizing bodies and with the absence of penalties for non-compliance to standards regarding
questionable products, banks can always hire a scholar who judge these products as necessary
compromises to facilitate economic activity without engaging in Riba transactions.
However, this indiscreet use of Tawarruq and some other comparable debt instruments fuels the
perception that Islamic financial institutions are only wrapping up interest-based instruments without
following the essence of the Shariah and without achieving the required Islamic socio-economic
objectives. In fact, Tawarruq creates new debts that are far larger than the cash received. This could
have a negative impact on the credibility and integrity of Islamic banking industry as a whole,
particularly in the aftermath of the 2008 property crash in the Gulf Arab region. In addition, by
moving the banking sector from the asset market toward the debt market, the underlying mechanisms
get disconnected from the real economy without any increase of the net wealth of the society.

Alternatives
For that reason, there is a need for a paradigm shift to find alternative mechanisms to these dubious
financial techniques and to replace them by other viable options for liquidity management purposes.
The Fiqh Academy encourages Islamic banks to set up special Qard Hasan Fund. However, some
professionals reject the idea of Qard Hasan as a workable solution arguing that despite being socially
responsible, Islamic financial institutions have to deliver returns to their shareholders. Instead, Islamic
Banks can use a range of valid Shariah-compliant solutions to get adequate neutral liquidity such as
Salam or Ijarah. For example, by using Salam, banks have a genuine alternative product to meet the
liquidity needs in many economic sectors, such as the agriculture, where it was clearly approved by
the Prophet (saws). However, the risk of a fall in the market price, discourage many banks from using
it. Though, there are different risk-mitigating techniques such as parallel Salam or Wa‟ad-based
currency hedge to obtain a foreign exchange in case goods are paid for in foreign currency; these
techniques allow justifying the perceived “price risk”.
Other genuine alternatives for Tawarruq are Mudarabah and Musharakah in investment projects,
where liquid funds are advanced to the customers; and where a variety of tools can be used by
Islamic banks to reduce the usual moral hazard. These profit/loss-sharing products follow the noble
ethical values probed at the heart of the Islamic economic system; however, because of the fact these
modes may lead, from the economic point of view, to a change in the ownership structure, makes
them still underused by banks. They account for less than 14% of the total financing modes in Islamic
banks, while fixed-return modes such are largely predominant in their activities.

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Conclusion
The global Tawarruq market estimated to over US$1.2 trillion per annum and since there will always a
need for lending products to meet the short-term liquidity needs, reducing the utilization of Tawarruq
in Islamic banks in favor of more compliant Shariah financing modes, would require a resolute political
determination. In fact, the move towards greater reliance on equity participation and asset based
financing necessitates reviewing and reforming the current practice in the sector. This goes through
the development of a sustainable system of inter-bank transactions based on Islamic values. The
absence of such a system forces Islamic financial institutions to turn to conventional banks for
meeting their short-term liquidity needs which is generally provided using a direct or disguised use of
interest. There is also a need for setting up of a central depository to mobilize surplus funds of Islamic
banks based interest-free loans. This will allow the utilization of resources between Islamic financial
institutions without resorting to conventional financial markets. Finally there should be a review of
standards and regulations to harmonize the existing interpretations and conventions between different
regions and institutions.

© Adil MSATFA

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