IB1005IB1005DEPOSITS AND FINANCING PRACTICES DEPOSITS AND FINANCING PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS OF ISLAMIC FINANCIAL INSTITUTIONS CHAPTER 12 : TRADE FINANCINGCHAPTER 12 : TRADE FINANCING

COMPILED BYHAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance)

Certified Professional Trainer (MIM)Industry Expert

INCEIF

HJ MAHMUD HJ BUNTAT, MBA(AUOL, UK), DBM (Swansea Inst., UK), CIL (UIA)Part-time Lecturer (INCEIF)

Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd

Chapter 12 – Trade FinancingChapter 12 – Trade Financing

Refers to the various forms of financial support and financial transactions used in international trade.

The facility is used to mitigate the financial risks

for both exporter and importer.

• Banks may assist by providing various services such as letter of credit, collection of payment upon presentation of certain documents or advancing payment on the basis of export contract.

In many countries, trade finance is often supported by quasi-government entities known as export credit agencies that work with commercial banks and other financial institutions.

Bank as Collection AgentBank as Collection Agent

Once the terms of contact have been agreed, the two parties have to appoint a bank on their behalf to effect transactions.

To seller/exporter the bank can act as their collecting agent.

To the buyer/importer the bank can act as their paying agent.

Collection BasisCollection Basis

Importer(London)

CONTRACT

BANK ABC KUALA LUMPUR

(Exporter banker)AGENT BANK TOKYO

MEMO OF BILL PAYMENTDOCUMENTS

DOCUMENTS

1. Exporter ships the merchandise and presents documents to

his Bank for collection of payment

Exporter(Kuala Lumpur)

Importer(Tokyo)

CONTRACT

MERCHANDISE

2. Exporter’s Bank checks documents and sendsthem to Agent Bank in Tokyo for collection

3. Agent Bank, Tokyo on scrutinizes documents. Informs Importer of arrival of import documents and requests

importer to pay if documents are on sight basis or accept if documents are on usance basis

4. Importer makes payment to theAgent Bank and take possession

of documents

Trade Financing FacilitiesTrade Financing Facilities

1. Letter of Credit-I (LC-i) 2. Trust Receipt-i (TR-i) 3. Shipping Guarantee-i (SG-i) 4. Letter of Guarantee-I (LG-i)

5. Islamic Accepted Bill-i (IAB-i)

Bills of ExchangeBills of Exchange

Drawn under BANK ABC MALAYSIA BHDLetter of Credit No : 00183002 dated 8nd July 2009

No…………………

0001/2009

EXCHANGE for………………………………………………………………………………………………………20………At………………………………………………………………………………………………………………………………..Pay

this First of Exchange ( Second being unpaid) to the order of XYZ Bank, Tokyo

………………………………………………………………………………………………………………………………………..

…………………………………………………………………………………………………………………………………………

US$28,572.00 09

SIGHT

US Dollars : Twenty Eight Thousand Five Hundred Seventy Two Only

Value received and charge the same to account of

…………………………………………………………………….

…………………………………………………………………….

To…………………………………………………………………

…………………………………………………………………...

One Thousand units of Motor Parts

Jasa Trading Sdn Bhd

Lot 101, Jalan Sungai Besi

57000 KUALA LUMPUR

Tokyo Supplier Pt Ltd

9th July

Letter of Credit (LC)Letter of Credit (LC)

LC is a secured means of acquiring prompt payment for the sale of goods. With the availability of LC facility, exporters can obtain quick, secure and guaranteed payment of goods from the banks.

Offers an acceptable compromise by providing for payment to be effected against documents representing the goods and making possible the transfer of title to the goods from seller to the buyer.

Letter of Credit-iLetter of Credit-i

Provides the buyer with financial backing, better pricing and repayment terms.

Eliminates commercial risk of non-payment to

the supplier.

Assured all documents are in order as payment is made upon once the terms have been complied.

Stage1: OpeningStage1: Opening a Documentary Credit a Documentary Credit

CONTRACT

BANK ABC KUALA LUMPUR AGENT BANK TOKYO

APPLICATIONFOR CREDIT

DOCUMENTS

CREDIT

1. The importer and the exporter sign asales contract providing for payment

through a letter of credit

Exporter(Tokyo)

Importer(Kuala Lumpur)

CONTRACT

2. The importer instruct Bank ABC ,KL.- The Issuing bank-to issue a letter of

credit in favor of the exporter

3. Bank ABC, Kl asks Agent bank to advise the credit to the exporter

4. The advising bank informs theexporter that the letter of credit

has been issued

ADVISING BANK ISSUING BANKADVISING BANK ISSUING BANK

Importer(London)

BANK ABC KUALA LUMPUR AGENT BANK TOKYO

MEMO OF BILL PAYMENTDOCUMENTS

DOCUMENTS & ADVICE OF DEBIT

1. Exporter ships the merchandise And presents documents to

Negotiating Bank Tokyofor negotiation

EXPORTER IMPORTER

2. Negotiating Bank negotiates and pays theexporter if all documents comply with

the terms of Credit and debits account of Bank ABC, Kland sends documents to Bank ABC. KL

3. Bank ABC, KL scrutinizes documents. If documents

are in order, it will advise the importer and release

the shipping documents upon payment by the importer

4. Importer makes payment to theBank and take possession

of documents

Stage 2 : NegotiationStage 2 : Negotiation

MERCHANDISE

NEGOTIATING BANK ISSUING BANK

Shariah Concepts for Shariah Concepts for Letter of Credit-i Letter of Credit-i

The issuance of LC-i can be based on the Shariah principles of:-

1. Wakalah (Agency) 2. Murabahah (cost plus basis) 3. Musharakah (joint venture / profit /loss sharing)

Al-Wakalah LC-i (Agency)Al-Wakalah LC-i (Agency)

1. The bank effectively acts a customer.

2. Before granting the facility, the will generally insist on a deposits from the customer up to the total cost of the goods in questions.

3. The deposits will be placed with bank under the Al-Wadiah Yad–Dhamanah principle.

3. Upon establishing the LC-i, the bank will pay the proceeds (from the deposit) to the negotiating bank.

4. The bank will then release the documents to the customer, charging the customer a fee for its services.

Al-Murabahah LC-i (Cost plus)Al-Murabahah LC-i (Cost plus)

1. The customer will negotiate his LC-i requirements with the bank on the basis he will purchase the goods from the bank under Al-Murabahah principle.

2. The bank will then establishes the LC-i and makes use of its own funds to pay the negotiating bank.

3. The bank subsequently sells the goods at the agreed profit margin. The customer is entitled to settle his liabilities on an agreed deferred term.

Musharakah LC-i (Joint venture,Musharakah LC-i (Joint venture,profit/loss sharing)profit/loss sharing)

1. On establishing the LC-i, the customer will place a deposit (under the Al-Wadiah Yad

Dhamanah principle) for his agreed share of the cost of the goods in questions.

2. The bank then establishes the LC-i and pays to the negotiating bank. The customer’s deposits as well as the bank’s fund (for its share of the cost of the goods) will be utilised

3. The documents are released to the customer, who will dispose of the goods as agreed under the Al-Musharakah agreement.

4. The profits derived therefore will be shared between thebank and the customer as agreed.

Contents/Documents Contents/Documents with Letter of Credit (LC)with Letter of Credit (LC)

1. Date of application.

2. Stamp Duty of RM3.00 is placed and cancelled.

3. Whether the LC is to be revocable, irrevocable, transferable or revolving.

4. Whether the LC is to opened by mail or telex/cable and whether telex/cable advice to be the operative credit instrument.

5. Whether the advising bank is to add its confirmation. If so, to insert the clause “Please request your agent to add its confirmation.”

6. Full and correct name and address of the applicant.

7. Full and correct name and address of the beneficiary and that the beneficiary is not domiciled in Israel.

8. Amount of the LC and the ISO currency code are clearly stated.

9. Trade terms – whether CIF, C&F or FOB etc.

10. Whether the draft is to be drawn at sight or usance. If drawn on usance basis, it should state “30 days after sight” or “30 days after date of bill of lading.”

11. Expiry date of the LC and the country in which the LC is valid for negotiation are clearly stated (UCP 500 Article 42).

12. Whether the draft is to be drawn against 100% invoice value or for a lesser percentage. The draft is to be drawn on the issuing bank [UCP 500 Article 9(a) and (b)].

13. Types of documents required

a) Signed commercial invoice

b) Certificate of origin

c) Weight Note

d) Packaging list

e) Insurance policy/certificate

f) Bill of lading/airway bills/ delivery order

No. of copies required &to indicate Import License no.

Name country of origin

No of copies required

No of copies required

FOB, CFR insurance to becovered by buyer

Authority to claim goods

14. The brief description of merchandise and quantity.

15. Shipment – Ports of origin and destination.

16. The latest shipment date (must not be more than 21 days from expiry of the LC).

17. Whether partial shipments are allowed.

18. Whether transhipment is allowed.

19. Presentation period of documents.

20. Any special instruction, e.g payment of charges.

21. Authorised signature of the applicant

22. Terms and conditions imposed.

23. Submission of relevant forms e.g KPWP.

Letter of Credit operationsLetter of Credit operations

LC established on 02-01-2009 to 30-04-2009 Beneficiary : In TokyoAmount : US28,571-43Exchange Rate : 3.50%Amount in RM : RM100,000-00Commission : 0.1% per monthPeriod of LC : 4 monthsProfit rate : 9%Postage : RM37-00

Charges on Letter of CreditCharges on Letter of Credit

Commission RM4,000-00Profit rate from the date of negotiation @ 8 days to-date of payment plus 10 remittance days 443-84

• Postage (courier) 37-00• Stamp duty (application) 3-00 40-00 Total charges 4,483-84

Trust Receipt-iTrust Receipt-i

Trust Receipt-i is a financing facility to finance domestic or international trade documents drawn against Letter of Credit-i (under Murabahah concept) or Inward Bills for Collection-i (under Wakalah concept).

It is facility granted to customers for financing their short-term working capital requirement by way of murabahah.

Process flow of Trust Receipt-iProcess flow of Trust Receipt-i

1. The Bank appoints the customer as its agent to purchase goods he requires on behalf of the bank. 2. Upon delivery of the goods, the Bank pays the exporter/supplier for the cost of the goods based on the invoice value.

3. The bank will purchase the goods from the customer at invoice value and resell them to the customer on deferred payment terms at a price inclusive of bank’s profit margin.

The Bank will purchase the goods from the customer at invoice value and resell them to the customer on deferred payment terms at a price inclusive of the Bank's profit margin.

The deferred payment terms of sale of goods granted to the customer constitutes a creation of debt. This is secured in the form of Bill of Exchange drawn by the Bank and accepted by the customer and payable on maturity

The deferred payment terms of sale f goods granted to the customer constitutes a creation of debt. This secured in the form of Bill of Exchange drawn by the bank and accepted by the customer and payable on maturity.

The Bank holds customer's Trust Receipt-i executed by him to signify his holding of goods in trust pending sale of the goods.

Customer undertakes to settle the selling price on the expiry date

Creation of Trust Receipt-i Creation of Trust Receipt-i

Amount of Bill : US28,571-43Exchange rate : 3.5Amount in RM : RM100,000-00Period of Financing : 90 daysProfit rate : 9% p.aDate of Inception : 01-03-2009Maturity : 29-05-2009

• The bill amount in USD28,571-43 will be converted to MR based on rate of exchange prevailing on the date payment is affected by the LC-i issuing bank.

Trust Receipt Selling PriceTrust Receipt Selling Price

Invoice face value FV 100,000-00Profit rate r 9%Tenor (days to maturity) t 90 Murabahah Selling price 102,219-18Profit SP – FV 2,219-18

SP = FV x [1 + r*t/365]

Shipping Guarantee-iShipping Guarantee-i

A negotiable instrument be used by consignee to take delivery of merchandise at the port.

The issuance of Shipping guarantee by the bank to indemnifies shipping company against all consequences and liabilities of any kind whatsoever should there be any claim on its rightful owners.

It is signed by the importer and counter signed by the bank.

SG- i does not have any qualifying clauses as regards to the value and time.

The liability of the bank ceases only upon presentation of the original shipping documents in exchange for return of SG-i or perhaps by the law of limitation.

Under LG-i operation , the issuing bank would normally advise that the shipping documents should be presented to the negotiating bak for negotiation within. Say 7 days from the date of shipment To ensure speedy delivery all documents be sent by courier service

Al-Kafalah Letter of GuaranteeAl-Kafalah Letter of Guarantee(LG-i)(LG-i)

A customer requires a Letter of Guarantee-i in respect of say a loan procurement.

The bank requires a deposits from the custmer which is place under Al-Wadiah Yad–Dhamanah principle.

The Bank provided Al-Kafalah LG-i by charging a fee to the customers.

Islamic Accepted Bills (IAB)Islamic Accepted Bills (IAB)

IAB is a mode of financing available for imports and domestic sales; in the primary market, IAB-Import is concluded on the basis of murabahah, and IAB-Export is concluded on the basis of a sale of debt (bai’ al-dayn).

IAB is also traded in the secondary market on the basis of bai’al dayn.

IAB – Purchase/ImportIAB – Purchase/Import

The bank draws a Bill of exchange, which is a Certificate evidencing the debt, on and to be accepted by the customer.

The amount drawn is the full selling price payable by the customer to the bank on the maturity date of the financing.

The contract used is debt trading (bai al-dayn).

• The document essentially involves the creation of IAB as a security to finance working capital in the form of cash purchase of raw materials at cost which is sold back to the customer inclusive of profit margin (murabahah), with the customer acting as an agent to the bank.

• Upon acceptance by the customer, the bank may sell the bill to a third party (baial-dayan) at adiscunt (not less than te cost ) based on an agreed price.

Murabahah Selling PriceMurabahah Selling Price

Invoice face value 100,000-00Islamic cost of fund icof 7%Accepted commission rateRate (spread) acr 2%Profit rate r 9%Tenor (days to maturity) t 90 Murabahah Selling price 102,219-18Profit SP – FV 2,219-18

SP = FV x [1 + r*t/365]

39

ISLAMIC ACCEPTED

To……………………………………………………….…………………………………………………………..

At days after sight without days of grace pay to the order of ourselves

the sum of RINGGIT…………………………………………………………………

……………………………………………

Drawn to finance……………………………………………………………………of goods described in the record of the drawing/accepting bank.

For and on behalf of

ABC BANK BHD

…………………………………………

NO SIGNATURE /WRITING BELOW THIS LINE

Dated……………………..

IMPORTER SDN BHD

RM327,795-00

IMPORTATION INTO MALAYSIA

30-2-2008

“001674” 40”140141:

Due Date: 1-11-02

BB53-1IAB NO: 001674Br Ref No: LC 9993020224

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IAB DRAFT (Purchase/Import)IAB DRAFT (Purchase/Import)

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IAB – Export/SaleIAB – Export/Sale

The exporter seeks finance from the importer by preparing the export documents as required by the sales contract/letter of credit.

The IAB-Exports is drawn to finance exports or domestic credit sales and it is payable on a specified future date.

The customer sells the debt arising from his credit sales to importer/ local buyer to the Bank at discount (bai al-dayn)

• On the maturity date, customer will settle the debt to the Bank. The IAB-Exports may be sold in the secondary market.

A minimum amount of financing of RM50,000 is typically required.

A bank discount the face value of the IAB issued in the primary market, and may sell it to third party in the secondary Islamic money market. The discount

The discount rate offered by the Islamic money market dealer is 4% (as per table below).

Debt trading is only applicable in Malaysia, as in the middle East a debt is deemed money owed and may not be traded to a third party at a discount.

IAB proceedsIAB proceedsafter discountafter discount

IAB face value RM102,219-18Discount rate r 4%Tenor (days to remaining) t 60 Proceeds P 101,547-05

P = FV * [1 - r*t/365]

44

ISLAMIC ACCEPTED BILL

To……………………………………………………….…………………………………………………………..

At days after sight without days of grace pay to the order of ourselves

the sum of RINGGIT…………………………………………………………………

……………………………………………

Drawn to finance……………………………………………………………………of goods described in the record of the drawing/accepting bank.

For and on behalf of

XYZ Corporation

…………………………………………

NO SIGNATURE /WRITING BELOW THIS LINE

Dated……………………..

EXPORT IMPORT ISLAMIC BANK

180

MYR100,000.00

SALES WITHIN MALAYSIA

1/3/2008

“001674” 40”140141:

Due Date: 1/09/2008

BB53-1IAB NO: 001674Br Ref No:AdDayn77009901

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IAB DRAFT (Export/Sales)IAB DRAFT (Export/Sales)

For any queriesplease call 019-3893846 or e-mail to:

mahmudbuntat@yahoo.com

Have a good day Have a good day May God bless youMay God bless you

Thank you & Wassalam Thank you & Wassalam