Islamic trade financing

GROUP ASSIGNMENT OF ISLAMIC TRADE FINANCING

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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 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


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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.

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). 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.


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In fact, this is a credit granted by the importer to the exporter. Being a

credit, the 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.

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”.


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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 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.

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.


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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

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 importer is substitute

by the guarantee of a bank for a specific transactions.


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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 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.


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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 seller

(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:

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.


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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.

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


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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

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.

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.


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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

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 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.


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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, to

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.


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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 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 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.


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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 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.


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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 trust 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 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


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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 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.


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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, 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

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


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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 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


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amount of the bank’s selling price payable at maturity. If the bank decides to 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.

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).


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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

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 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.


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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 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 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 Credit

Definition A legal instrument executed by

Islamic bank on behalf of its

An instrument issued by Islamic

bank on behalf of and for the


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customer or applicant to the

beneficiary in connection with the

contract entered between the

applicant and beneficiary.

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 liability is contingent upon

the failure of applicant’s obligation.

Wakalah Islamic Letter of

Credit (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 the Company A is able to settle the payment, Company B will send back


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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 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


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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.

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 formalities are buyer’s

responsibility. Seller may contract for carriage at buyer’s expense and risk.


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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 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.


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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 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.

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.


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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 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 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)


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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. pg 257-258.

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

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Islamic trade financing

Economy & Finance

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