SHAR!(AH AND REGULATORY ISSUES OF ISLAMIC TRADE FINANCE IN MALAYSIA

BY

SHARIF AH F AIGAH SYED AL WI

A thesis submitted in fulfilment of the requirement for the degree of Doctor of Philosophy in Islamic Banking

and Finance

Institute of Islamic Banking and Finance International Islamic University

Malaysia

APRIL 2012

ABSTRACT

One of the main facilities offered by Islamic banks in Malaysia is trade finance. Operational practices of Islamic trade finance (ITF) in Islamic banks differ from one another. These practices raised some questions or issues among bankers, Shari'ah advisors and experts in ITF. Thus, this research aims to highlight the Sharf'ah issues on the operation of ITF facilities in Islamic banks. The ITF facilities must conform to the laws and regulations imposed by Bank Negara Malaysia (BNM) and are bound to follow rules and standards of the International Chamber of Commerce (ICC) for trade finance transactions. Therefore, this research also investigates the Sharf'ah issues in relation to these governing rules and regulations. This research adopts the qualitative method as the main research methodology. Sharf'ah issues on the operation and governing rules of ITF are gained from semi-structured interviews conducted with bankers who directly involved with the operation of ITF, Shari'ah officers, Sharf'ah advisors and experts of ITF and international trade in Malaysia. From the interviews, this research discovers many Shari'ah issues related to ITF facilities and the ICC rules such as the issue of converting the contract of letter of credit (LC) wakiilah to LC muriibaJ:iah, the issue of charging fees for bank guarantee which is using kqfiilah contract and the issue of the element of interest in the ICC rules. This research analyzes those issues by determining whether they are in line with Shari'ah principles. Generally, many of ITF facilities are Sharf'ah compliant except for a few facilities which need to be amended. Hence, some possible solutions to resolve the Shari'ah issues are proposed to BNM, Islamic banks and other related authorities.

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APPROVAL PAGE

The thesis of Sharifah Faigah Syed Alwi has been approved by the following:

Uzaimah Ibrahim Supervisor

Joni Tamkin Borhan External Examiner

Radwan Jamal Chairman

lV

DECLARATION

I hereby declare that this thesis is the result of my own investigations, except where

otherwise stated. I also declare that it has not been previously or concurrently

submitted as a whole for any other degrees at IIUM or other institutions.

Sharifah Faigah Binti Syed Alwi

V

INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA

DECLARATION OF COPYRIGHT AND AFFIRMATION OF FAIR USE OF UNPUBLISHED RESEARCH

Copyright© 2012 by Sharifah Faigah Binti Syed Alwi. All rights reserved.

SHARIAH AND REGULATORY ISSUES OF ISLAMIC TRADE FINANCE IN MALAYSIA

No part of this unpublished research may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission of the copyright holder except as provided below.

1. Any material contained in or derived from this unpublished research may only be used by others in their writing with due acknowledgement.

2. HUM or its library will have the right to make and transmit copies (print or electronic) for institutional and academic purposes.

3. The HUM library will have the right to make, store in a retrieval system and supply copies of this unpublished research if requested by other universities and research libraries.

Affirmed by Sharifah Faigah Binti Syed Alwi.

Signature

'i'J\ 7···~-

Vl

Date

ACKNOWLEDGEMENTS

B ismillahhirrabmannirrahim.

Albamdulillah, all praises to Allah SWT the Most Gracious and the Most Merciful that with His blessings, I am able to complete my work despite all the obstacles I faced. First and foremost, I would like to express my sincerest gratitude to my main supervisor Assistant Professor Dr Uzaimah Ibrahim for her intelligence, thoroughness and attention to my work. Her precious guidance, valuable comments, brilliant ideas and detailed criticisms have contributed a lot to the quality of my work. My undying appreciation also goes to my co-supervisor Assistant Professor Dr Mohd Fuad Sawari for his crucial contributions, helpful comments, never ending encouragement and valuable expertise in this field.

I must thank and acknowledge Universiti Teknologi Mara Malaysia for approving my study leave and also Bank Negara Malaysia for awarding me the Shartah Scholarship to do my doctorate in IIUM. My study would not have been feasible without the full support from these two reputable institutions.

I would like to express my deepest love and gratitude to my dearest husband Aziz Mohd Noor for his endless support for me in pursuing my doctoral research and his full belief of my ability to succeed in my work. Therefore, I share the beauty and the result of this work with him for I am surely unable to complete this study without his unfailing love, patience, encouragement and keeping my spirit high throughout the long journey.

I would also like to express my thanks and love to all my beloved children Atiyyah, Nisrin Sofea, Muhammad Imtiaz, Yasmin Sofea and Muhammad Imran for patiently tolerating throughout the period of my study. Their unconditional love, laughter, hugs and kisses have always wiped away my tiredness and worries.

I would also like to dedicate my work to my beloved parents Syed Alwi Syed Muhammad and Shoba'aton Sulin together with my beloved auntie Zaiton Sulin for their unfailing love and prayer for my success. My gratitude also goes to my beloved siblings Sharifah Noor, Syed Naqib and Syed Mahdhar for their trust in me to get my doctoral degree.

Thanks are also due to those who provided me with their assistance in facilitating my work in data collection especially in interview sessions. The personalities include; Prof. Dato' Dr. Mohd. Azmi Omar, Prof Dr Abd Ghafur Ismail, Associate Professor Dr Shamsiah Mohammad, Dr Ahcene Lahsasna, Dr Aznan Hasan, Dr Azman Mohd Noor, Ustaz Mohd Bakir Mansor, Ismail Mahayuddin, Mokhlis Maizan, Lukman Harun, Ahmad Tarmizi Abu Hanifah, Hayatey Baharum, Badriyah Md Taha, Asnul Hadi, Selamat Hj Sirat, Azlan Abdul Samad, Ustaz Ahmad Suhaimi Yahya, Ustaz Zamiri, Ustaz Hishamuddin Ab Hamid, Ustaz Saiful Anuar Hambali, Ustaz Muhammad Hisyam Hassan, Ustaz Ahmad Turmuzi Hamezah, Jamaliah Abdul

Vll

Malik, Sara Shamshudin, Shahar Ashari, Ferdaus Toh Abdullah, Azahari Awang Ahmad, Aniza Rahayu, Zulbahri Zainuddin, Md. Shah Nordin Ujang, Fisol Amri Mansor, Mexdelina Hussein, Wan Azizah, Fakihah Azahari and all the bankers, Shari'ah advisors, Shari'ah officers and experts in the area of Islamic trade finance and international trade who were directly or indirectly involved in my work.

Last but not least, I also would like to record my appreciation to my friends and colleagues who have given me support and encouragement to accomplish my work especially Bibik Nurhaidah, Wan Nur Akidah, Kak Rosmawani, Kak Salwana, Kak Norzihan, Ismah, Rafeah, Kak Chik Baterah, Kak Maz and Razmah. Not to forget my deepest thanks to Associate Professor Dr Rusni Hassan and Assistant Professor Dr Safi.ah for their precious advices and tips for me to complete my work despite being a mother to five growing kids. May Allah bless all of you.

Jazakumulliih khair al-jaza ', amin ya rabbal'iilamin..

vm

TABLE OF CONTENTS

Abstract .............................................................................................................. ii Abstract in Arabic ................................................................................................... iii Approval Page ......................................................................................................... iv Declaration Page ...................................................................................................... v Copyright Page ........................................................................................................ vi Acknowledgement .................................................................................................. vii Table of Contents .................................................................................................... ix List of Tables .......................................................................................................... xiv List of Figures .......................................................................................................... xv List of Statutes, Rules and Regulations ................................................................... xvi List of Abbreviations ............................................................................................... xvii Arabic Transliteration .............................................................................................. xix

CHAPTER ONE: INTRODUCTION ................................................................. 1 1.0 Legal Background ................................................................................. 1 1.1 Problem Statement ............................................................................... 3 1.2 Research Objectives .............................................................................. 12 1.3 Significance of Research ..................................................................... 13 1.4 Scope and Limitation ........................................................................... 14 1.5 Hypothesis ............................................................................................ 15 1.6 Research Methodology ......................................................................... 16

1.6.1 Data Collection ............................................................................ 16 1.6.2 Data Analysis ............................................................................... 19

1. 7 Literature Review ................................................................................. 20

CHAPTER TWO: LEGAL AND REGULATORY FRAMEWORK OF ISLAMIC TRADE FINANCE IN MALAYSIA ................................................ 29

2.0 Introduction ............................................................................................ 29 2.1 Legal Provision ...................................................................................... 30

2.1. l Central Bank of Malaysia Act 2009 ......................................... '". 30 2.1.2 Banking and Financial Institution Act 1989 ................................ 31 2.1.3 Islamic Banking Act 1983 of Malaysia ....................................... 32

2.1.3.1 Shari'ah Advisory Board (SAB) and Sharf'ah Advisory Council (SAC) ............................................................................. 34

2.1.4 Exchange Control Act 1953 ......................................................... 36 2.1.5 Bill of Exchange Act 1949 ........................................................... 37 2.1.6 Payment Systems Act 2003 ......................................................... 38 2.1.7 Companies (Amendment) Act 2007 .......................................... .40 2.1.8 Contracts Act 1950 ...................................................................... 41 2.1.9 Customs Act 1967 ........................................................................ 43 2.1.10 Sale of Goods Act 1957 ............................................................. 43 2.1.11 Stamp Act 1949 ........................................................................ .44

ix

2.2 Regulatory Framework ......................................................................... 45 2.2.1 Local Rules and Regulations ....................................................... 45

2.2.1.1 Bank Negara Malaysia- Guidelines on Accepted Bills-i 45 2.2.1.2 Bank Negara Malaysia- Shari'ah Parameter Reference. 47 2.2.1.3 Association of Bankers Malaysia Rules ......................... 4 7 2.2.1.4 Export-Import Bank of Malaysia Berhad- Guideline on Islamic Export Credit Refinancing ............................................. 48

2.2.2 The Relevant International Chamber of Commerce Rules .......... 49 2.2.2.1 International Commercial Terminologies ....................... 50 2.2.2.2 Uniform Customs and Practice for Documentary Credits52 2.2.2.3 Uniform Rules for Collections ........................................ 54 2.2.2.4 Uniform Rules for Demand Guarantees ......................... 56 2.2.2.5 Uniform Rules for Bank-to-Bank Reimbursements under Documentary Credits ................................................................... 57 2.2.2.6 International Standard Banking Practices ....................... 58 2.2.2.7 International Standby Practices ....................................... 59

CHAPTER THREE: SHARi'AH CONTRACTS IN THE FACILITIES OF ISLAMIC TRADE FINANCE IN MALAYSIA ........................................... 61

3.0 Introduction ........................................................................................... 61 3.1 Contracts in Islamic Trade Finance Facility ........................................ 61

3 .1.1 Mur<ibafiah (Cost Plus) ............................................................... 61 3.1.2 Wak<ilah (Agency) ....................................................................... 67 3.1.3 Kafiilah (Guarantee) ................................................................... 72 3.1.4 Bay' al-Dayn (Sale of Debt) ....................................................... 79 3.1.5 Jjiirah (Leasing) and Ujrah/Ajr (Fee) .......................................... 83 3.1.6 Wadtah (Safe Custody) .............................................................. 88 3.1.7 Tawwarruq (Monetization/Cash Procurement) ........................... 91

CHAPTER FOUR: TRADE FINANCE FACILITIES IN ISLAMIC BANKS IN MALAYSIA ..................................................................................................... 96

4.0 Introduction ........................................................................................... 96 4.1 Islamic Banks in Malaysia ................................................................... 97 4.2 Islamic Trade Finance Facilities .......................................................... 97

4.2.1 LetterofCredit-i ......................................................................... 98 4.2.1.1 Letter ofCredit-i under the Contract of Wak<ilah .......... 102 4.2.1.2 Letter of Credit-i under the Contract of Muriibafiah ...... l 05

4.2.2 Trust Receipt-i under the Contract of Mur<ibafiah ...................... l 07 4.2.3 Working Capital Financing-i under the Contract of Mur<ibafiah and Tawarruq ....................................................................................... 109 4.2.4 Accepted Bills-i under the Contract of Muriibafiah and Bay' al-Dayn ................................................................................................ 112

4.2.4.1 AB-i (Purchase) for Imports and Local Purchases ......... 113 4.2.4.2 AB-i (Sales) for Exports and Local Sales ....................... 115

4.2.5 Inward Bills for Collection-i and Outward Bills for Collection-i under the Contract of Wak<ilah ........................................ 117 4.2.6 Bills of Exchange Purchased-i under the Contract of Bay'

X

al-Dayn ................................................................................................ 122 4.2. 7 Export Credit Refinancing-i under the Contract of Murabal;ah and Bay' al-Dayn ........................................................................................ 125

4.2.7.1 Pre-Shipment Export Credit Refinancing-i ..................... 126 4.2. 7 .1 Post-Shipment Export Credit Refinancing-i ................... 129

4.2.8 Bank Guarantee-i under the Contract of Kafalah ....................... 132 4.2.9 Shipping Guarantee-i under the Contract of Kaftilah ................. 135

CHAPTER FIVE: OPERATIONAL SHARi'AH ISSUES IN ISLAMIC TRADE FINANCE ................................................................................................ 138

5.0 Introduction ........................................................................................... 138 5 .1 The Issues Related to Letter of Credit ................................................. 13 8

5.1.1 Problem of Letter of Credit Wakalah Conversion to Trade Murabal;ah and the Relationship with the Type of Letter of Credit-i Offered by the Islamic Banks ............................................................... 139 5.1.2 ThetitleofGoods ........................................................................ 143 5.1.3 Appointment of Bank as Paying Agent in LC Wakalah .............. 146 5 .1.4 Sale Contract between the Buyer/Importer and The Seller/ Exporter ................................................................................................ 14 7 5.1.5 Charging Fees on the Issuance of Letter of Credit-i .................... 152

5.2 Charging Fees for Bank Guarantee-i in Islamic Banks ........................ 155 5.2.1 Different Methods in Charging Fees for Bank Guarantee-i and the Issue of Fees onKafalah Contract ................................................. 156 5.2.2 Qarrj (Loan) in the Case of Customer Defaulting Obligation in Bank Guarantee-i ................................................................................. 165

5.3 The Issues under Shipping Guarantee-i ................................................ 169 5 .3 .1 Execution of Murabal;ah Financing in Letter of Credit Murabal;ah Together with the Issuance of Shipping Guarantee-i.. ...... 170 5.3.2 Liabilities of Shipping Guarantee-i ............................................. 175

5.4 The Usage of 'Nostro' Account in International Trade Payments ....... 179 5.4.1 'Nostro' Account Being the Non Shari'ah Compliant Account. 179 5.4.2 Islamic Bank Leverages on the Parent Bank's 'Nostro'Account 184

5.5 The Issues under Trust Receipt-i ......................................................... 187 5.6 Documentation Issues .......................................................................... 193

5.6.1 Shari'ah Compliance of Documentation oflslamic Trade Finance Facilities in Islamic Banks .................................................................... 194

5.7 Issue of Pricing .................................................................................... 198 5.8 Issue of Permissibility of Bay' al-Dayn as Applied in Islamic Trade Finance among the Shari'ah Scholars ......................................................... 203

CHAPTER SIX: SHARi'AHISSVES IN RELATION TO GOVERNING RULES AND REGULATIONS OF ISLAMIC TRADE FINANCE ................ 209

6.0 Introduction ........................................................................................... 209 6.1 Issues in Relation to Local Rules and Regulations ............................... 209

6.1.1 Lack of Proper Rules or Guidelines and Regulations for Islamic Trade Finance ........................................................................... 210

6.2 Issues in Relation to International Regulations .................................... 211

Xl

6.2.1 Shari''ah Issues on the Uniform Customs and Practice for Documentary Credit No. 600 .......................................................... 212

6.2.1.1 Ribii (Interest) Elements ................................................. 213 6.2.1.2 The Status of Letter of Credit Muriibabah under Uniform Customs and Practice for Documentary Credit No.

600 ······························································································ 218 6.2.1.3 Insufficiency in Dealing Solely with Documents for LC Muriibabah and LC Wakiilah without Checking on the Conditions of Goods .............................................................. 222

6.2.2 Shari"ah Issues on the Other International Chamber of Commerce Rules ..................................................................................................... 227

6.3 Introduction of an International Islamic Rule to Govern the Islamic Trade Finance from the Opinion of the Bankers and the Experts in Islamic Trade Finance and International Trade ........................................... 228

CHAPTER SEVEN: SUMMARY AND RECOMMENDATIONS .................. 236 7.0 Introduction ........................................................................................... 236 7.1 Summary ............................................................................................... 236 7 .2 Recommendations ................................................................................ 240

7.2.1 Documentation of the Islamic Trade Finance Facilities .............. 240 7.2.2 Structures of the Islamic Trade Finance Facilities ..................... °" 242

7.2.2.1 Letter of Credit-i .............................................................. 242 7.2.2.2 Fees on Bank Guarantee-i ............................................... 245 7.2.2.3 Shipping Guarantee-i ....................................................... 248 7.2.2.4 The Usage of 'Nostro' Account in International Trade Payment ............................................................................. 249 7.2.2.5 Trust Receipt-i ................................................. 250 7.2.2.6 Bay' al-dayn in Islamic Trade Finance Facilities ............ 251 7 .2.2. 7 Appointment of Agent to Check on the Underlying Asset ............................................................................................ 252

7.2.3 Legal Framework oflslamic Trade Finance ................................ 253 · 7.2.3.1 Standard Circular or Standard Guidelines on Islamic Trade Finance ............................................................ 254

7 .2.4 Human Capitals Who Deal with Islamic Trade Finance Facilities ................................................................................................ 255

7.2.4.1 Adequate Knowledge and Understanding of the Bankers and the Shari''ah Officers in Islamic Banks on Islamic Trade Finance ....................................................................................... 256 7.2.4.2 Islamic Trade Finance as a Major Subject in Islamic Banking and Finance Course in Institutions of Higher Leaming ....................................................................................... 256 7.2.4.3 Shari"ah Review and Audit in Islamic Banks ................. 257

7.3 Conclusion ............................................................................................ 258

BIBLIOGRAPHY .......................... ~ ....................................................................... 259

XU

APPENDICES ..................................................................................................... 282 APPENDIX A: List of the Islamic Banks in Malaysia ............................................ 283 APPENDIX B: List of Respondent Interviewed from Bankers, Sharf'ah Officers, Shari'ah Advisors and Expert in the area of Islamic Trade Finance and International Trade in Malaysia ................................................................................................... 284 APPENDIX C: List of Questions for Semi Structured Interviews .......................... 290 APPENDIX D: List of Courses Attended ............................................................... 294 APPENDIX E: List oflssues and the Sources ......................................................... 295

Xlll

Table No

4.1

5.1

5.2

5.3

5.4

5.5

5.6

5.7

6.1

LIST OF TABLES

Islamic Trade Finance Facilities: Islamic Contracts Use and Purpose

Type of Letter of Credit-i Offered by the Islamic Banks in Malaysia

Charging Fees for Letter of Credit-i Issuance

Methods of Charging Fees by Islamic Banks in Bank Guarantee-i

Execution of Murababah Financing in Letter of Credit-i Murababah in Shipping Guarantee-i Whether It Is Done Together with the Issuance of Shipping Guarantee-i or After the Arrival of Documents

Islamic Banks 'Nostro' Accounts

Islamic Banks Offering Trust Receipt-i with or without Letter ofHypothecation

Bay' al-Dayn Contract in Islamic Banks

The Need for Islamic UCP or Additional Rules for Letter of Credit-i in the UCP 600: Views of Bankers and Experts in Islamic Trade Finance and International Trade

XIV

Page No.

98

139

153

158

171

185

190

204

230

Figure No

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

4.9

4.10

4.11

4.12

4.13

5.1

LIST OF FIGURES

Letter of Credit Wakalah

Letter of Credit Murababah

Murababah Trust Receipt-i Financing

Tawarruq Transaction

Accepted Bills-i (Purchase)

Accepted Bills-i (Sale)

Documentary Collection - Sight Bills

Documentary Collection- Usance Bills

Bay' al-Dayn Financing m BEP and BEP/AP-i

Pre-Shipment ECR-i - First Stage using Murababah

Pre-Shipment ECR-i - Second Stage using Bay' al-Dayn

Post-Shipment ECR-i using Bay' al-Dayn

Bank Guarantee-i

Opening an Letter of Credit

xv

Page No.

103

105

109

111

114

116

120

121

124

127

128

131

133

148

LIST OF STATUTES, RULES AND REGULATIONS

Statutes

Banking and Financial Institution Act 1989 Bill of Exchange Act 1949 Central Bank of Malaysia Act 2009 Companies Act 1965 Contract Acts 1950 Customs Act 1967 Exchange Control Act 1953 Islamic Banking Act 1983 Payment Systems Act 2003 Sale of Goods Act 1957 Stamp Act 1949

Rules and Regulations

Association of Bankers Malaysia Rules Bank Negara Malaysia- Shari'ah Parameter Reference Export-Import Bank of Malaysia Berhad Guideline on Islamic Export Credit Refinancing Guidelines on Accepted Bills-i International Commercial Terminologies International Standard Banking Practices International Standby Practices The Relevant International Chamber of Commerce Rules Uniform Customs and Practice for Documentary Credit Uniform Rules for Bank-to-Bank Reimbursements under Documentary Credits Uniform Rules for Collections Uniform Rules for Demand Guarantees

XVI

LIST OF ABBREVIATIONS

Common abbreviation

ed. eds. edn. e.g et al. etc. 1.e

Ibid n.d. n.p. PBUH vol.

editor editors edition (exempligratia)for example (et alia): and others and so fourth that is (ibidem) in the same place no date no place of publication or no publisher Peace Be Upon Him volume

Notes on abbreviations

AAOIFI

AB-i ABM AIBIM BA BAFIA BE-i BEP/AP-i BEP-i BFR BG BG-i BIMB BIS BLR BNM CBMA2009 CERT CGBP ECR ECR-i EXIM eUCP GCC IAB IBA

Accounting and Auditing Organisation for Islamic Financial Institution Accepted Bills-i Association of Bankers Malaysia Association of Islamic Banking Institutions of Malaysia Banker's acceptance The Banking and Financial Institution Act 1989 Bills of exchange-i Bills of Exchange Purchased/Authority to Purchase-i Bills of Exchange Purchased-i Based Financing Rate Bank Guarantee Bank Guarantee-i Bank Islam Malaysia Berhad Bank for International Settlement Based Lending Rate Bank Negara Malaysia The Central Bank of Malaysia Act 2009 Centre of Excellence for Applied Research and Training Code of Good Banking Practice Export Credit Refinancing Export Credit Refinancing-i Export-Import Bank of Malaysia Berhad Electronic Uniform Custom Practice Gulf Co-operation Council Islamic Accepted Bills Islamic Banking Act

xvn

IBC-i IBFIM ICC INCOTERMS ISBP ISP ISRA ITF KLIBOR LC LC-i LIBOR MTR-i MWCF-i OBC-i ore PSA SAB SAC SG SG-i SWIFT TM-i TR TR-i TWCF-i UCP URC URDG URR

USD WCF-i

Inward Bills For Collection-i Islamic Banking and Finance Institute Malaysia International Chamber of Commerce International Commercial Terminologies International Standard Banking Practices International Standby Practices International Shari'ah Research Academy for Islamic Finance Islamic Trade Finance Kuala Lumpur Interbank Offered Rate Letter Of Credit Letter Of Credit-i London Interbank Offered Rate Murababah Trust Receipt-i Murabafiah Working Capital Financing-i Outward bills for collection-i Organisation of Islamic Cooperation The Payment Systems Act 2003 Shari'ah Advisory Board Sharf'ah Advisory Council Shipping Guarantee Shipping Guarantee-i Society for Worldwide Interbank Financial Telecommunication Trade Murababah Trust Receipt Trust Receipt-i Trade Working Capital Financing-i Uniform Customs and Practice for Documentary Credits Uniform Rules for Collection Uniform Rules for Demand Guarantees Uniform Rules for Bank-to-Bank Reimbursements under Documentary Credits United States dollar Working Capital Financing-i

xviii

ARABIC TRANSLITERATION

This research adopts the Arabic Transliteration Scheme that is based on the American Library Association-Library of Congress (ALA-LC) with slight modifications such as the use of 'h' for the 'o' that indicates the feminine gender in Arabic nouns.

Transliteration Table

F- ' t kh ~

0" Sh t Gh (J N

'-:I B .l D (jo::I ~ u F ,k. H

i.::i T j dh u,Q <;l J Q .J w

l.!i Th .J r .l:i t ~ K Li y

[ J j z .l:a ? J L

1). s t C

r M C 0"

Short Vowels I a

-

i -I ' u

-

L V I on~ owes \+ L a

Li+ - i I

.J+ ~ u

XIX

CHAPTER ONE

INTRODUCTION

1.0 LEGAL BACKGROUND

Islamic banking has emerged as a new reality in the international financial scene with

its fast growing development in a few Islamic countries in the 1970s.1 Its philosophies

and principles are however, not new having been outlined in the Quran and the

Sunnah of the Prophet Muhammad (PBUH) more than 1,400 years ago. Islam allows

and encourages Muslims to involve in trade and business activities and at the same

time it prohibits all unlawful means of acquiring wealth such as ribri (usury or

interest) and gharar (uncertainty). 3 The emergence oflslamic banking is often related

to the revival of Islam and the Muslim's desire to live all aspects of their live in

accordance with the teachings of Islam. In Malaysia, people with separate Islamic

legislation and banking regulations live side-by-side with those for the conventional

banking system. The legal basis for the establishment oflslamic banks was the Islamic

Banking Act (IBA)4 which came into effect on 7 April 1983. The IBA provides Bank

Negara Malaysia (BNM) with powers to supervise and regulate Islamic banks5

together with other licensed banks.

1 Sobri Salamon, Bank Islam (Petaling Jaya: Persatuan Ulama Malaysia, 1984), vi. 2 Ribii (usury or interest) in conventional banking may come in the form of interest charges. Interest here is defined as ''the charge made for borrowing a sum of money. The interest rate is the charge made, expressed as a percentage of the total sum loaned, for a stated period of time (usually one year)." See A Dictionary of Finance and Banking (Oxford: Oxford University Press, 4th edn., 2008), 232. 3 Sudin Haron and Bala Shanmugam, Islamic Banking System: Concepts and Applications (Subang Jaya: Pelanduk Publications (M) Sdn. Bhd., 1997), 30-32. 4 The discussion on the Islamic Banking Act can be found in chapter 2 of the thesis. 5 Sudin Haron, Prinsip dan Operasi Perbankan Islam (Kuala Lumpur: Berita Publishing Sdn. Bhd., 1996), 21.

1

One of the main banking facilities offered in Malaysia is trade finance. Trade

finance facilities have always played an important role in facilitating the

purchase/import and sale/export of goods and machineries, and the purchase and

holding of stock and inventories, spares and replacements, raw materials and semi­

finished goods for the conventional or the Islamic bank's customers generally on short

term basis. 6 Trade finance consists of bank facilities such as letter of credit, bank

guarantee, shipping guarantee, trust receipt, banker's acceptance and

purchased/discounted bill.7 For decades, banks worldwide have been practicing the

conventional method of trade financing until recent years with the emergence of the

Islamic banking system. The system has become very popular particularly in the

region because it offers an excellent alternative to the customers.

Islamic trade finance (ITF) operation is a specialized area of Islamic banking

utilizing various concepts that need to be understood by the parties involved

particularly bankers and traders. Among the ITF facilities8 offered by Islamic banks in

Malaysia are letter of credit using the contract of muriibabah9 (cost-plus) and

wakiilah10 (agency), bank guarantee and shipping guarantee using the contract of

kafiilah 11 (guarantee), trust receipt and working capital financing using the contract of

muriibabah and tawarruq 12 (monetization or cash procurement), accepted bills using

the contract of muriibabah and bay< al-dayn13 (sale of debt) and a few other

facilities. 14

6 Nik Norzrul Thani, Mohamed Ridza and Megat Hizaini, Law and Practice of Islamic Banking and Finance (Petaling Jaya: Sweet & Maxwell Asia, 2003), 87. 7 The discussion on conventional trade finance facilities can be found in chapter 4 of the thesis. 8 The discussion on Islamic trade finance facilities can be found in chapter 4 of the thesis. 9 The discussion on muriiba!zah can be found in chapter 3 of the thesis. 10 The discussion on wakiilah can be found in chapter 3 of the thesis. 11 The discussion on kafiilah can be found in chapter 3 of the thesis. 12 The discussion on tawarruq can be found in chapter 3 of the thesis. 13 The discussion on bay' al-dayn can be found in chapter 3 of the thesis. 14 Nik Norzrul Thani, Mohamed Ridza and Megat Hizaini, 129-135.

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Most of the trade finance facilities are governed by rules and standards issued

by the International Chamber of Commerce (ICC) such as International Commercial

Terminologies (INCOTERMS), Uniform Customs and Practice for Documentary

Credits (UCP), Uniform Rules for Collection (URC), Uniform Rules for Demand

Guarantees (URDG), Uniform Rules for Bank-to-Bank Reimbursements under

Documentary Credits (URR), International Standby Practices (ISP) and International

Standard Banking Practices (ISBP)15 because they are the products of ICC. The ITF

facilities offered in the Islamic banks in Malaysia are also governed by the same ICC

rules as well as the local legal provisions, rules and regulations endorsed by the

Government of Malaysia. Only two of the trade finance facilities in Malaysia are not

the ICC's products namely banker's acceptance and export credit refinancing. These

two trade finance facilities are the product of BNM and Export-Import Bank of

Malaysia Berhad (EXIM Bank).

1.1 PROBLEM STATEMENT

Islamic banking facilities and services have become so important and significant in

Malaysia today. Nevertheless, the wide Islamic banking practices have given rise to

some issues and questions that have being brought forward by the public, bank

practitioners and Muslim scholars. For ITF facilities, there are also some issues being

raised towards its operation in the banking system. In order to identify the Shari'ah

issues in the operation ofITF, a few interviews have been conducted with the bankers

who are directly involved with ITF16 and also the distinguished Sharf'ah scholars.17

15 International Chamber of Commerce, "Policy and business practices", <http://www.iccwbo.org/ policy/banking/id2424/index.html> (accessed 30 March 2010); Nik Norzrul Thani, Mohamed Ridza and Megat Hizaini, 129-135. 16 Asnulhadi Yeop Aziz, Interviewed by Thesis Writer, Kuala Lumpur, 19 June 2007; Hayatey Baharum, Interviewed by Thesis Writer, Kuala Lumpur, 26 June 2007; Azlan Abd Samad, Interviewed

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Apparently, the issues ofITF in Malaysia can be categorized into two main areas. The

first area of issues pertains to Sharf'ah issues on the operation of ITF and the second

area of issues pertains to Shari' ah issues on the rules and regulations that govern the

operation of ITF in Malaysia.

There are a few Sharf(ah issues on the first area of issues that is on the

operation of ITF. These issues arise mainly because there is no standard written

guideline on every ITF facility. The first Sharf'ah issue is on the LC-i which applies

the contract of murabaf:iah and wakalah. There are few issues highlighted under LC-i.

One of the issues of LC-i is pertaining to LC murababah where there is a possibility

that the practice of murababah will only become cover for continuing the present

interest-based transactions18 if it is not implemented according to the real conditions

of al-bay' (sale). Muriibaf:iah originally is a kind of sale and not a mode of financing.

Thus, the use of murabaf:iah as a mode of fmancing in LC murabaf:iah is subject to

certain conditions such as the bank as the financier must be involved in a real sale and

not merely advancing a loan to the customer. 19 For example, if the customer requires a

fund to pay the price of a commodity which he had already bought, murabaf:iah cannot

be executed because the bank has not entered a real sale of goods but only gave a loan

or fmance to the customer. This circumstance sometimes happens to the customers of

Islamic banks who are the buyers/importers who have executed a sale contract with

the sellers/exporters before going to Islamic banks for financing. The sale contract

by Thesis Writer, Kuala Lumpur, 3 July 2007; The list ofrespondents interviewed in this research from bankers, Shar'i'ah officers, Shar'i'ah advisors and experts in the area of Islamic trade finance and international trade in Malaysia can be found in Appendix B. Some of the respondents agreed that their identities revealed for this research. However, some of them preferred to remain anonymous and thus they are addressed as R15 for example and not their real names. 17 Ustaz Mohd Bakir Hj. Mansor, Interviewed by Thesis Writer, Kuala Lumpur, 14 June 2007; Dr Aznan Hassan, Interviewed by Thesis Writer, Kuala Lumpur, 15 June 2007. 18 Muhammad Nejatullahi Siddiqi, Issues in Islamic Banking-Selected Papers (Leicester: The Islamic Foundation, 1983), 137-139. 19 Muhammad Taqi Usmani, An introduction to Islamic Finance (New Delhi: Idara Isha'at-e-diniyat (P) Ltd., 2005), 105-106.

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executed between the customer and the seller/exporter shows that the customer is the

owner of the goods whereas he comes to the bank for murababah financing. The bank

has to become the owner of the goods first in order to sell the goods to the customer

under murababah financing. 20 The Shari'ah point of view on this particular issue and

other issues on LC-i has to be clarified especially on the ownership of the goods in

murababah financing, i.e. between the Islamic banks and the customer.

Another Shari'ah issue is the application of contract of kafalah in ITF facilities

which is considered by most jurists as a tabarru' (voluntarily gift). In giving guarantee

which is based on kafalah contract, the guarantor can only claim compensation for the

actual amount that he pays to the beneficiary and thus he cannot expect a reward for

his guarantee. In modern banking, fees are imposed for the guarantee services given

for bank guarantee (BG)21 and SG. Most of the Islamic banks in Malaysia impose fees

on the services that use kafalah contract in the ITF facilities such as bank guarantee-i

(BG-i)22 and SG-i. However, some Middle Eastern based Islamic banks in Malaysia

like Al Rajhi Banking & Investment Corporation (Malaysia) Berhad, Asian Finance

Bank Berhad and Kuwait Finance House (Malaysia) Berhad only impose fees on the

kafalah contract for the administrative fees incurred in issuing the BG-i. Hence, the

practices of Islamic banks in Malaysia somehow contradict with the practice of

Middle Eastern based Islamic banks in Malaysia.23

"Shari'a Standards"24 of the Accounting and Auditing Standards for Islamic

Financial Institutions (AAOIFI) has stated that it is not permissible to take

remuneration for issuing a letter of guarantee or BG. It is further explained by

20 The discussion on this particular issue can be found in chapter 5 of the thesis. 21 The discussion on bank guarantee can be found in chapter 4 of the thesis. 22 The discussion on bank guarantee-i can be found in chapter 4 of the thesis. 23 The discussion on this particular issue can be found in chapter 5 of the thesis. 24 Accounting and Auditing Standards for Islamic Financial Institutions (AAOIFI), Shan-'a Standards (Bahrain: AAOIFI, 2004), 63.

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