Importer

Open Account
Documentary
Collections
Letters of
Credit
Cash-in-
Advance
Exporter
Cash-in-
Advance
Letters of
Credit
Documentary
Collections
Open Account
Trade Finance
In global activity nowadays, many domestic firms start to import goods and services from
foreign suppliers and to export as well to foreign buyers. However, many issues must be faced by
domestic and also foreign firms to conduct this international transaction. Therefore, bank is
willingly to solve this dilemma by being intermediary amongst those parties, importer and
exporter. There are three key documents that bank acts as an intermediary, which are Letter of
Credit, Draft (also known as Bill of Exchange), Bill of Lading (Moffett et. al, 2011). According
to Boland (2011), trade financing with the bank as middle man, is conducted in short-term, self
liquidating, secured, speedily completed, and the short life of documentary credit.

Methods of Payment in International Trade
Based on the date of U.S. Department of Commerce (2007), the exporter is suggested to choose
the appropriate payment method that reduces the risk and also accommodating the needs of the
buyer. There are four methods of payment for international transaction.
Payment Risk Diagram


Most Secure Most Secure




Least Secure Least Secure

Source: U.S. Department of Commerce, International Trade Administration 2007
Cash-in-Advance
Under this method, the exporter is able to lower the credit risk, since the payment is
received in advance prior to the shift of ownership of the goods. Two most commonly
used modes of payment to conduct this cash-in-advance, wire transfers and credit cards.
However, there are also some disadvantages by requiring the importer to do cash-in-
advance, which will make the importer least attractive to do the business in the future. It
is due to creating cash flow problems and foreign buyers are also afraid that the goods
may not be shipped after the payment is conducted. Those exporters that persist on this
method of payment as their exclusive method of payment doing business will face
themselves in losing themselves with their competitors who may be offering more
attractive payment terms.

Letter of Credit
Letter of Credit is the most secure instrument among traders in the international business
transaction. An LC is a bank commitment on behalf of the importer that payment will be
performed to the exporter according to the terms and conditions that have been agreed, as
validated through the presentation of all required documents. However, the buyer
(importer) is required to pay this facility before bank provides this service. This letter of
credit is useful for the exporter to gain some reliable credit information about a particular
foreign buyer which is difficult to obtain. An LC also secures the buyer (importer) for not
paying immediately the amount of the goods until the goods have been shipped or
delivered as promised.

Documentary Collections
A documentary collection is a process of transaction whereby the exporter hand over the
collection of the importers payment to its bank or remitting bank, which sends
documents and also instruction of payment to a collecting bank (importers bank). The
importer pays the required funds which will be remitted to the exporter through the banks
involved in the collection in exchange for those documents. Documentary collections
engage with the use of draft that obliges the importer to pay the face amount either in
sight draft or time draft mode. Sight draft is also known as document against payment
(D/P) whereas time draft or payment on a specified date in the future also know as
document against acceptance (D/A). Instructions on draft list specify that the documents
required in favor of the transfer of title to the goods. As the banks role as facilitators on
behalf of their clients under the collections, consequently, no verification is offered under
documentary collections and limited recourse as well in the event of default. Drafts are
mostly less expensive instrument compare to letter of credit.

Open Account
An open account is a transaction that being conducted when the goods are shipped and
delivered but the importer are not required to make some immediate payment, usually
between 30 to 90 days. This is the most secured method of payment for the importer side
which benefits them in cash flow and cost terms. However, the exporter faces higher risk
for doing this payment method. This method arises due to very tight competition between
the exporters in the market; moreover, the importer even press the exporter to do this
open account transaction since the extension of credit by the seller to the buyer is more
common abroad. As a result, the exporters who are unwilling to do this transaction may
result losing their business in the market. It is possible to transfer the risk of default under
open account trade by using export credit insurance and factoring. Moreover, the exporter
is also permissible to seek for working capital financing to the bank to ensure that they
are able to financing for both exports production and any credit while waiting for the
payment from the importer.






The Concept of Kafalah
This concept is also known as letter of guarantee, which merely bank acts as an intermediary in
certain kinds of transaction as the purpose of ensuring both parties in the atmosphere of security
and confidence. In other words, the bank is putting its role as a guarantor of its clients liability
against the counterparty. In the case of default by the particular customer, the liability may be
endured by the bank as the customers guarantor and may be obliged to pay up the amount
guaranteed. According to past scholars, there is no a voluntary service and fee can be charged
because the guarantee itself is a free service. It is because under the Islamic scheme, a person is
not allowed to charge a fee for advancing a loan. In fact, the guarantor does not even put his
money in advance and merely undertakes his liability to pay in the event of default by the
customer (Obaidullah, 2005).
However, in this present time, the bank puts the charges for issuing this letter of guarantee. The
charges are accepted under the Shariah point of view as stated by Obaidullah (2005), some
contemporary scholars put their views which the charging of guarantee fee is not explicitly
prohibited in the Quran and Sunnah. Therefore, it may be accepted due to necessity or darura.
In fact, nowadays in international trade, guarantee has become a necessity for both sellers and
buyers, especially in a case of international trade, whereby they do not know each other very
well and afraid that the payment of the price by the buyer may not be paid immediately after the
supply of the goods. For that reason, an Islamic bank can charge or pay a fee to cover expenses
arouse in the process of issuing a guarantee.

Based on information found from ISRA (International Shariah Research Academy for Islamic
Finance), issued by Al-Rawad al-Nadiyyah fi al-fatwa al-Shariah, Faisal Islamic Bank of
Bahrain.
The ruling said, it is not permissible to put a fee that is based on the guarantee value and
its period. However, there is an alternative that the bank can charge a fee which is from
actual services provided to the customer, for instance the advisory services. The fee must
represent the normal fee that is imposed for those service types; along with the
permissible documentation services (can only be charged once).

Bank Guarantee-i (Kafalah)
Bank Guarantee-i (BG-i) allows the customers to enlarge their business or enter into the dealings
where their business partners require BG-i as an element of the business arrangement. When
issuing the BG-i, Islamic Bank, as the guarantor, provides assurance to the customers
counterpart that the bank will pay them to encompass the customers losses in the event of
default, violate of contract or non-performance by the customer. BG-i would take part as an
added relieve to the customers partner of the obligation payment imposed to them. This BG-i is
in accordance with the concept of Kafalah (RHB Islamic Banking, 2013).

Shipping Guarantee-i (Kafalah)
It is an indemnity given by consignee to which the Bank jointly ensures the shipping company so
that the consignee named can take delivery goods prior to receipt of the relevant original bill of
lading. This is made under Kafalah concept (Bank Muamalat Malaysia Berhad).
Features
- SG-I is a facility granted by the Bank to importers for clearance of goods at the port
without presenting original Bill of Lading.
- It should be issued for documents drawn under the Banks LC only or clients with
approved SG-i facilities for collections documents.
- It is a Letter of Indemnity to the company signed by the clients and countersigned by the
bank authorizing
Benefits of Shipping Guarantee-i
- Customer is able to take delivery of goods immediately
- Customer will not have to incur port storage or demurrage charges
- Enables the customer to sell the goods without delay



ANALYZING THE BENEFITS AND SHORTCOMINGS FOR PATRONIZING
ISLAMIC TRADE FINANCE FACILITIES

Shipping Guarantee

- In CIMB Bank, both Islamic and conventional shipping guarantee, they put in the same price of
its fees and charges. Non-SME and SME customers charge 0.1% flat for the first 3 months on the
invoice value (minimum RM 50.00 if the price of 0.1% is lower than the minimum price or as
per Letter of Offer). The returned of SG-i is over than 3 months period, additional cost of 0.5%
p.a. or minimum RM 50.00 is charged upfront every 3 months until SG is returned. It is an issue
for CIMB Islamic Bank. First, it creates the Islamic banking product less attractive due to price
similarity with conventional. Second, in the case of not returned within 3 months, Islamic bank
sets higher fee from 0.1% flat to 0.5% per annum. In my opinion, since the Islamic Bank aimed
as a guarantor of its clients liability and the essence of this kafalah concept, which is actually no
cash outflow involved or a free service (Obaidullah, 2005), therefore, the Islamic bank should
simply charge a fixed fee of shipping guarantee-i in more period rather than 3 months only.

Bank Guarantee

- In the case of CIMB bank, Islamic banking side offers lower fees and charges to the customer
compare to conventional. Both non-SME and SME customers are charged in the same cost for
every issuance, renewal and amendment which minimum 0.6% per annum or RM 100.00
meaning bank will choose whichever is higher cost between the two or as per Letter of Offer,
whereas conventional side offers 0.1% p.m. or part thereof or as per Letter of Offer, or minimum
similar with Islamic banking RM 100.00. Therefore, shipping guarantee-i can be a very attractive
choice for customer to use this product and also complied under the Shariah rules.