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Prospects of Shari'ah-based global value chain finance

M S Siddiqui | October 11, 2018

Islamic finance has been defined as finance in consonance with the ethos
and values system of Islam and governed, in addition to the conventional
good governance and risk management rules, by the principles laid down by
Islamic Shariah. "Shariah" means such rules and regulations as have their
origin in the holy Qur'an and Sunnah t o govern all aspects of human life.

Islamic finance is a concept denoting a number of financing instruments or

operations, which avoid interest. It is not only to avoid interest -based
transactions, prohibited in the Islamic Shariah, but also to avoid uneth ical
practices and participate actively in achieving the goals and objectives of an
Islamic economy. Financial institutions should have 'halal' income and
depositors should also receive stable and 'halal' income.

Islam permits businesses including joint ve ntures based on sharing of risks

and profits for all concerned for cash and credit transactions. Trade is
permitted but prohibited Riba or interest charged on loan is prohibited. The
performance of capital should also be considered while rewarding the capi tal.
It is based on risk -sharing, owning and handling of physical goods, as well as
involvement in the process of trading.

Profit has been recognised as 'reward' for use of capital and Islam permits
gainful deployment of surplus resources for enhancement o f their value along
with the liability of risk of loss on capital rests with the capital itself, and no
other factor can be made to bear the burden of the risk of loss.

Financial institutions (FIs) cannot undertake activities which are detrimental

to society and its moral values and have to go through an exhaustive test of
Shariah compliance. They are not allowed to invest in narcotics, casinos,
nightclubs, breweries etc. This requires that the clients of Islamic banking
must have business which should be beneficial for society, creating real
wealth and adding value to the economy.

Islamic finance involves FIs as a partner in trade and has to concern itself
with the nature of business and profitability position of its clients. To avoid
loss and reputational risk, Islamic banks have to be extra vigilant about their
clientele.

There is an alternative. Islamic trade finance may play effective role in

promoting business. It is an effective trade financing methods and
instruments to provide the traders with best p re- and post-shipping financing
with compliance of Islamic rule.

The Islamic trade financing instruments provide working capital, pre -shipping
and post-shipping financing such as Istisna'a, Murabahah, Ijarah Muntahia Bi
al-Tamlik, Salam, Musharakah, Mudarabah, Installment Sale or Bay'
BithamanAjil (BBA). These Islamic financing modes depend on financing the
product in kind, which is very different from debt financing that exists in the
conventional banking system.

Some of these products are very convenient for financing global value chain
(GVC). Murabaha sells a commodity as per the purchasing price with a
defined and agreed-upon profit markup, which may be a percentage of the
selling price or a lump sum. It is a purchase with a promise to buy submitted
by a person interested in acquiring the goods through the institution, in which
case it is called a banking Murabaha: i.e., murabaha to the purchase orderer.
This may also be done through Bai-Murabaha. It is a contract between a
buyer and a seller under which the seller sells certain goods permissible
under Islamic Shariah and law of the land to the buyer at a price determined
by charging agreed profit, margin or mark -up over the cost price. In this
case, the buyer either makes cash payment to receive the goods or is
allowed to make payment by installments or on a fixed future date. The profit
mark-up may be fixed in lump sum or in percentage over the cost price of the
goods.

In Bai-Murabaha method, the client requests the bank or agent to purchase

certain goods for him. The bank purchases the goods as per specification
and requirement of the client. The client receives the goods on payment of
the price which includes mark-up profit as per contract. Under this mode of
investment the purchase/cost price and profit are to be disclosed separately.

Sometimes the buyer make payment at an agreed later date. This transaction
is called Bai-Muajjal.

It means sale for which payment is made at a future fixed date or within a
fixed period. In short, it is a sale on credit. It is a contract between a buyer
and a seller under which the seller sells certain specific goods (permissible
under Shariah and Law of the Country), to the buyer at an agreed fixed price
payable at a certain fixed future date in lump sum or within a fixed p eriod by
fixed installments. The seller may also sell the goods purchased by him as
per order and specification of the buyer.
In FI's perspective, Bai-Muajjal is treated as a contract between the FI and
the client under which the FI sells to the client cer tain specified goods,
purchased as per order and specification of the client at an agreed price
payable within a fixed future date in lump sum or by fixed installments.

Bai-Murabaha and Bai-Muajjal have become very relevant in the context of

recent developments in global value chain (GVC). These changes have made
value chain finance (VCF) an integral part of GVC. The buyers would like to
delay paying cash for their purchases. They always search for pre -shipping
financing which is necessary for them to acqui re raw materials and pay for
other pre-shipping trade activities. Likewise, the sellers or exporters also
look for the best possible way to get short -term financing to settle their post -
shipping expenses until they receive the payment for their goods and
services.

VCF also facilitates the movement of capital and investment between

countries through meeting financial need of both the buyer and the seller.

Many FIs are active in VCF apart from local banks. Some of the local banks
are also partners with overseas FIs. First Security Islami Bank Ltd (FSIB)
and Agrani Bank Ltd entered into agreement with Prima Dollar, a British non -
banking financial institution (NBFI) to provide VCF to exporters and/or
importers. The mode of finance includes a tripartite agreement between
buyer, seller and PrimaDollar for export of any products to buyers in
overseas markets. The buyer, seller and PrimaDollar made contract for
certain quantities of products for a certain amount of transaction. The
exporter in Bangladesh agreed to supply certain quantity of products at
agreed price against contract or Letter of Credit. LC or a contract issued
either from buyer or PrimaDollar.

The important features of the Bai-Murabaha mode of investment are (a) The
client (buyer) requests the bank to purchase particular goods and promises
to purchase the same from the bank at a price fixed by charging profit over
the cost price. (b) Under the Bai-Murabaha mode of investment there is no
scope to increase the price once it is fixed. (c) After buying the goods, the
Bank has to bear all the risk until goods are actually delivered to the client.
The credit extended by PrimaDolalr to the buyer also as per principle of Bai -
Muajjal as the amount is fixed earlier by the contract between buyer, seller
and PrimaDollar.

Bangladesh is a very good market for Islamic finance. VCF through Bai -
Murabaha and Bai-Muajjal may help promote the country's active
participation in global supply chain.

M.S. Siddiqui is Legal Economist.

mssiddiqui2035@gmail.com