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4th DECEMBER 2017


Settlement (finance) of securities is a business process where there is a distribution of interest in

securities normally distributed in simultaneous exchange of money, to meet contractual obligations, as
arising under securities. As part of performance of delivery obligations needed by the trade,
settlement involves the delivery of securities and the corresponding payment. Settlement at the
various custodian are more moving towards the DvP method (the simultaneous and irrevocable
exchange of security and cash). This method is used to reduce the risk amongst sellers and buyers
where delivering one asset without receiving the contra asset at the same time. In other words, the
delivery of security will not be affected without simultaneous payments of cash and vice versa.

So, in order to succeed in today’s global marketplace presents a spectrum of risks which causes
uncertainty over the timing of payments between the exporter (seller) and the importer (foreign
buyer). For exporters, they want to receive payments as soon as possible, whether after the order was
made or before the goods were delivered to the importer. For the importers, they want to receive the
goods as soon as possible but to delay the payments, preferably until the goods are resold to generate
enough income to pay the exporter.

2.1 Types Of Method Trade Settlement For Islamic Bank

2.1.1 Cash in advance/ Advance payment (prepayment)

Under this term of settlement, the exporter will receive the money before they
delivers the goods to the importer. In fact, this is a credit granted by the importer to the
exporter. Besides, the importer can ask the exporter the payment of an interest. It is quiet
common for a sale contract require partial payments in advance.

The risks of exporter is maybe they receive the specialized goods and if the importer
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 when the does not send the
goods, the documents can be wrong, and the goods are sent with a delay or to a wrong
destination. But, it also give advantages to the importer, where 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 this term, the exporter can avoid the credit risk because the payment is received
before the ownership of the goods is transferred. However, requiring payment in advance
is a method that is less used by the buyer because it creates cash-flow problems. Foreign
buyer are also concerned that the goods may not be sent if payment is made in advance.
This method of settlement 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”.

2.1.2 Open Account

Generally, an open account transaction is a sale where the seller are shipping and
delivering the goods before the payment due which is usually in 30 to 90 days. When a
buyer and a seller agree with an open account term, it means that the seller will dispatch
the goods included with invoice requesting payment. The seller trust that the buyer will
pay in accordance with the invoice because he loses control on the goods as soon as he
dispatches them. This presents the greatest risk because the exporter delivering the goods
without payments.

However, open accounts settlements also have 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. Due to the intense competition in export markets, foreign buyers often press
exporters for open account terms since credit extension by the sellers to the buyers more
commonly abroad. Therefore, exporters who are reluctant to advance credit may lose
sales to their competitors. However, exporters can offer competitive open account terms
using one or more appropriate trade financing techniques, such as export credit insurance.
2.1.3 Documentary Collection (Drafts/Bills of Exchange)

A documentary collection (D/C) is a transaction in which the exporter entrusts the

collection of payment to bank remitters (exporter’s bank), which sends the documents to
the collecting bank (importer’s bank), accompanied by payment instructions. Funds are
received from the importer will be sent to the exporter through the bank involved in the
collection in exchange for those documents.

D/Cs involve using of draft requires the importer to pay the face amount either in
sight (documents against payment) or at a specified date (documents against acceptance).
The draft gives instructions that specify the documents required for the transfer of title to
the goods. However, D/Cs will not offer verification and limited resource in case of non-

Furthermore, this method of 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 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.

2.1.4 Documentary Credit

The documentary credit also known 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, it 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. 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.

There are the main steps in a typical documentary credit transaction. Firstly, the buyer
arranges with a bank to open documentary credits after finalizes the export contract. The
issuing bank will check the buyer credit worthiness. Next, the issuing bank sends the
documentary credit to an advising bank. The advising bank verify the authenticity of the
documentary credits and forward it to the buyer. Third step is when documentary credit
set out the documents, the buyer must present the payments. The buyer ship the goods
and compiled all the necessary documents and lodge with negotiating bank. Then, the
negotiating bank checks the documents to ensure it fulfill the terms of documentary
credits. And send it to the issuing bank with a request payment. Lastly, if the issuing bank
is satisfied with that necessary documents, 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.


3.1 Definition of Documentary Collection

Documentary collection is the collection by bank of funds due from a buyer against the
delivery of documents. The bank, acting as agent for the exporter that is present documents to
the importer through that party’s bank. Islamic documentary collections typically based on

3.2 Different Between Documentary Collection an Letter Credit or Open Account

- Letter of credit = bank does not assume any liability to pay if buyer unable to pay.

- Open account sales = documentary collection offer more security to seller.

3.3 The use of Documentary Collection

 The seller and the buyer know each other to be reliable

 There is no doubt about the buyer’s willingness
 The political and economic conditions of the buyer’s country are stable.
 The importer’s country does not have restrictive foreign exchange control.

3.4 The Advantages of a Documentary Collection

The advantages of Documentary Collection are simple and inexpensive to handling. Next,
Documentary Collection also offer faster receipt of payment. Lastly, Documentary Collection
also give a seller retain title to the goods until the payment 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 a Documentary Collection

If buyer unable to pay, the seller has three option that are,

 Find another buyer

 Pay for return transportation
 Abandon the merchandise

3.6 The Parties Involved

The parties that involved are principal. It will manage by the exporter, seller, remitter,
drawer of the draft.

Second, is the remitting bank that is exporters of the bank will handling the

Third, the presenting, it be handle by the buyer’s bank. Lastly, drake that is handle by
importer, buyer, payee.

3.7 Types of Documentary Collections

 Documents against Payment(D/P)

 Documents against Acceptance (D/A)

3.8 The steps in Documentary Collection

- Firstly, the importer and exporter agree on the term of sale, shipping dates and payment.

- Secondly, the exporter through a freight forwarder, arranges for delivery goods.

- Thirdly, forward deliver goods to the point of departure and prepare the necessary

- Fourthly, delivered the export document and instruction to the exporter’s bank.

- Fifth, following the instructions of the exporter.

- Sixth, buyer bank, on receipt of documents, contact buyer and request payment.

- Seventh, documents released to buyer.

- Eighth, the buyer’s bank remits funds to seller bank or advice that the draft has been

- Lastly, on receipt of good funds, the sellers of a bank credits the account.


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 mechanisms in trade transactions where the seller and the buy do not
reside in the same country. Both parties involves in this transaction will be reluctant to give any
commitment unless they are assured that their positions are protected.

Thus, LC plays 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 have been declared in conformity with the term and condition of LC.

4.1 Islamic Letter of Credit

LC is one of the most secure methods for seller to be paid. Normally, LC is used in business
practise for long distance trade and particularly important commission earning service for any
bank. ISRA defined Islamic Letter of Credit (ILC);

“is written undertaking given by the Islamic Bank (IB), to the seller at the request and on the
instructions of the buyer, to pay at sight or at a determinable future date, a stated sum of
money within a prescribed time limit and against stipulated documents which must comply
with terms and conditions.”

There are contract used by IB to offer ILC such as;

i) Wakalah (agency)
ii) Murabahah (cost-plus profit)
iii) Musyarakah (partnership)
4.1.1 Wakalah Islamic Letter of Credit

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 creates 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 releases 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

The IB issues the ILC and both the financier and customer involves to the purchase price
under ILC. Next, they 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. 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 under the principle of Wadiah yad Dhamanah. Later, IB creates 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 releases the documents to the customer. Lastly, the
customer takes possession of the goods and disposes of these in the agreed manner.

4.1.3 Murabahah Islamic Letter of Credit

The IB will provide a financing facility to customer that unable to pay the purchase price to
the exporter. Then, the bank will resell the good at a higher price agreeable to the customer.
The new price will include mark-up of certain profit.

The customer informs the IB of his ILC requirement and requests the IB to purchase or
import the good by executing. The customer is appointed by IB as an agent to purchase the
required goods. Later, the IB will sell the goods to the customer at a sale price comprising its
cost and profit margin for settlement on a deferred time.
4.1.4 Difference between Murabahah Letter of Credit and Musyarakah Letter of Credit

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. In Murabahah LC, the banks only have benefits from the total
capital invested where it earns some profit. The bank is not liable for any loss and only
customer is responsible to honour the selling price to the bank on the agree date.

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 owns the business with its customer. Both parties
will share the profit in accordance to the ratio of the invested capital. In both transactions, the
LC is used as the payment mechanism. But, under Murabahah trade transaction, the bank does
not have any control over the business venture. In Musyarakah, the bank has power to control
the business venture.


Trust receipt is a written legal document between the bank and the person borrowing from the
bank. The bank will provide merchandise to the borrower but the bank will keep a small amount of
goods and can have it if the borrower does not uphold the terms that are decided in the trust receipt.
At the same time, the borrower must keep the merchandise and profit from the item separately from
the 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 trust receipt is similar to a loan. However, this type of loan is considered a secure
loan because an item known as the collateral is listed as part of arrangement. The difference between
trust receipt and a standard loan is that in a trust receipt the item being borrowed, and any money
made from selling them also serve as the collateral for the loan.
5.1 Islamic trust receipt

Islamic trust receipt (ITR) is issued by IB to the customer based on the concept of Murabahah
for financing the purchase of goods.

Procedure involve in modus operandi

1. 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 terms of the facility
2. The customer informs the bank of his letter of credit requirement and request the bank to
purchase the goods.
3. The Islamic bank retains the legal title to good 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.
4. Upon delivery of the goods, Islamic bank pays the exporter or 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 to the customer on deferred payment terms at a price inclusive of the IB’s
profit margin. If the IB appoints customer as its agent, then the IB cannot purchase from the
customer. The deferred payment terms of sale of goods granted to customer constitutes a
creation of debt. This is securitised in the form of a bill of exchange drawn by the IB and
accepted by customer and payable on maturity.
5. The IB hold 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.


The banker act 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

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 50000
 Bunching of documents to reach the minimum of RM 50000 is allowed
 Separate bunching for domestic sales and foreign sales
 Usance draft drawn by the buyer or seller and discounted by the bank

6.1 Islamic Banker’s Acceptance

Islamic banker’s acceptance well known as accepted bills-I (AB-i)

- 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 or buyer
creating a debt owing to the bank
- AB-I formulated based on 2 shariah concepts
I. Bai’ dayn (debt trading) – refers to the sale of a debt arising from a trade transaction
in the form of a deferred payment sale.
II. Murabahah (cost plus) – refers to the selling of goods at a price based on cost plus
profit margin agreed to both parties.

Types of financing under the AB-I facility

1) Import and local purchases

An applicable mechanism is the working capital financing under murabahah. The

bank will appoints customer then purchases the required merchandise from the seller on
behalf of bank. Then, bank will pay the seller and resell the merchandise to customer at a
price, comprehensive of profit margin.
Upon maturity of murabahah financing, customer can pay bank the cost of goods plus
bank’s profit margin. Moreover, customer allowed a deferred payment term of up to 365 days.
Sale of goods by bank to customer on deferred payment term constitutes creation of
debt. The debt is securitised in form of bills of exchange drawn by bank(drawing bank) on
and accepted by customer (acceptor) for full amount of bank’s selling price payable at
maturity. If bank decides to sell the AB-i to a third party, AB-i will be sold under concept of
bai’ dayn.
2) Exports and local sales

Uses type of financing facility bai’ dayn comply with shariah cocept. Customer
prepares sale documents as required under sales contract or letter of credit. Next, the sale
documents are sent to purchaser’s bank. Customer draws on bank a new bill of exchange as a
replacement bill that represents the AB-i. Bank will purchase AB-i at a mutually agreed price
using the concept of bai’ dayn and the proceeds will be credited to customer’s account.


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. SG a document that allow a customer to take possession
of shipped goods before shipping.

With SG, bank certifies that the importer is legal owner of the goods. The importer cannot
prove himself to be rightful owner. The bank’s SG the shipping company will allow the importer to
take delivery of the goods.

Nevertheless, importer must have line of Trade Finance Facilities to obtain SG. SG not affect
the Basel CAR. However, the risk is minor and being off-balance sheet item, the impact on capital
under Basel CAR is treated as zero.

7.1 Islamic Shipping Guarantees (ISG)

Islamic shipping guarantees known as Shipping Guarantee- I that is one facility

Islamic trade financing provided. The facility is document issued by the bank to the shipping
company that allows the importer or buyer to collect goods from that shipping without the

Under kifalah, the function is as contract of performance given by one party to set
free liability of third party. The several advantages shipping guarantees-I are, will make clear
goods without having to wait for complete sets of important documents. Then, this brilliant
facility make importer/buyer felt comfortable. Lastly, it will help you avoid any demurrage or
other port charges.

Bank Guarantee (GB) 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

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.

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 fulfilment of contract.

8.1 Islamic Bank Guarantee (IBG)

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 IB will assure the payment in case of demand by beneficiary and act as guarantor to the

The Kafalah principles is actually a surety given by an IB who agree to bears a liability of beneficiary
in the case of the applicant or the bank’s customers are default in fulfil their obligation to the
beneficiary. The applicant is required to place certain amount in the IB as deposit for this facility
which is under the Islamic principles of wadiah (safe-custody).
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 An instrument issued by Islamic
Islamic bank on behalf of its bank on behalf of and for the
customer or applicant to the account of the buyer of goods.
beneficiary in connection with
the contract entered between the
applicant and beneficiary.
Feature Two types of guarantee : Islamic Bank undertakes the
 Financial Guarantee bills of exchange and trade
 Performance Guarantee 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-  Wakalah Islamic Letter
up and the liability is contingent of Credit (fund is from
upon the failure of applicant’s the customer to the
obligation. buyer)
 Murabahah Islamic
Letter of Credit (fund is
from Islamic Bank via
Syariah principle  Kafalah (guarantee)  Wakalah (agency)
 Wakalah Bi Al-Istihmar  Murabahah (cost plus
(investment agency) profit sale)
and kafalah (guarantee)