Group

Groups Members
1. Irshad Ali Khan (13381)
2. Dawar Naveed (13039)
3. Syed Obaid (13053)
4. Quratulain (12022)
5. Yamna Usmani (13568)
6. Farhan Ahmed (13896)
Treatment with LCs in Islamic Banks
 Letter of credit

A letter of credit is a promise by a bank on behalf of the buyer

(customer/importer) to pay the seller (beneficiary/exporter) a
specified sum in the agreed currency, provided that the seller
submits the required documents by a predetermined deadline.
 Islamic Letter Of Credit

When used by Islamic banks for export/import financing, L/Cs are

not treated as a guarantee but rather as a fee based banking
service to facilitate trade. Islamic banks usually issue L/Cs on the
basis of Wakalah, Murabaha or Musharakah. All operations must
fulfil the requirements of the Sharia .
 Kinds of LC

There are two major types of Islamic LC

 LC at sight
 LC at Deferred payment
 LC at sight

Payment occurs as soon as the seller submits acceptable

documents to the appropriate bank. If the documents are
compliant, payment is made immediately.
 LC at Deferred payment

Deferred Payment Letter of Credit or Usance LC is a letter of credit

payable at a predetermined time / future date after the conforming
documents are presented.
Conventional Banks Deal With LCs

 The buyer sets a list of terms and conditions under which he

would like to buy and ship the cargo from the seller.
 This L/C is then issued by the buyers bank and is generally sent to
the seller and his bank.
 The seller than proceeds to prepare his goods and documents
based on the L/C, Once the shipment has been accomplished,
the seller will take the copies of all the documents as per the
instructions on the L/C to his bank. His bank checks the veracity
and correctness of the submitted documents against the L/C
specifications.
Conventional Banks Deal With LCs

 Once the bank is satisfied that the docs and shipment are in
accordance with the L/C, they pay the seller the money that is
due to him as per the price agreed between him and the buyer.
 The nominated bank, then sends all the docs to the issuing bank
who cross verifies the same and once they are satisfied with the
conditions, they reimburse the receiving bank the money that
they paid to the seller.
Conventional Banks Deal With LCs

 The issuing bank then advises the buyer that the shipment has
been effected and that they are in possession of all the
documents. The buyer then arranges to pay the issuing bank the
money that has been reimbursed by them to the receiving bank.
 Upon receipt of these funds, the issuing bank then endorses the
bill of lading so that the cargo can be released to the buyer.
Conventional Banks Deal With LCs

 Hence the income of LC in conventional Banks is interest, which

is haram in Islam.
 The banks naturally charge interest for this service.
 Islamic Modes of financing

An Islamic bank may offer ILC under the some Sharia’s contract
namely
 Murabahah (cost-plus profit)
 Musharakah (partnership)
 Wakalah (agency)
Murabahah Islamic Letter of Credit

 The Islamic bank opens the L/C

 After shipment of goods and submission of stipulated
documents, it makes payment to the exporter, using the bank’s
own funds.
 It takes delivery of the goods on arrival and sells the imported
goods to the client.
 The bank recovers its cost and gets a small commission for
services rendered as an agent.
 The client repays the bank on a deferred basis as agreed.
Murabahah Islamic Letter of Credit
 Musharah

In the case of a Letter of Credit with Musharakah

 The client deposits with the bank an agreed share of the cost of
the imported goods, representing the client’s share in the
transaction.
 After shipment of the goods and submission of the stipulated
documents, the bank makes full payment to the exporter, using
the client’s deposit and the bank’s own funds for the balance.
 After the imported goods are sold at the market price, the bank
and the client share the profit at a pre-agreed ratio.
 The client may also purchase the bank’s share of the imported
goods at the market price.
Musharah
 Wakalah

When using the Wakalah concept

 The bank acts as the agent of the importer.
 Importer deposits with the bank the full amount of the L/C to
cover the import transaction
 The bank opens the L/C
 After shipment of goods and submission of stipulated
documents by the exporter, the bank makes payment using the
client’s deposit.
 The bank charges a fee/commission for its services.
Wakalah
Problems Islamic Banks are facing in
LC

 There are objections to a letter of credit that is based on purely

Islamic concepts and which derives its regulations and rules from
Islamic law.
 In convincing banks and business communities from very
different backgrounds and business practices to accept a
scheme that they may not be familiar with.
Problems Islamic Banks are facing in
LC

Targeting the global community will have to be done under the

following difficult conditions:
 The global environment in banking and finance is not entirely
suitable for the Islamic letter of credit. Leading banks and
financial institutions that must take the lead are controlled by
non-Muslims and they are not interested to implement Islamic
law in the international trade
Problems Islamic Banks are facing in
LC

 Current standards in many Islamic banks and finance companies

are not up to international standards
 The network of Islamic banks is not sufficiently widespread and
unless it extends its reach to include all if not most countries it
clearly will not be possible to promote Sharia based letters of
credit on a global scale.