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Revisiting OIC Fiqh Academy rules on Organised Tawarruq1

Ezry Fahmy
Fawwaz Faisal
‘Alia Habshi
Wiaam Hassan
Farhana Ariffin
Khok Lee Kuan
Yarlaeva Azizakhon


Interesting to note that the Tawarruq concept has been the key financing structure used
and up to $1 trillion in the Islamic finance industry. But whether or not the way it is
organized in modern banks contradicts Shariah, or Islamic law, has triggered fiery
debates between scholars as the industry is struggling with a decline in business during
the global financial crisis. The discussion or debate rises especially when the The
International Council of Fiqh Academy, a leading industry body based in Saudi Arabia,
in April declared that organised tawarruq "a deception" that carries elements of interest-
based lending, prohibited under Islamic law. This paper will evaluate the differences of
opinion (proponents and opponents of tawarruq) between scholars and analyze it by
taking a case study of Al-Rajhi banking practice on Tawarruq and lastly analyze the
relevance of the scholars arguments that support the use of Tawarruq in the industry as
long as it fulfill the Shariah requirements.

This project paper is partial fulfillment of Paper IB1006 of Part 1 of Certified Islamic Finance
Professional (CIFP)

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1.0 Introduction
A holistic and integrated understanding of structure and mechanism of commodity
murabahah as an innovative liquidity management tool is essential since its being widely
use in the Islamic finance industry. The effectiveness and efficiency of liquidity
management mechanism via the usage of commodity murabahah currently is expanding
from time to time. Liquidity management lies at the heart of confidence in finance
industry. Therefore, this paper provides insights into the structure and mechanism of
Commodity Murabahah or also known as Tawarruq as an instrument to serve the
liquidity need and investment opportunity of Islamic financial institutions in Malaysia
and the Middle East.

2.0 Definition of Tawarruq: An Overview

Tawarruq from the juristic point of view can be defined as a person (mustauriq) buys
commodity at a deferred price in order to sell it at cash usually at a lower price to third
party other than the initial seller for the purpose of getting cash. This is the classical
tawarruq, which is permissible, provided that it complies with the Shari’ah requirements
on sale (bay’).

Similarly, the contemporary definition on organized tawarruq, a person (mustauriq) buys

commodity from local or international market at a deferred price. Simultaneously, he
(mustauriq ) will ask the financier in his own capacity or through his agent or by special
agreement with mustauriq to rearrange the sale transaction usually at a lower spot price .

3.0 The modus operandi of Tawarruq Financing

For basic understanding, following is a simple mechanism of Tawarruq Financing:
Figure 1: Tawarruq Financing.

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1. The Islamic Financial Institution (“IFI”) purchases commodity from Trader A in
the commodity market on cash basis;
2. Ownership of the identified commodity will then be transferred to IFI.
3. Thereafter, the IFI sells the commodity to the Counterparty (e.g. other Islamic
financial institutions, or client) on deferred price, i.e. cost price plus profit
4. The ownership of the commodity will be transferred to the Counterparty.
5. The Counterparty will then sell the commodity to Trader B on cash basis in the
commodity market.
6. Finally, the ownership of the identified commodity will be transferred to Trader
In the classical tawarruq structure, each transaction shall be independence.
To achieve cost effectiveness, in practice, IFI will be appointed as an agent to sell the
commodity to third party on behalf of the Counterparty.

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4.0 The practice of Commodity Murabahah
The commodity Murabahah is the most commonly used liquidity management instrument
by Islamic finance institutions. It can give a fix return to IFI and, hence, it is widely used
as a commodity Murabahah in Malaysia as well as Middle East. Acceptable Tawarruq
arrangement can be executed in the following manner:

One IFI ( in need of funds) and another IFI (intends to place funds) select any commodity
which are liquid in nature; the surplus IFI purchases the commodity on cash payment
from the market; the deficit IFI purchases the commodity from the surplus IFI on credit
(Murabahah) and after taking delivery, sell it in the market at spot price.

Following figure illustrates how commodity Murabahah works when an Islamic Financial
Institution provides funds to its counterparty to earn profit.

1 . Deliver warrants.
Is lamic Financ ial 1 . Pay spot. Trader A
Ins titution

3 . Appoint IF I
2. sell as agent to s ell
warrant. 3 . S ell warrant
warrants. as agent.

C ounterparty Trader B
4. Pay spot.
Majority of commodity Murabahah transactions use London Metal E xchange (LME ) base
metals as an asset since they meet all criteria for a commodity (i.e.non-perishable, freely
available and can be uniquely identify) and are easily identifiable via warrants.
(Sourc e: lamic financ enews .com)

1. IFI purchases warrants from Trader A and pay spot.

2. IFI will then sell the warrants to the Counterparty. The Counterparty accepts the
offer from the IFI to purchase warrants on a deferred payment basis, where the
mark-up and the repayment date are pre-agreed.

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3. The Counterparty appoints IFI as an agent to sell warrants on its behalf. The IFI
now acts as an agent to sell the warrants at spot to another Trader B.
Alternatively, the Counterparty could sell the warrants in the open market.
4. Payment made to the counterparty; ownership of warrants transfer to the end
buyer. In most of the case, whether the counterparty requests the IFI to sell the
warrants on its behalf or arrange to sell to third party by itself, the counterparty
will be paid the spot counter value of the warrants.
5. Deferred payment will be made by the Counterparty to the IFI. This payment
takes place at a pre-agreed time in the future and consists of the principal of the
original purchase plus a pre-agreed mark-up.

The net result of the above movements of warrants and cash is that the counterparty now
holds an amount of money against an offsetting payment to the IFI for a pre-agreed
principal plus a mark-up at a pre-agreed future date, thus creating a synthetic deposit.

The Tawarruq process seems to be very simple. However, extra care should be taken
while undertaking such transaction, and it should be ensured that the transaction does not
become a mere exchange of papers between two brokers, and one or two financial
institution. IFI needs to understand that Tawarruq arrangement should be used in extreme
cases where no option is available to avoid interest. Widespread use of this Tawarruq is
harmful to the industry in long run. Therefore, Shariah Board needs to strictly monitor all
Tawarruq based transaction which includes the commodity Murabahah.

5.0 Case Study of Tawarruq concept by Al-Rajhi Bank

In regards to Murabahah Commodity, Al-Rajhi Bank is executed to serve among others

the following products:
i. Liquidity management/ inter bank placement
ii. Corporate financing
iii. Home Financing and Refinancing
iv. Personal Financing

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5.1 How Al-Rajhi Bank practiced it?

1st Leg:
1. The customer request to purchase certain type from the Al- Rajhi bank. The bank,
consequently, buys well identified commodity, in accordance to customers
request from ABC supplier.
2. ABC Supplier delivers the commodity on the same day and the ownership is
transferred to Al- Rajhi. The bank shall take possession of the commodity and
receive a copy of identification documents of the commodity.
3. Al- Rajhi will then issue its sale offer to sell such identified commodity to
customer or counter bank.
4. Customer or counter bank pays the purchase price on deferred. Al- Rajhi shall
submit a copy of the identified documents of the commodity to customer or
counter bank. Upon the sale transaction is concluded, the rights and liabilities of
the commodity shall immediately be transferred to counter bank or customer.
Now the customer or counter bank has the right to keep the commodity, or to sell
it in the market for cash.

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2nd Leg:
5. Customer or counter bank sells the commodity to XYZ on the same day.
6. XYZ pays the purchase price to customer or counter bank at spot price

To ensure the product is inline with Shariah, there are some conditions that must be met
by Al- Rajhi in carrying out the above transaction:

1. The commodity trader shall have full ownership and right over the commodity
prior to selling it to the bank
2. The commodity must be fully indentified e.g. with the serial number and place of
3. The commodity trader shall covenant to the bank not to trade or deal in the
identified commodity or create any charge thereon or grants any third party any
rights in the identified commodity, as long as the commodity is under the bank’s
4. The bank shall have full ownership and rights over the identified commodity prior
to selling it to customer.
5. The bank shall covenant to the customer not to trade or deal in the identified
commodity or create any charge thereon or grants any third party any rights in the
identified commodity, as long as the commodity is under the customer’s
6. To avoid tripartite inah, the bank is not allowed to sell the identified commodity,
on behalf of the customer, to the same commodity trader that bank has bought the
commodity from.
7. The commodity must be halal and permissible in Shariah.

6.0 Arguments that against the Tawarruq practices

The introduction of Tawarruq in the Islamic economy has encouraged higher

indebtedness leading to speculation through proliferation, monetary fluctuations,

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instability in the economy through debt finance and inequity in the distribution of income
and wealth.

In Tawarruq, the client buys commodity from the bank and sells it back for a cash
amount less than the deferred price to a third party. Therefore, it creates a debt that is
more than the cash received and it encourages debt-based financing. This debt creation or
debt finance is inefficient and inequitable due to; finance provided goes to the most credit
worthy client and it redistributes wealth in favour of suppliers of finance (bank),
irrespective of actual productivity of the finance supplied. It is also fundamentally unfair
as the concept of exchanging money with money with the underlying concept of buying
and selling commodity is also accompanied by the uncertainty of the value that may
involve in the long run. As such, by allowing Tawarruq, it leads to a debt market where
the underlying mechanisms are no longer linked to the real market and naturally,
speculation plays a role in debt markets.

However, the nature of the instruments enhances the role of speculation in this market
unmatched by any other market. In addition, there are no standards in evaluating the
quality of a debt being repaid as agreed and debt prices are susceptible to fluctuations in
response to manufacturing rumours or false news that may manipulate the market prices.
Realistically, when all these factors are observed, in a macroeconomic perspective, the
market for debt instruments are much more vulnerable to gambling like speculation than
the markets for goods and services. Therefore, some has agreed that it is better not to
have a debt market and to disallow Tawarruq altogether.

Another mafasid of the organized Tawarruq according to Monzer Kahf is that it should
be limited as it may be economically worst than interest. Additionally, the Fiqhi also
shares the same opinion as the Shafi’i and Hanbali schools, the correctness of the
component contract is something that is different from the true judgement on the
complete transaction and should not disregard the true intention of obtaining the facility
in the first place. Therefore, the limitation should be when there are no other alternatives
and it is the last resort.

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Al-Shalhoob shares his view that the organized Tawarruq is not just or fair to the client
as when the commodity is sold back to a third party by the appointed agent (bank), the
selling price is determined by the prevailed market price on the spot. With this, there is
no flexibility for the client to set the selling price and furthermore, there is no reference
made by the appointed agent (bank) to the client prior to setting the selling price. The
selling price is usually lower than the price when the agent (bank) first bought the
commodity from the client.

7.0 Arguments that allowed the Tawarruq practices

Tawarruq in its basic form had been accepted as valid and permissible by majority of the
jurists of the past, including among the companions of the Prophet (peace be upon him).
Although a minority of them disapproved the practice; this was more of a precoution
against it becoming a mere hilah (trick). Moreover, there were no reports or narrations
attributed to the Prophet (peace be upon him) disapproving the practice.

In the traditional books of Islamic jurisprudence, Tawarruq has been discussed mainly by
the Hanbali and Shafi’e jurists and generally allow Tawarruq. Maliki’s jurists, who are
very strict about Bay’ al-Inah, do not see the major problem in Tawarruq. Thus, they
consider it a way to avoid Riba. Majority of the Hanafi jurists have views that Inah is
restricted to a situation where the commodity is sold back to the person from whom it
was purchased; if it is sold in the market, the transaction is valid and permissible. Thus,
the preferred in all the four schools of Islamic Fiqh is that Tawarruq is permissible. The
AAOIFI has also taken up the view that if a commodity is sold to a third party, it is
acceptable in the Shariah.

Most of jurists allow the real Tawarruq if the following stipulations are fulfilled:
1. Before selling it to the customer, the bank owns the commodity bought and
receives it;

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2. The customer must not sell the commodity that he bought from the bank until he
has legally received it;
3. The customer can sell the commodity to anyone who is not a party to be
transferred to it (commodity) to either the first financier or second, so that it will
not become the Inah that is prohibited by the Shariah. Based on this, if a bank acts
as an intermediary in buying a commodity from a financial institution and sold it
to the customer by installment, it is disallowed to sell it to the first financial
institution; and
4. There is no prohibition if the customer appoints the banks as an agent to sell the
commodity on behalf oh him (customer) to the party who is not in agreement to
whom Tawarruq is legal, provided that the sale will not be made to the customer
who is an agent of the bank in sale. In addition, the agency contract must be
independent from the sale contract and will be after the agreement with the bank
has been signed.
The evidences that are used to allow Tawarruq are as follows:
1. The commodity must be bought by the person for the purpose of the commodity,
like a person who buys a car for using it, or he buys it for the value of the car, so
that he can sell it and increase the price.
2. If the sale is complete with its pillars and its conditions, the it is valid according to
Allah’s saying, “Allah legalizes sale and prohibits Riba,” and
3. Tawarruq is different from Inah, which leads to Riba.

A study of the Islamic banking products that resort to Tawarruq shows that the most of
them are for the purpose of providing liquidity to the parties concerned. However, with
the expansion of the Islamic banking and financial services, Tawarruq contracts have
also been used in Islamic hedge instruments, such as the Islamic profit rate swap (For
example, Standard Chartered Bank), commodity murabahah currency delivery-I and
hybrid of Tawarruq in sukuk which Shariah Advisors have been approved such
transactions. Thus, Engku Rabiah opined, although Siddiqi claimed that financial
instruments whose mafasid are much greater than masalih such as Tawaruq cannot be
permissible and characterised as Shariah compliant, Tawarruq structures still be used as

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an alternative structures to avoid bay’ Inah as it has been proven seemingly suffered from
“oppresive” character of Riba. At a very least, this will improve the image of Islamic
Banking and finance industry in Malaysia and globally.

8.0 Masalih aspect of Tawarruq

Without dealing with Riba (which is strictly prohibited by Shariah), Tawarruq is so far
the best option to facilitate the bank’s liquidity management as well as to assist individual
in obtaining cash via trading of commodity. Up to to-date, Tawarruq is a key financing
structure of the $1 trillion Islamic finance industry. Hence, if Tawarruq were suddenly
withdrawn, it would have a dramatic effect to those Islamic financiers who rely on
Tawarruq as a means of liquidity management as well as to provide working capital.

Of course, it is better if we can avoid any Shubhah (ambiguous). However, unless and
until we can find a better structure, Tawarruq is still an important Islamic principal which
able satisfy legitimate financing needs.

9.0 Comprehending various views on Tawarruq

Tawarruq has been a quite contoversial issue lately since the recent resolution of the
International Fiqh Academy Council on Tawarruq. It has ignited a new the already
controversial application of modern Tawarruq. Due to the fatawa, various stakeholders of
Islamic finance such as Shariah scholars, bankers and accountants, have attempted to
express their opinion on the matter.

Shariah scholars like DeLorenzo, Dr Nikan Faroozye, Dr Aznan Hasan, Dr Akram

Laldin, Shaikh Nizam Yaquby and Monzer Kafh are among scholars that responded to
the matter with some unique arguments. These scholars (and we believe many more)
understand and sees that matter from a global perspective in responding towards the
resolution made.

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They hold the view that Tawarruq is permitted provided that it is properly axecuted and
fulfills all its requirements of a valid sale contract as well as proper documentation that
highlight the rights and liabilities of the parties involved clearly detailed for any possible
dispute resolution or litigation later. They supported the AAOIFI standard to be referred
to and provide the necessary checks and balances to prevent the abuse of Tawarruq.

First is that it is better to strengthen the practice, rather than prohibiting it. Meanwhile, it
is encourage for people in the industry to understand that the permissible come with
responsibilities where by the implementation and practices of tawarruq in the products or
instruments use must fulfilling the requirement made by the Shariah Advisory Council in
order to avoid miss-used of such concept.

If we understand the usage of Tawarruq globally and see it from a bigger picture, it is
understandable that not only Tawarruq.concept can be miss-used. It also goes to any
products or services offered by the institutions if the usage is not fulfill the requirement
or the standard acquired in order for it to be Shariah compliance. Thus this shows that the
practice of Tawarruq is not prima facie prohibited, but due to several violations of its
practices. That is why a proper monitoring is needed by the respective regulatory bodies.

Therefore, if the Tawarruq is properly executed and fulfilling all its requirements, and all
the violations have been eliminated, the practice of modern Tawarruq should not be
prohibited simply because it is somehow systemized and organized. Explain of modern
financial instruments, it should be understandable that any modern practice has to be
organized. Without it to be undertaken on the spur of the moment would not only render
the transaction impracticable in most circumstances, but also expose the parties involved
to a very high and unexpected risk.

However, we should see and evaluate each of these arguments addressed carefully
without denying it has its merits of course. Moreover, we also could not deny the fact that
Tawarruq is a hugely popular financing method, and is probably the most used single
liquidity providing scheme and is used in virtually every country which practices Islamic

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Finance as an alternative concept rather than Bay al-Inah or Bay Bithamanil Ajil that are
more criticize by the scholars in Islamic finance. Due to that we can obviously seen the
distinction between the Tawarruq and Bay al-Inah drives the careful specifications of
Tawarruq transactions.

10.0 Conclusions

In conclusion, we hope that people who directly and indirectly connected to the markets
and the practice of Tawarruq is not ease by the counter-arguments, we just hope that the
actual fine print of Shariah rulings is more likely to be adhered to more closely in the
future, with Islamic financial institutions are striving to show that their Tawarruq
(although an organized Tawarruq) complies with every detail of the Shariah.

The dispute between scholars opinion on this is healthy, but the questioned arises how
other people will view on it? This is due to the decision that is quick and does not quench
one’s thirst about the íllah behind the decision made. There should be an economic study
done to analyze the impact of the instruments and the implication of the fatwa.

Eventually we do hope that the ruling will likely lead to other alternatives being
developed in order for Islamic financial institutions practicing ideally as according to
Memon and Ansari who believe that we should not try to pull the legs of an infant who is
just trying to take his first step towards a long journey just because of which only reflects
to one more element in the confusing array of opinions and decided to put the nail into
the coffin of Tawarruq. However, we should try to ensure that he commences his journey
the right way, on a strong footing. More appropriately, it will serve us well when we are
in a position to implement the complete Islamic way of living.

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