Export Bill Discounting under Islamic Financing

by K. Nizardeen 2017 Jul/Aug/Sept

Question: How do Islamic Banks handle Export Bill discounting and is it permissible under Sharia? If it is permissible, can an L/C be issued for the financing of services provided? 

Answer: Under Islamic finance, outright discounting of debt is not permissible since any difference paid or received from the outstanding debt is a form of Riba (usury) income which is prohibited by Shari’a. However to cater to banking or working capital requirements, Islamic banks have an alternative product structured under the Murabaha concept. Under this structure, an Islamic Bank will treat the acceptance of the issuing bank or confirming bank as a security and do another separate transaction under Nasdaq Murabaha. An Islamic bank, i.e. acquirer of debt, will buy Shari’a compliant liquid assets for a price equal to the outstanding debt and then the Islamic bank will sell the purchased asset to the customer, i.e. seller of debt, on Murabaha basis for a price equal to the aggregate value of the debt. Settlement of the Murabaha price, by the customer, will be through transfer of all the rights and obligations in the debt from the customer to the Islamic bank. In the event there is any delay the Islamic Bank cannot charge any interest or additional charges for the delay as the Murabaha price has been already settled by the customer. Upon signing a Murabaha contract and transferring his rights to the Islamic bank, the customer is free to do what he feels right with the purchased asset. 

The booking of the Murabaha will be under the issuing bank’s credit line since the recourse is on the issuing bank and the Islamic bank is taking issuing bank’s risk. The Islamic bank has no recourse against the customer since Murabaha is no longer outstanding on his side.

Alternatively, Islamic banks could provide financing with recourse to the customer as well wherein the Murabaha price will be settled through settlement of the export bill. In case no payment is received, for any reason, from the issuing bank the Islamic bank has the right of recourse to the Murabaha buyer i.e. the customer who took financing against export bills.

The above is the current practice in most UAE-based banks while some banks in other parts of the world use post and pre shipment financing solutions for bill financing (discounting) through pre shipment on istisna (order to manufacture) basis and post shipment is on Qard (Interest free loan) plus Wakalah (agency) basis.  

The trade or transaction banking staff handling these transactions should have appropriate, adequate specialization knowledge of UCP, ISBP, and are well-versed with export bill discounting even though discounting is handled outside the L/C rules. The staff should be aware of consequences relating to the fraud exception and adequate precautionary measures should be in place through appropriate SWIFT message types to ensure payment at maturity. Special attention should be given to L/Cs issued by banks with deletion of UCP 600 Article 12(b) (Nomination) and relevant SWIFT messages and amendments should be obtained prior to handling financing of export bill transactions. The staff also should be thoroughly familiar with SWIFT 700 series messages. 

Moreover, as UCP 600 has cleverly kept away from fraud-related provisions and these matters have to be handled through applicable local law, this requires banks to have tight and stringent policies on export bill financing. These should especially cover trade-based money laundering since most fictitious L/Cs are issued with a motive to discount. Though the bank is discounting or financing against the available credit line of the issuing bank and payment is fully secured, banks should take maximum care by scrutinizing their customer and the particular transaction prior to approving. This is one area banks often fall into trouble and face litigation issues due to fraud.  

The answer to the second question is, yes, you could even though it is an L/C issued for services purpose and there are no underlying goods. In this scenario, the export L/C proceeds are used only as a security and the financing is done under a different Murabaha by buying and selling Shari’a compliant liquid assets like shares, Nasdaq certificates, or commodities.

Volume 19, Issue 3, July-September 2017