Advanced Islamic Banking and Finance

Islamic Financial Contracts

Bay Al-Dayn (Sale of Debt)

Bay Al-Inah
Tawriq
Sarf (Sale of Currency)
Tawarruq (Reverse Murabahah)
Concept of Exchange-Based Contract

Bay Dayn (Sale of Debt)

• Fundamentally, this form of contract is a sale and purchase
transaction involving a quality debt
•  Ex.: A person has a debt receivable from a another person
and he wants to sell it to a third party at a discount
Position of Modern Jurists

• Since debt is a liability on a person, some modern scholars

believe there is no room for profit in debt trading, including
that which takes place within bay dayn transactions.
Concept of Exchange-Based Contract

Bay al-Inah (Sale with immediate repurchase)

• Bay al-Inah: Where a commodity is sold on a cash basis;

the seller immediately repurchases the same commodity on
a deferred payment basis at a price higher than the initial
cash price 

• In Malaysia, the typical Bay al-Inah process is that a bank

or financial institution sells the underlying asset to a client
on a credit basis. The bank subsequently repurchases the
asset from the customer immediately at a price lower than
its earlier cost price on cash basis.
• Bay al-inah is controversial in the global Islamic finance
industry
Concept of Exchange-Based Contract

Bay al-Inah (Sale with immediate repurchase)

Example:
1. A client approaches a bank and concludes a sale contract
for the sale of land worth 600,000 USD through a deferred
sale.
2. The bank immediately concludes a separate purchase
contract with the client for the sale of the same land to the
bank for payment of 500,000 USD in cash.

• Bay al-inah is controversial in the global Islamic finance

industry
 Concept of Exchange-Based Contract
Bay al-Inah (Sale with Immediate Repurchase)

Views on the Validity of Bay al-Inah

• The Shafi’i School: Bay al-inah contracts are permissible

in Islamic law

• The Maliki, Hanafi and Hanbali Schools: Bay al-inah is

not permissible in Islamic law because the motive of the
parties in such a contract is illegal

• The majority of jurists prohibit bay al-inah in Islamic

commercial activities because they believe it is tainted
with elements of interest
Concept of Exchange-Based Contract

Tawriq (Securitisation)

• Tawriq is a process of converting an asset into cash issued

as tradable certificates of investments (tradable in the
secondary market)

• Is the equivalent term for securitization in Islamic

commercial jurisprudence.

• The end product of tawriq is the issuance of sukuk or

sanadat to a large number of investors  
Concept of Exchange-Based Contract

Parties to Tawriq

The most important parties in securitization are:

• Originator/Issuer of Sukuk: large corporations, governments

• Special Purpose Vehicle

• Investment Banks: Islamic banks or Islamic windows of

multinational banks

• Subscribers or Investors: individuals and corporate entities

Concept of Exchange-Based Contract

Sarf (Sale of Currency)

Definition and Nature

• bay’ al-sarf: a foreign exchange contract involving

exchange of currencies either of the same or of different
kinds

• The delivery of both currencies has to be made in full at the

time of concluding the contract

• The contract of exchange must take place at the same

sitting where the contract is drawn up
Concept of Exchange-Based Contract

Sarf (Sale of Currency)

Validity of Foreign Exchange Contract in Islamic Law

• Trade in currency is permissible in Islamic law.

• “Gold for gold, silver for silver, wheat for wheat, barley for
barley, dates for dates, salt for salt, like for like, same for
same, face to face. If the types are different then sell
however you like, so long as it is face to face” (The Hadith)

• Limitation: the exchange must be done hand-to-hand in one

sitting if it involves different currencies

• If the currencies are the same, the currencies being

exchanged must be of equal amounts, and the exchange
must take place at the same sitting
Concept of Exchange-Based Contract

Tawarruq (Cash Financing or Reverse Murabahah)

• Hybrid sale contract where a customer approaches a financial
institution to purchase a commodity with payment arranged in
installments and in turn sells the commodity to a third party
for cash
• Permissibility of Tawarruq is based on:
- The general principles of a typical contract of sale
- The absence of any bit of interest in this transaction (it does
not amount to riba)

• Permissibility of Tawarruq is subject to:

- The person must be in real need of money
- No other permissible alternative available
- The contract being free of any modicum of riba
- The customer having full possession of the commodity
Concept of Exchange-Based Contract

Tawarruq (Cash Financing or Reverse Murabahah)

1. The customer approaches the bank and concludes a tawarruq

contract.
2. The Islamic bank purchases the commodity from a seller in
accordance with the customer’s instructions.
3. The commodity is sold to the customer at a mark-up price.
4. The customer pays the price in installments.
5. The customer sells the commodity to an identified buyer and
receives spot cash.
Concept of Exchange-Based Contract

Figure 3.7:Permissible Reverse Murabahah (Tawarruq)

Concept of Exchange-Based Contract

Tawarruq Case
• A person needs Cash to run his business. Lets say he has an
immediate business opportunity to earn 40%-50% returns for
the year, but he needs $100,000 to do it.
• He looks around the market for a liquid commodity that can be
sold quickly for Cash. Let’s say he identified there is need for
Cocoa Beans by a few buyers.
• He approaches a Cocoa Beans supplier (maybe direct from the
plantation) and negotiates a deal for the beans. He offered to
buy the beans (worth around $95,000 to $100,000) for a price
of $120,000 to be settled in 12 months time. This is a
Murabaha for purchase of Commodity transaction (in other
words, Commodity Murabaha i.e. Profit Sale using
Commodities). Murabaha is an accepted Sharia compliant sale-
contract.
Concept of Exchange-Based Contract
Tawarruq case (Continuing…)
• Once the supplier agrees to this deal, he takes ownership of
the Cocoa Beans (worth around $95,000 to $100,000).
• Now, it is not his intention to just “own” the Cocoa Beans (as
he needed Cash for his business) so he will use the Cocoa
Beans as Commodity goods to sell in order to obtain Cash. Is
there any thing wrong with that? He plans to use the proceeds
for his business to generate economic benefit for him. This is
his main intention.
• As he already identified the buyers of Cocoa Beans in the
market, he approaches them to sell the Cocoa Beans under
contract of Musawama (simple sale). He may eventually sell all
the beans for $100,000, but he may even get more than that,
depending on his negotiation skills. All he needed was to
obtain Cash of $100,000 for him to proceed to do his business
which may earn him up to $150,000 for the year.
Concept of Exchange-Based Contract
Tawarruq case (Continuing…)
• He makes the sale at the market price on Cash-basis and
managed to collect $102,000 which is sufficient for his
requirements (with additional estimated up-front profit of
$102,000 less $95,000 = $7,000). Again, nothing wrong for
this profit deriving from a sale transaction, as he has taken
some ownership & valuation risks by buying the beans.
• With that Cash, he funds his business and finally earns a profit
of $147,000 (about 44% profit per annum) from the capital of
$102,000.
• On the 12th month, he pays off the debt with the Cocoa Bean
supplier for $120,000. His net profit will therefore be $147,000
less $120,000 = $27,000.
• All the underlying transactions are based on valuable, real and
deliverable assets which meets the requirements of the Sharia.
 Concept of Exchange-Based Contract
Organized Tawarruq (Tawarruq Al Masrifi)- commodity
murabhah

1. A Principal (Bank) purchases an Asset or Commodity from a Supplier for the

purpose of entering into a Commodity Murabahah transaction
2. A buyer (Customer) buys an asset from the Bank for a deferred payment
(either periodic instalments or lump sum settlements).
3. The buyer (Customer) subsequently sells the asset (via an appointed Agent)
to a third party for cash at a price less than the deferred price (usually
equivalent to the original purchase price), with the objective of obtaining
cash.
4. The terms of the transaction is agreed up-front by both parties, including the
type and price of commodities to be transacted, and the settlement details.
5. The above transactions must be executed based on the sequence and in a
timely manner.
• In 2009, OIC Fiqh Academy Ruled Organized Tawarruq
Impermissible