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Tuesday, May 15, 2012

Organized Tawarruq Between Masālih (benefits) and Mafāsid (harms)

By : Dr. Zaharuddin Abd Rahman

The renowned Muslim economist Prof. Nejatullah Siddiqi lists the harmful effects of tawarruq in his view as the following:[1]

• It leads to the creation of debt whose volume is likely to go on increasing.
• It results in an exchange of money now with more money in the future, which is unfair in view of the risk and uncertainty involved.
• It leads, through debt proliferation, to gambling like speculation.
• It leads, through debt finance, to greater instability in the economy.
• In a debt-based economy, the money supply is linked to debt with a tendency towards inflationary expansion.
• It results in inequity in the distribution of income and wealth.
• It results, through debt finance, in an inefficient allocation of resources.
• It contributes, by consolidating debt financing, to raising anxiety levels and the destruction of the environment.

He also dictates that the approval of tawarruq may benefit individuals. However, if this is practised on a large scale, it would result in the proliferation of debt in the society, which would bring macroeconomic instability. Thus, before deciding on the Sharīʿah compliance of such a product, the Sharīʿah Advisory Board of any Islamic financial institution must take into account the macroeconomic consequences of approving the product.


In reply to the Siddiqi’s statement, which says that ‘tawarruq may have benefited individuals, however, if this is practised on a large scale, it would result in proliferation of debt in the society, which would bring macroeconomic instability’, during the interview made by the Islamic Finance News editor in 2007, I pointed out several points through the below response, which remain as my viewpoint today.

This opinion is quite interesting and the result of the analysis is deemed relevant to the Sharīʿah Advisory Board (SAB); however, I do not think these facts would prohibit Tawarruq immediately. Especially when such a result is tied to ‘if practised on a large scale’, the new Sharīʿah ruling (prohibition of Tawarruq) will only come into the picture when that particular situation takes place and the large-scale definition is quite vague, since the maqasid is conditional upon a predicted situation that might or might not occur. Therefore, this kind of analysis will not greatly impact on the current ruling on Tawarruq. However, as more accurate and empirical evidence is accumulated, then the Sharīʿah scholars may see the need to reconsider their earlier opinion.[2]

Secondly, that is because the issue of ‘debt in the society’ is a real fact and almost every person has personal debts. Moreover Islam allows debt and deems a person who gives a benevolent loan to be 18 times better than giving charity. Debt also carries one of the Maqasid Sharīʿah, which is helping the one in need. If the Sharīʿah scholars issued a fatwa based on the argument of the proliferation of debt in the society, the Sharīʿah scholars might also have to prohibit all kind of debts in all products, such as Istisna, Murābahah, Salam etc., because all of it also would result in proliferation of debt in the society. As for me, this kind of prohibition will contradict the Maqasid Sharīʿah, because Muslim life will turn to be very difficult and no business can be made.[3]

                                                       Exhibit : Tawarruq Transaction

The experienced Islamic banker Haneef seems to agree with the above statement when he poses a similar rebuttal against Siddiqi’s debt argument; he elaborates:

Importantly mafāsid also can be perpetrated through the contemporary murābahah, ijārah and all contemporary contracts. Contemporary Murābahah also creates debt and results in more money in future for the financier. Contemporary murābahah also can lead to gambling-like speculation and also create instability in the economy. Contemporary ijārah can also create inequity in wealth distribution and inefficient resource allocation. Contemporary istiṣnaʿ can also raise anxiety levels and destroy the environment. So why should only tawarruq be prohibited? It may well be true that, compared to other contemporary contracts, the nature of the tawarruq has the potential to create greater abuse and spread of mafāsid, but none of the learned tawarruq opponents were able to provide any empirical evidence or studies to show that tawarruq has in fact spread more mafāsid than the other contemporary contracts.

Haneef later on proposed four controls, which he believes would limit the issue of excessive usages and abuses of the tawarruq concept.[4] All of the suggestions are sensibly acceptable from my perspective, especially when looking to the current needs of Islamic financial institutions to be competent in managing their assets and liability and liquidity administration, reducing risk exposure to the interest rate and currency rate volatility and also attracting corporate clients who are in need of such similar hedging arrangements. Indisputably, we could realize that there is a contradiction between the harm and the benefit. Contrary to the potential harmful effects that were pointed out by Siḍḍiqi, here is a list of the benefits (maṣālih) that could be achieved through commodity murābahah:

It converts the creation of conventional ribawi debt to which is carried out according to Islamic law, even if only from the micro level it is still believed to have initial effect to the betterment in the future.It gives an opportunity to the commodity owner to venture into the industry by offering its commodity to be used for the transaction. This is in turn would benefit many commodity owners, though it could not be realized today, but it will open a new potential market for the commodity owner to sell its commodity efficiently. This henceforth will link the organized tawarruq to the real development in economic activities. If not, it would at least furnish the owner with financial strength to provide opportunities to move forward.It would offer the companies alternatives to deviate from the dreadful conventional derivatives market, and as a result mitigate the potential exposure to gambling and excessive speculation. This is because the Sharīʿah advisers of the Islamic financial institutions supervise every single use of the Sharīʿah-compliant derivatives-like options and swaps, to ensure that they are for hedging purposes only. It protects the Islamic financial institution from being badly hurt by the usury effect of interest and currency rate manipulation.It provides Islamic financial institutions with a considerable opportunity to move forward in expanding their business size. Currently, assets under Islamic financial institutions’ management across the globe still barely reach 20% compared with their conventional counterparts. It is believed that organized tawarruq could play a positive role in increasing IFIs’ stability in the immense conventional market. Slowly, it is hoped, when the time comes, IFIs would be able to shy away from organized tawarruq to a better product. Haneef says: ‘perhaps, a 2/3rd market share may be the appropriate level to be considered as significant given the enormous challenges to be faced in transforming the current debt-oriented financial platform into a profit and loss sharing financial system’.[5] I may not agree with the two-thirds idea, but at least Islamic financial institutions could courageously make up radical changes when they have reached 50% of the market share.


While apprehending the Achilles heel of the present organized tawarruq practices, especially with regard to the LME, firstly, each and every single violation in the transaction should not be generalized to other organized tawarruq arrangements made by individual Islamic banks, as there are several other IFIs using Bursa al-Silaʿ of Malaysia, Able Ace Raakin Private Limited Company of Malaysia[6] and also IdotTV airtime commodity[7] as their product. Whilst some others might have their own arrangement with the real seller, it is immaterial to prohibit the whole concept and its application by referring only to violations made by certain IFIs. Furthermore, the need for options and swaps-like products is undeniably necessary to maintain the survival of the IFIs in this conventional financial framework. There are several Islamic maxims that support this, among others:

كل ما نهي عنه لغيره يباح للحاجة

Meaning: Everything which is forbidden because something else may be allowed because of the necessity.[8]

حكم الشيء مع الحاجة يخالف حكمه مع عدم الحاجة

Meaning: Ruling constitution at the time of necessity differs from while it is not.[9]

According to the Islamic Banker’s editor, M. Parker, tawarruq has hitherto been practised in most countries where Islamic finance is provided except perhaps in Qatar, where the Sharīʿah scholars have discouraged its use per se. However, more and more Islamic banks in countries including Saudi Arabia, Malaysia, Kuwait and the UAE are now shunning tawarruq, even its accepted form, perhaps to avoid market confusion.[10]

Notwithstanding the above fact, it is noted that Saudi’s biggest Islamic bank, Al-Rajhi, approves the organized tawarruq concept; furthermore, it has already undersigned an agreement with the Malaysian Commodity Murābahah House, namely Bursa Suq Al-Silaʿ, which at the same time claims to be the world’s first end-to-end Sharīʿah-compliant commodity trading platform that facilitates commodity-based Islamic financing and investment transactions. ‘The admission of Al-Rajhi, one of the world’s largest Islamic banks, is further testament of the acceptance of the Bursa Suq Al-Silaʿ platform and the structure of Tawarruq in facilitating Islamic finance by Sharīʿah Scholars from the Middle East’, explained a statement from Bursa Malaysia.[11]

To conclude the discussion on organized tawarruq, which is the backbone of the most Sharīʿah-compliant products, it is realized that most of the issues raised by the opponents of the concept are rather fragile. While some notably cannot withstand the refutation, others are either confined to an isolated bad practice or part of the violation of a valid sale, which should not trigger a mass prohibition of the concept.

Other than that, the concern that surfaces is whether or not it seems to fall into the bayʿ al-ʿInah category, and that is when the commodities are being prearranged in the transactions where the commodities will eventually be returned to the original seller. In the situation where there is no arrangement, the customary practices of the commodity’s seller would be crucial for reference. It is recognized in Islamic law that the customary practice will be considered as a condition, so it could be deemed that the transactions contain al-ʿInah elements. Still, the proponents and opponents’ views in this sense are fairly balanced.

I would be inclined to say that the utmost view in the case of organized tawarruq, at this present size of the Islamic financial institutions, is to balance the harm and benefit of the transaction, and it should be contained only for the hedging-related product where no other better concept is available.

As for other than derivatives-related products, it should also be allowed in the event that other acceptable concepts cannot be practised due to various constraints, especially concerning the state law or regulation, which is beyond the control of the Islamic financial institutions. For example, in the case that was put forward by Haneef, in some markets, the law allows a conventional bank to give a home loan and take a mortgage over the native land, like Arab land or Malay reserve land. An Islamic bank, if it is to offer the Ijārah, Mushākarah or Murābahah concept to its customers, needs to own the land first before pursuing the next contract. Unfortunately, the local laws forbid such ownership of native land, unless all the shareholders of the Islamic bank are natives. Because most of the Islamic banks or Islamic windows are part of a public listed company, such a requirement is highly difficult to fulfil. In another instance, a corporation won a license to run a cellular phone business in Saudi Arabia, and is in need of a large amount of cash to enable the operation. The Islamic financier offered a simple tri-partied murābahah product, where the financier would buy the license from the regulator and subsequently sell it to the corporation at a mark-up price. The regulator rejected the proposal, stating that the law only provided the sale to the corporation and it cannot be given to the financiers. Even after the financier tried to use wakālah, or agency contract, and created a Special Purposes Company to circumvent the state law, its efforts were wasted. These are two genuine instances, which require Islamic financial institutions to seek assistance from the organized tawarruq concept.[12]

It is realized that, while the product might be acceptable on its micro level, it may not necessarily be allowable at a certain point in time, when the overwhelming harm outweighs the benefits. For instance, purchasing goods on a credit basis is allowable in Islam, but if the buyer already expects to fall short in his payment obligation, the seller is permitted to refute the purchase, as it will inflict harm on either the seller or the buyer. A well-known Islamic legal maxim states:

لا ضرر ولا ضرار

Meaning: There should be neither harming nor reciprocating harm.

However, allowing the Shariah compliant product based on commodity murabaha or tawarruq will neither bring any direct harm nor reciprocate it to either the Islamic world or the Muslim community, as the usage of tawarruq it certain product especially with regards to shariah compliant derivative product could help the Islamic financial institutions to mitigate the unnecessary financial risks that inherited from conventional finance and its framework. Thus, such a restriction is not applicable in this matter.

The existence of Islamic laws that originated from the pre-Islamic foundation such as the slavery system is accepted in Islam but with modifications, and the same applies to the Niẓām al-ʿĀqilah,[13] Al-Qasāmah,[14] Jāhiliy poetry, the slavery system, the usage of gold and silver coins as currency and many more. All of these evinces that Islamic law may adapt to any system and foreign law, on the condition that it straightens up justice to people and brings benefits. Hence, the modern financial system and products unarguably can be acclimatized to suit the Islamic commercial law’s requirement, which eventually benefits the people at large.

Dr. Zaharuddin Abd Rahman
25 April 2012

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Dr Purva Pius said...
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