Tawarruq – a Tripartite Inah?

The OIC Fiqh Academy rules that organised Tawarruq is unacceptable (Resolution 179 (19/5) 26 – 30 April 2009). In particular they ruled that it came into conflict with Maqasid Shariah (the basic principles underlying Shariah).

Tawarruq is widely used as a liquidity management tool and most scholars sanction the structure. However, some scholars argue it involves legal trickery and contains elements of interest based lending. Tawarruq does not create any economic activity but instead it creates debts.

Tawarruq is a tripartite arrangement between a bank and two commodity brokers. The bank will undertake a Tawarruq transaction whenever it gives out loans (or in a more Shariah compliant term – financing) or when the bank requires funds.  The modus operandi is as follows:

1. The bank will procure commodities or metals from a broker at price P, payment is spot.
2.  The bank will then sell the commodity to the customer (borrower) at price P plus profit, payment is deferred as per the financing agreement.
3. The customer then instructs the banks to sell the commodity/metal back to the market at price P, payment spot. The customer gets his cash from the “sale proceeds”.
4. The commodity is bought and sold within minutes and never leaves the warehouse. All this buying and selling action has no real economic value. Only the brokers make money.

•  The operations is reversed if the bank wishes to borrow from another institution.

To me, Tawarruq is basically an Inah with an additional contracting party. The whole process of buying and selling metals/commodities is merely a charade, a legal trick as the main purpose is to transfer cash from one party to another.

It has always been argued by some that niyah (intention) is secondary when undertaking such contracts. I do not agree. If we exclude niyah, everything will be permissible. A lot of observers have urged Islamic finance practitioners to look at the substance behind the form when structuring Shariah based solutions, the on going debate on substance over form of Islamic banking products and services.

Dr Nikan Firoozye (http://islamic-finance-resources.blogspot.com/) opines that we should categorize products by their Shariah-risk, with hiyal (legal trick) the most risky. I wish to add that if such measure is used, the higher the Shariah-risk is, the less compliant the product is.

Dr Mohammad Akram Laldin, a respected Malaysian religious scholar, disagreed with OIC's ruling, saying organised tawarruq does not violate Islamic law principles. “From the point of view of Islamic law, there is nothing wrong with the transaction itself.” (http://islamicfinanceupdates.wordpress.com/2009/06/04/islam-allows-organised-tawarruq-asset-sales-scholar/)

I do not see this declaration as a hindrance to the growth or development of Shariah based finance. I see it as moving out and away from the conventional norms and in the long run will bode well for Islamic banking and finance. BBA and Inah based products are being gradually phased out in Malaysia and with the latest declaration, expect to see more products being out of favour. I hope Commodity Murabahah will be next.