CROSS BORDER ISLAMIC TRADE FINANCING
ADIL AHMAD
The total stock of Islamic financing currently available world-wide is estimated to range from US $40-80 billion. The variation is due to the unavailability of complete data. The stock refers to money that has been mobilised from primarily retail depositors by Islamic financial institutions throughout the world. The stock is estimated to be growing at 10-15 per cent per annum.
The majority of this stock is utilised by Islamic financial institutions in their domestic markets. Perhaps as little as 20-30 per cent of the total stock is available to finance transactions in the international market.
Categories of Islamic Financing
Islamic financing modes can be divided into three broad categories as follows:
1. Concessional financing.
2. Profit-and-Loss-sharing.
3. Trade-related financing.
The first of these categories, concessional financing, involves modes such as Qard-Al-Hasana. This is an important financing mode in Islam, but owing to the in-built element of concessionally, it is of limited use in commercial financing.
The second category that profit-and-loss-sharing, is considered to be the finest form of Islamic financing. The reason why this is the most preferred category is because the financier and the user of finance are sharing completely the risk of the underlying project. Musharaka financing is included in this category.
Given the imperfect world we live in, however, this mode has, to date, not achieved a pre-eminent position in Islamic financing. What may be one of the reasons was explained to me by a leading conventional banker some time ago. He told me that companies making good profits did not wish to enter into Musharaka financing agreements with his bank because they could mobilise financing at lower rates in the conventional financing market. On the other hand, his bank did not wish to enter into Musharaka agreements with companies making low profits because that would affect the bank’s earnings.
However, it is estimated that the profitand-loss-sharing mode constitutes a very small portion of the total volume of Islamic financing at present. The mode of financing which constitutes the vast majority of Islamic financing transactions is the trade-related category of finance.
The trade-related modes of financing being conducted outside the domestic markets of the Islamic financial institutions can be further sub-divided into two:
1. Islamic cash management
2. Cross-border Islamic trade financing
Islamic cash management involves Islamic financial institutions entering into agency agreements with Western banks and placing large amounts of their short-term funds with these Western banks. Under the agency agreement, the Western banks undertake to utilise the funds placed with them in short-term Murabaha transactions and guarantee to the Islamic financial institutions the principal plus an agreed return.
Cross-border Islamic trade financing involves the Islamic financial institution financing the acquisition of real assets by entities in another country and taking the repayment risk of those entities.
Of the total Islamic financing available for transactions in the international market, the majority is utilised in Islamic cash management schemes.
Cross-Border Islamic Trade Financing
Working through the numbers, it is estimated that perhaps as little as 5-10 per cent of the total stock of Islamic financing is utilised for cross-border Islamic trade financing.
The two most frequently utilised financing modes in this area are Murabaha and Ijara. The former is mainly used for shorter-term commodity financing, while the latter is used for longer-term capital asset financing.
A few years ago. Islamic financial institutions were interested in financing only short-term border transactions. In the last couple of years, they have started selectively financing longer-term transactions. The data at hand suggests that the largest number of transactions being financed by Islamic financial institutions continue to be for Pakistani entities. Other countries to which financing has been provided include: Algeria, Iran, Egypt, Turkey, India, Bangladesh, Indonesia and South Africa.
The commodities financed through Murabaha transactions include oil, wheat, rice, chemicals, pharmaceuticals, iron, etc. Capital assets financed include all types of plant and machinery, ships, motor vehicles, aeroplanes, etc.
Initially Islamic financial institutions had limited ability for sourcing cross-border transactions and relied on conventional banks to originate suitable transactions for them. For example, in the early 1990s, ANZ Bank arranged oil financing for the Pakistani and Indian state oil companies. Our role was to identify the borrower, structure the relatively simple buy-and-sell and ensure that the documentation was in order.
Nowadays the Islamic financial institutions want us to do more. Increasingly, many of them are developing their own origination capability in countries such as Pakistan. The reason why they want banks such as ANZ is to originate business in geographic areas where they have not yet done business, or structure more complex transactions. We are accordingly endeavouring to move in these directions.
As far as security for the financing is concerned, the Islamic financial institutions generally continue to insist on a bank guarantee/letter of credit issued by a large bank in the borrower’s country. Alternatively, if the borrower is a government-owned entity, then the Islamic financial institutions require the government to guarantee the financial obligations. In select cases, however, the Islamic financial institution may be willing to take the repayment risk of a private sector borrower.
Islamic Trade Financing Facility
As in many developing countries, Pakistan has a large number of state-owned enterprises (SOE). These SOEs are engaged in a range of activities, including trading, manufacturing and finance. Many of them regularly import raw materials, etc., from international suppliers. Late last year (1995)), together with two Islamic financial institutions, ANZ structured an Islamic trade financing facility for several of these SOEs.
The facility basically involves the Islamic financial institution providing financing of up to US $25 million for the imports of select SOEs. Through a Murabaha arrangement, the Islamic financial institution pays off the foreign suppliers on a sight basis and sells the commodity to the SOE on a deferred payment basis. The repayment by the SOE is through one of two sources. One source is the exports of the SOEs. When an SOE exports, the foreign purchaser pays the sale proceeds directly to the Islamic financial institution under a pre-agreed arrangement.
In case the exports of the SOEs are insufficient, a second source is utilised. This involves the home remittance of the Pakistani workers employed in the Gulf.
Although the Islamic funds available for cross-border trade transactions are only a small portion of the entire stock of Islamic funds, these do play an important role in financing the trade of some, predominantly Islamic, countries. In the near future, financing of this nature will probably be utilized in more countries and will be made available for longer terms than at present.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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