CHAPTER 1: RESEARCH OVERVIEW
Islamic Banking Background
Islamic banking is fundamentally a system of financial intermediation; its most important objective is to avoid payment and receipt of interest. In other words is about conducting banking transaction with the philosophy of the value system of Islam. Islam does not only disallow dealing with interest but also with pornography, pork, gambling, liquor and any other thing, which are considered Haram according to Islamic law (Shariah).
Islamic banking implies banking operations, which are complying with principles given in the basic Islamic law (Shariah). While some of these standards are shared by conventional and Islamic financial systems, certain standards are exclusive to Islam.
The pioneering effort, led by Ahmad El Najjar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted until 1967, by which time, there were nine such banks in the country, and [over the next three decades a diverse number of Islamic Banks, Islamic Investment Banks, and Islamic Development Banks emerged, and eventually received government backing in some Muslim countries, e.g. Pakistan, Malaysia, Gulf States and across the world. They have largely focused on trying to become major players in international banking and developing instruments akin to those used by other banks whilst finding technical legal explanations to accommodate those developments with the stipulations of Islamic Law. Thus they can often be seen as an attempt to make banking practices more acceptable to Muslims and to provide competition for non-Muslim banks.] (Islamic Party of Britain, 2003).
Actually, some Islamic banking restrictions are severe enough to render certain conventional banking practices and transactions completely void. Prohibition of gharar and riba are two of the most important restrictions compulsory by the Quran and the Sunnah. Most of the current Islamic scholars agree that riba, which literally means "an excess", includes both usury and interest. The prohibition of riba is basically considered to be the most significant of all Islamic banking principles. Gharar signifies uncertainty, lack of specificity, or ambiguity in the terms of a financial contract.
1.1.2 THE IDEOLOGY OF ISLAMIC BANKING:
Islamic banks have devised many innovative financial products established on the profit-sharing principles risk-sharing of Islamic banking. Islamic banking, founded on the Qur'anic ruling out of charging interest, has changed from a speculative concept to hold close more than 196 banks operating in 45 countries with multi-billion dollar deposits global. The basic principle of Islamic banking is the sharing of loss, profit and the prohibition of RIBA (interest). The key principles of Islamic Banking can be summed up as follows:
Principle of Sharing of Profit and Loss: [Participatory financing]
As described in the Shari'ah, translated into banking terms, the depositor, the bank and the lender ought to all shares, the rewards and the risks of financing business ventures.
In Islam, profit is the recognized reward for capital. A depositor in an Islamic bank be able therefore, make incomes on his or her deposit in various ways. Via return on his capital while that capital is employed in a business venture; via sharing of profit while his capital is part of the capital that is occupied in a partnership, and lastly via rental incomes on an asset that has been partially financed by his capital. The principle which thereby emerges is that Islam supports investments in order that the society may benefit.
Principle of Prohibition of Usury
"Afraid of Allah and give up what remains (due to you) from Riba (usury)"
Verse 278 of Surah Al-Baqarah "Quran".
The mainly excellent known characteristic of Islamic banking is the forbiddance on interest. The definition of interest in traditional terms was "superfluous consideration without complement" or "to ensure equivalency in actual value" and that "numerical worth was of no consequence. Any predetermined payment above and beyond the real amount of principal is forbidden. Sharia permits only one type of loan, and whereby the loaner does not charge any interest or extra amount over the money loaned. The principle obtained from the quotation emphasises that connected or indirect benefits are forbidden.
As riba is prohibited, investment can only be made in allowable activities and commodities. Furthermore, suppliers of capital become depositor instead of creditors. Such as, one cannot deal in the export and import of alcohol. in the same way, it is prohibited to invest in a casino.
Principle of acceptable transactions:
Investments ought to not encourage practices or yield that are even discouraged by Islam or forbidden. Islamic banking operates in compliance with the rules of Shariah, below Islamic trading transactions. Islamic banking is restricted to islamically acceptable transactions, which exclude those involving gambling, pork, alcohol, etc. for instance a real-estate loan might not be made for the construction of a nightclub or Wine bar; and the bank might not loan money to other banks at interest.
Principle of moral purchasing and ethical investing:
Making money from money in Islamic law (Shariah) not acceptable and it is just a medium of exchange. A key characteristic of Islamic banking is deal mainly in money and financial securities. The purpose of this is to involve in only principled, honorable purchasing and investing.
This principle which thereby comes out is that Islam supports investments in order that the community may benefit. All money ought to be invested in industries Muslims believe ethical and the receiving or giving of interest is prohibited and money cannot be merely traded for money and thus money can be used to buy services or goods, which can then be sold for a profit.
Principle of Certainty:
Uncertainty, Risk or Speculation is also prohibited. Under this prohibition any transaction entered into should be free from uncertainty, risk and speculation.
This is based on the principle of 'uncertain gains' which, on a strict interpretation, does not even allow an undertaking from the customer to repay the borrowed principal plus an amount to take into account inflation. Therefore, options and futures are considered as un-Islamic and so are forward foreign exchange transactions because rates are determined by interest differentials.
Based on the above-mentioned principles, there is a variety of Islamic banking instruments and transactions in vogue. Musharaka is a business structure in which the bank not only makes a financial contribution to the enterprise, but may also participate in managing the venture. Profits are shared between the parties according to a pre-determined ratio, and losses are borne by them in proportion to their capital contributions. In terms of classification, this is an equity-based transaction.
In Mudaraba, the bank provides the requisite financial resources, but does not participate in managing the enterprise. It is a form of partnership in which one party provides the funds while the other provides expertise and management. Profits are divided among the parties according to a mutually agreed ratio. Financial losses are borne by the investor alone. This is also an equity based transaction.
Murabaha is an arrangement in which the bank, instead of advancing a loan to the client wishing to purchase certain goods or equipment, purchases the items and sells them to the client at cost plus a declared profit.
In tawarruq, the bank buys an asset and immediately sells it to the client on a deferred payment basis. The client then sells the same to a third party for immediate delivery and payment.
Consequently, the client receives a cash amount and has a deferred payment obligation for the marked-up price to the bank. The asset is typically a metal, like copper or platinum.
Islamic banking in Sudan:
The traditional banking system was inherited from the Anglo-Egyptian condominium (1899-1955). When the National Bank of Egypt opened in Khartoum in 1901, it obtained a privileged position as banker to and for the government, a "semi-official" central bank. Other banks followed, but the National Bank of Egypt and Barclays Bank dominated and stabilized banking in Sudan until after World War II. Post-World War II prosperity created a demand for an increasing number of commercial banks.
Before Sudanese independence, there had been no restrictions on the movement of funds between Egypt and Sudan, and the value of the currency used in Sudan was tied to that of Egypt. This situation was unsatisfactory to an independent Sudan, which established the Sudan Currency Board to replace Egyptian and British money. It was not a central bank because it did not accept deposits, lend money, or provide commercial banks with cash and liquidity. In 1959, the Bank of Sudan was established to succeed the Sudan Currency Board and to take over the Sudanese assets of the National Bank of Egypt. In February 1960, the Bank of Sudan began acting as the central bank of Sudan, issuing currency, assisting the development of banks, providing loans, maintaining financial equilibrium, and advising the government. Banks were nationalized in 1970 but in 1974, foreign banks were allowed to open branches in Sudan. Banks are required to maintain 20% of total deposits as a statutory reserve with the central bank. They must also direct to the agricultural sector 40% of the funds that they have for lending under the new credit ceilings. Currently there are about 26 banks with total capital of over US$ 700 million (Bank of Sudan, 2007). With opening up of the Sudanese economy to the great extent in the last few years, new banks like Al Salam bank, from the United Arab Emirates (UAE), Babylos Africa Bank started to enter Sudanese market. These foreign banks are coming with huge capital, new technology, new ideas and new vision.
In Sudan a number of Islamic banks and their branches are now in operation and provide interest free loans and work on the basis of profit sharing.
The Faisal Islamic Bank of Sudan (FIBS) is one was incorporated in 1974 as a public company under the company Act (1952) with headquarter in Khartoum. The Faisal Islamic Bank, whose principal patron was the Saudi prince, Muhammad ibn Faisal Al Saud, was officially established in Sudan in 1977 by the Faisal Islamic Bank Act. The "open door" policy enabled Saudi Arabia, which had a huge surplus after the 1973 Organization of Petroleum Exporting Countries (OPEC) increases in the price of petroleum, to invest in Sudan. Members of the Muslim Brotherhood and its political arm, the National Islamic Front, played a prominent role on the board of directors of the Faisal Islamic Bank, thus strengthening the bank's position in Sudan. Other Islamic banks followed.
Due to its success, other Islamic banks were established and the Sudanese authorities have supported the Islamic banking movement. As a result, three other Islamic banks were opened in 1983, there were:
EL-Tadamon Islamic Bank, the Sudanese Islamic Bank and the Islamic Co-operative Development Bank owned by co-operative union. In 1984, two other Islamic banks started operations, there were: Al-Baraka Bank (Sudan) and the Islamic Bank for Western Sudan.
The former regime in Sudan enacted laws in September 1983. As a result of this non-islamic commercial banks were asked to change their business activities to be consistent with Islamic Shariah, and in September 1984, the banking system was "Islamized". A number of Islamic Investment Company and Islamic were also established. E.g. Islamic Investment Company and Islamic Development Company and they were licensed under the Companies Act of (1925) to work in Sudan.
Letter of Credit:
One of the most important elements in international trade is that of the methods of payment. The seller would like to be sure to receive the contract price for the goods that has shipped. On the other hand, the buyer would like to make payment when the seller has complied all of his obligations under the contract of sale. The seller will try to obtain the contract price for the shipment as early as possible and the buyer also will try to delay to make payment until he receive the shipped goods in hand. Therefore, there have been facing with several problems regarding to the methods of payment in international trade in the past. Consequently, if the seller is unsure with the credit-worthiness of the buyer, the seller will wish to stipulate for the full payment in advance of the shipment. The seller also may claim for the payment after the delivery of the related documents. Alternatively, the parties may choose the third parties (usually, banks) in order to handle over their payment systems. [1]
It can be divided into two major categories of the methods of payment under international law such as the payments without interposition of banks and the payments with interposition of banks. The payments without interposition of banks are the payment on "open account" or "direct payment" and the payment by "bill of exchange". The payments with interposition of banks are "collective arrangements" and the payment under a "documentary credit". Albeit there are several modes of payment in international commerce, the researcher will analysis throughout the dissertation only on the legal application of documentary credits under one of Islamic banking product (Murabaha Finance).
"Documentary credit" is one of the most essential methods of payment which has been utilizing in international trade since several centuries ago. In the case of The Bhoji Trader, [2] it has been described by the courts as "the life blood of international commerce". It is also the most secure method for a seller to receive the contractual payment and the most common method of payment for the goods in international trade.
Murabaha:
Murabaha simply means 'mark-up sale'. It is a particular type of sale that Islamic jurisprudence considers as a trust contract, because the seller and the buyer do not negotiate the price, but rather agree on a certain profit margin added to the cost, as faithfully declared by the seller. Originally, murabaha was not conceived of as a mode of finance, since it was not necessarily concluded on the basis of deferred payment. Murabaha sale for cash was the rule rather than the exception. The shift to credit murabaha, or murabaha with deferred price, is a first requisite for its transformation into a technique of finance. Credit murabaha can be used by non-financial firms to finance the purchase of goods by households and business concerns. Its rise to a fully fledged financial technique used by financial intermediaries, however, requires further amendment of the original contract (Hassan, 1990, p. 36).
Indeed, banks and other financial institutions which would like to practise credit murabaha would need to assume, more or less, a commercial intermediation function, in addition to their original function as financial intermediaries. They would have, in fact, to play the double role of intermediary buyer and seller between the ultimate buyer and seller. However, financial institutions are not specialized in commerce and they are not equipped to perform efficiently the economic functions of traders. Therefore, they would like to depart the least possible from their traditional financial intermediation function and to keep their commercial role to the strict minimum necessary to comply with Islamic principles. More particularly they would like to avoid holding inventories of goods and to market them over a prolonged period of time. This is achieved though the second amendment to the original concept of murabaha, that is to say the requirement that the sale contract be preceded by the customer's promise to buy the desired goods, once they are acquired by the financier (Ahmed, Shaghil 1999, p.65).
The resulting financing technique may thus be distinguished from the original murabaha sale on two grounds: (a) credit is an indispensable feature, and not just a mere possibility, (b) the existence of a prior promise to buy3 is a prerequisite for the extension of credit. For the sake of clarity, we will refer to this financing technique as 'financial murabaha'.
The scope of financial Murabaha:
Murabaha finance may be used, and is actually used, as an alternative to conventional banks' credit, if the latter is tied to the purchase of goods. However, Islamic banks and other financial institutions intervene in this market in a radically different way, as compared to conventional banks. While the latter have the choice between direct lending to the buyers and refinancing the credit originated by the sellers, Islamic financial institutions can only finance the buyers. Refinancing is excluded, as it amounts to the purchase of debts, on which no profit can lawfully be made. On the other hand, while conventional banks assume a purely financial intermediation role, Islamic financial institutions using financial murabaha have to further assume some kind of commercial intermediation. It was noted earlier that, by means of the 'promise to buy' device, Islamic financial institutions may avoid building up inventories of goods.
Furthermore, they usually mandate the prospective buyer to select the supplier of the demanded goods, to negotiate with him the terms and conditions of the cash sale contract and to check, on delivery, the conformity of the goods with the required specifications. This procedure minimizes for the financier the risk of buying goods that would be later refused by the customer. However, Islamic financial institutions have definitely to assume to some extent a commercial function and cannot act as pure financial intermediaries. They assume the commercial risk attached to their ownership of the demanded goods for the period of time elapsing between their acquisitions of the goods from the supplier to their delivery to the customer. This commercial risk is specific to financial murabaha and cannot be totally avoided, notwithstanding the abovementioned devices aiming at limiting it. It adds to the credit risk (delayed payment or default) which is common to both Islamic and conventional financial institutions. Furthermore, the commercial risk facing Islamic financial institutions may even be greater, in the case where the promise to buy is considered non-binding.5 This is because an additional cost may be incurred for marketing goods acquired on the basis of a prior promise to buy, that the customer later refused to honour [3] .
The scope of credit murabaha Credit murabaha provides an alternative to trade credit and retailers' credit extended by business concerns to other business firms or to consumers. They operate in a very similar way, with two exceptions. On the one hand, in the case of a two-part credit offer (discount for early payment or full price for a longer payment period), the choice should be made in advance and the contract should be definite with regard to the selected terms. On the other hand, the deferred price is definite and the contract should make no mention of any additional cost on possible overdues.6 The effective use of credit murabaha will however be seriously hindered, if the sellers are not efficiently backed by financial institutions. Indeed, the experience of trade credit in interest-based economies shows that refinancing is of vital importance for sellers' credit. Sellers who extend credit to their customers may of course keep the financial claims in their portfolios to maturity. But they frequently sell them for cash before maturity. In any case, sellers need to have the assurance of liquidating their receivables when needed without incurring an excessive cost. Otherwise, the sellers' opportunity cost would be higher and they would not be able to offer competitive credit terms. Business firms financing trade on the basis of credit murabaha have the same needs of financial support to enable them to extend credit to their customers. However, once the credit is extended, it becomes a debt that cannot be sold at a discount without violating the shari'a rules.
Business firms would practically cease to use credit murabaha, unless an appropriate alternative was found for the sale of receivables. Is it acceptable to displace credit Murabaha from the system and to rely completely on financial murabaha extended by Islamic banks? Some Islamic economists advise Islamic banks to become involved in real business,7 and especially trade. This would be achieved either through merchant departments staffed with adequate commercial skills or through the establishment of merchant subsidiaries (Aspinwall and Eisenbeis, 1985, p. 667). The principal advantage attributed to this way of doing business is that the Islamic banks would assume the business risk implied by the trade activity and thus draw an income which is unambiguously riba-free. One cannot underestimate this advantage of the bank-trader method over the murabaha method, as currently practised in Islamic banks, in terms of their relative compatibility with shari'a. However, this solution is seriously objectionable on macroeconomic and social grounds. Furthermore, it does not solve in all cases the financing problem. For one, Islamic banks raise mostly short-term funds, therefore they cannot use them, beyond certain limits, in long-term investments, like the acquisition of equity capital in trade subsidiaries. Second, the suggested method would lead to the establishment of financial empires controlling and dominating a large part of the economy. At the same time, it would subjugate the traders to powerful financial institutions. It is well known that the ensuing monopoly power is the source of both economic waste and social injustice. As a matter of fact, the subscription of commercial banking institutions to the capital of business concerns is in many countries tightly regulated (Omar, 1992, p. 65). Third, trade credit is indeed intimately linked to trade itself. Traders view it as an indispensable device to promote and expand sales. Fourth, the observed growing importance of trade credit in the developed market economies seems to imply that the provision of credit by business firms is efficient under certain market conditions. The elimination of credit murabaha would thus mean a loss of efficiency. Finally, the bank-trader method solves the refinancing problem only if it takes the form of merchant departments. But, when Islamic banks establish trade subsidiaries, these are financially independent of the mother-institutions. Thus, if the subsidiaries need liquidity to refinance the credit they had already extended to their customers, they find themselves in exactly the same situation as any other seller vis-à-vis the resources of the mother-banks. Therefore the establishment of trade subsidiaries does not eliminate the need to design appropriate methods to support financially the credit activity of traders.
Since traders' credit should remain in the system, solutions need to be devised to the impossibility of refinancing sellers' credit. Trade refinancing may be looked at as a financial back-up provided by banks and other financial institutions to sellers subsequent to their extension of credit. The common principle underlying the development of Islamic alternatives to conventional refinancing involves the replacement of the subsequent financial back-up with a prior financial support provided to the sellers. Contrary to conventional refinancing, which is based on the discount of debt instruments, the alternative prior support is based on the profit and loss sharing (PLS) principle. Sellers may obtain the needed support either directly in the financial markets through the issue of PLS certificates or from financial intermediaries. These techniques will be detailed below.
1.4.1 Murabaha LC:
There are two types of Murabaha contract were known in Islamic jurisprudences, local Murabaha and international Murabaha; the type that concerns us in this research is international Murabaha. International Murabaha is the essence of this paper due to the widely uses of the documentary credit in this part of Murabaha [4] . Letters of credit are open under this type of finance by the bank.
PROBLEM STATEMENT:
The Murabaha sale contract is in conflict with the Uniform Customs and Practice for documentary credit (UCP). Articles 4 states that "A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking of a bank to honour, to negotiate or to fulfill any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary " [5] . It's clear also by article 5 of the UCP that the parties to the credit operation are dealing in document and not in goods.
Articles 4 and 5 is about the autonomy letter of credit, which mean the paying bank, as the agent of the bank which issued the letter of credit, will have to pay without conditions if the beneficiary of the letter of credit complies with the requirements for payment under the letter of credit. In other words the terms and conditions under the sales and purchase contract between the seller and buyer will cause no effect to the payment by the bank under the letter of credit.
Meanwhile in Murabaha transaction the subject of sale should be objects goods or commodities against money moreover the original purchase contract between the dealer and the vendor (bank) has to be valid according to Islamic law (share'a), if not the Murabaha operation also invalid(Abd Al-Halim Umar). Consequently there conflict between the principle of letter of credit and the principle of Murabaha which is letter of credit dealing with document and the contract between the seller and the buyer will cause no effect to the LC transaction, on the other hand the Murabaha transaction dealing with the goods or commodities [6] .
This conflict arising when the subject matter of the contract in LC transaction are non-permissible in Islamic law (share'a), such as liquor, riba and pork.
Furthermore in the letter of credit there the buyer when he request the item and open the letter of credit and the bank import the item inconformity with stipulate document the buyer has no right to reject the goods or refuse even though the contract of sale is not completed yet to pay, adversely to Murabaha financing the buyer can refuse to accept the goods even though the bank has order the goods and incurred the cost of import. [7]
The research will be conducting to study the application of the LC under Murabaha financing under Islamic banking in Sudan.
RESEARCH QUESTIONS:
What is the method of the application of Murabaha finance under the letter of credit currently used in Sudan Islamic banking?
What are the Muslim jurist's views (Fatwa) regarding the issued letter of credit in Islamic banking?
Whether is a conflict between the Islamic law (Shariah) and the principle of letter of credit in applying Murabaha finance under letter of credit in Islamic banking?
OBJECTIVES:
The proposed dissertation is to study on the legal application and the functions of the Murabaha under documentary credits (Murabaha LC) under Sudan Islamic Banking, with the following purposes:
To study the legal application of the Murabaha letter of credits (Murabaha LC) under the Islamic Banking in Sudan.
To study the function of the Murabaha under documentary credits (Murabaha LC) under Islamic banking.
To study the Muslim jurist's views (Fatwa) regarding the issued letter of credit in Islamic banking.
SCOPE AND LIMITIONS OF THE STUDY:
Unquestionably, before the beginning of any research, it is extremely essential to be familiar with the historical background of the subject. Therefore, first of all, the researcher will present a brief background history of the Islamic banking in general then the Islamic banking in Sudan, Historical Background of letter of credit. Furthermore, the researcher will attempt to study the principle of Murabaha Finance and its procedure.
As a final point, the researcher aims to study the legal application of the documentary credits in Murabaha Finance under Sudan Islamic banking throughout this dissertation.
