By Mufti Mirza-Zain Baig
Traditionally trained in Islamic Sciences with substantial exposure in Academia. Mufti Mirza is passionate in providing creative solutions to bridge the gap between tradition and contemporary challenges-currently specializing in Islamic Finance.
Banks and financial institutions worldwide, whether Islamic or conventional, are often exposed to the risk of not being able to meet the demand for their funds from depositors or borrowers.
Such exposure, known as liquidity risk, arises because of an unexpected decline in the institution’s cash flow. While conventional banks can raise funds required to meet their liquidity needs by borrowing on interest, the options available for Islamic financial institutions are limited. A common method used by Islamic financial institutions is tawarruq, also known as monetization.
While most scholars around the world have unanimously accepted tawarruq, opponents of Islamic banking equate tawarruq to ‘īnah, a sale and buy-back transaction that is prohibited. They argue both transactions are legal stratagems to engage in riba. While both do share cursory similarities, an in-depth understanding reveals that both transactions are substantially different.
The literal meaning of ’īnah is a loan or an advance payment. According to the great Ḥanafi jurist Ibn Al-Humām, the term ’īnah has been derived from the word ‘ayn, which denotes a specific item. He explains that this sale has been termed ‘īnah, as the particular item purchased finds its way back to the original seller.
‘Īnah is used as a hīla (legal stratagem) for engaging in riba. Classically, ‘īnah was preceded by a request from one party to advance a loan. To avoid dealing in interest directly, the party advancing the loan instead sells an item for higher than its usual value on a credit basis. The item is then sold back to the seller at a lower cash price (usually, the amount initially requested). The net effect is that the item returns to the original seller with a loan binding on the buyer.
The vast majority of the fuqaha deem ‘īnah as impermissible. However, according to Imam As-Shafi’ī, such a transaction is permissible. Proponents of impermissibility state that the asset has merely been used as a ploy to make that which is unlawful appear as lawful. This is indicated firmly through the fact that the item never really leaves the original seller’s possession.
Tawarruq is derived from the word wariq, which denotes silver. It has been used to mean seeking or acquiring silver, comparable to the word ta’allum, which refers to seeking ‘ilm. In modern usage, tawarruq is not restricted to seeking silver, instead, it includes money in any form, whether silver, gold or other currencies.
Accordingly, tawarruq is used as an alternative to borrowing on interest. The mutawarriq, the person in need of liquidity, purchases an asset on credit, generally for a price higher than its market value, and sells it subsequently to a third party in cash. Through the second sale, the money the mutawarriq initially required is realized and the price of the first sale becomes a debt on him. However, as the debt has arisen from a valid sale (not a fictitious one), both parties save themselves from interest.
Classically, the term tawarruq was first introduced by the ḥanābilah. As for the rest of the maḍāhib, the discussion of tawarruq is generally found under the discussion on ‘īnah without reference to a particular name.
Types of Tawarruq
Tawarruq can be carried out in two ways: At Tawarruq- al Fardi (Individual Tawarruq) and At-Tawarruq al-Munaẓẓam (Organized Tawarruq).
This refers to tawarruq that is carried out by the mutawarriq himself. The mutawarriq can either be an individual or an institution requiring liquidity to carry out its operations. This can take three forms.
In the first form, tawarruq is not preceded by any loan request. Instead, the mutawarriq purchases an item on credit and sells it to a third party on cash without disclosing this arrangement to any of the parties involved.
In the second form, tawarruq is preceded by a loan request. In this case, the trader excuses himself from lending money to the mutawarriq but is willing to sell a commodity to him on credit. The mutawarriq sells the item in cash, whether it is less or more than the price he initially paid.
The third form is like the second form, except that the original seller sells the asset at a price that is higher than its market value. This is to ensure the seller receives an excess in return for carrying out this arrangement.
At-Tawarruq Al- Munaẓẓam
This refers to tawarruq that is managed by the original seller. Organized tawarruq can take many forms. For this paper, we focus on the scenario where the mutawarriq appoints the institution to sell the item on its behalf.
In the form in reference, after being approached by the mutawarriq, the seller sells the item to the mutawarriq and acts as an agent on their behalf to sell the item to a third party.
At present, organized tawarruq is practised by some banks. The bank purchases certain goods and sells them to the mutawarriq on credit. The mutawarriq then authorizes the bank to sell the item on its behalf. The process is generally instantaneous.
Differences Between At-Tawarruq Al-Fardī and At-Tawarruq Al- Munaẓẓam
A clear distinction between both is that in an organized tawarruq, the seller acts as the intermediary throughout the entire process. While in the case of an individual tawarruq, the seller has no role whatsoever in the resale of the asset. Similarly, in an organized tawarruq, the mutawarriq receives cash from the original seller, the creditor from the first sale. In an individual Tawarruq, as the mutawarriq manages the second sale himself, they will collect cash from the third party to whom the commodity was sold.
Islamic Ruling of Tawarruq
The vast majority of the fuqaha have regarded individual tawarruq as permissible. As for organized tawarruq, a significant group of latter-day scholars have deemed it impermissible. The Organisation of Islamic Conference (OIC) in Makkah resolved in April 2009 that organized tawarruq is not permissible, as they are merely stratagems to attain money on spot in exchange for money that is to be paid later. The International Council of Fiqh Academy’s (ICFA) resolution 179 on tawarruq states:
It is not permissible to execute both organized and reverse tawarruq because simultaneous transactions occur between the financier and the mustawriq (party seeking finance, also known as, mutawarriq), whether it is done explicitly or implicitly or based on common practice, in exchange for a financial obligation. This is considered a deception, i.e. to get the additional quick cash from the contract; hence, the transaction is considered as containing the element of riba.
While AAOIFI does not address organized tawarruq directly, article 4/7 in Standard# 30 on tawarruq does not allow the institution to assume an agent’s role unless the mutawariq is legally only able to sell the item through the institution. Hence, one can understand that the practice of buying and selling directly through the bank, in the absence of any legal restrictions, would not be acceptable under the AAOIFI Shari’ah Standards.
Comparing Tawarruq and ‘īnah
A superficial glance over these two transactions would lead one to believe they are identical to one another. For one, in both transactions, the purpose of setting up such an arrangement is to attain liquidity, and the sales are orchestrated purely for that purpose. In addition, the result of both transactions is the same, as they both result in the payment of a greater amount at a later date in exchange for a smaller amount of immediate liquidity.
However, the element that distinguishes one from the other is the commodity sold and the payment structure. In an ‘īnah transaction, the commodity is returned to the seller, whereas in a tawarruq transaction, the commodity is sold to a third party.
Similarly, although the result of both transactions is the payment of a greater amount in exchange for a smaller amount, the recipients are different. In an ‘īnah transaction, the one who advances the smaller amount is the same person to whom the greater amount is owed.
Hence, it can effectively be labelled as an exchange. While in a tawarruq transaction, the mutawarriq receives the smaller amount from a third party and returns the greater amount to the seller. Hence, one cannot label this setup as a greater amount in exchange for a smaller amount.
Therefore, although ’īnah and tawarruq do share some similarities, they are indeed distinct from one another.
Organized Tawarruq and its similarity to ‘īnah
The above discussion was concerning individual tawarruq. As for organized tawarruq, then, as discussed above, a significant group of contemporary scholars hold such a transaction to be impermissible. They base their ruling on the similarities present between ‘īnah and organized tawarruq.
The essential element that distinguishes individual tawarruq and ‘īnah is the presence of a completely independent third party. The third party is neither known to the seller nor are they arranged by them. However, this is absent in an organized tawarruq, as the intermediary is organizing the sale for the mutawarriq. Hence, there remains a greater possibility of creating a fictitious scenario.
Similarly, another element that distinguishes individual tawarruq and ’īnah is that the payer of the smaller amount is different from the one to whom the greater amount is to be paid. However, in an organized tawarruq, the intermediary is advancing the smaller amount and collecting the greater amount later. Although the first amount advanced comes from the sale that was delegated to the intermediary, the appearance of such a transaction is that a third party has been superficially included in the transaction in an attempt to legalize an interest-bearing loan.
Furthermore, an organized tawarruq turns the entire concept of tawarruq into a mere formality on paper without any certainty that actual possession has taken place.
Tawarruq has for many years served as an effective strategy for institutions to manage liquidity and as an alternative to interest-bearing loans for institutions and clients alike.
Due to its cursory similarity to ‘īnah, it has been criticized by some as a stratagem to engage in riba. However, a deeper understanding reveals the clear distinction between the two. Albeit some forms of tawarruq, such as organized tawarruq, do share certain similarities to ‘īnah.
Nonetheless, organized tawarruq has been deemed impermissible by most scholars. Hence, one cannot deem individual tawarruq impermissible based on organized tawarruq, especially given the tight controls and measures put in place by Shariah governance bodies to ensure individual tawarruq is carried out properly.