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IB 1005 DEPOSITS AND FINANCING PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS CHAPTER 12 : TRADE IB 1005 DEPOSITS AND FINANCING PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS CHAPTER 12 : TRADE FINANCING COMPILED BY HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance) Certified Professional Trainer (MIM) Industry Expert INCEIF HJ MAHMUD HJ BUNTAT, MBA(AUOL, UK), DBM (Swansea Inst. , UK), CIL (UIA) Part-time Lecturer (INCEIF) Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd

Chapter 12 – Trade Financing Refers to the various forms of financial support and Chapter 12 – Trade Financing Refers to the various forms of financial support and financial transactions used in international trade. The facility is used to mitigate the financial risks for both exporter and importer. • Banks may assist by providing various services such as letter of credit, collection of payment upon presentation of certain documents or advancing payment on the basis of export contract.

 In many countries, trade finance is often supported by quasi-government entities known as In many countries, trade finance is often supported by quasi-government entities known as export credit agencies that work with commercial banks and other financial institutions.

Bank as Collection Agent Once the terms of contact have been agreed, the two Bank as Collection Agent Once the terms of contact have been agreed, the two parties have to appoint a bank on their behalf to effect transactions. To seller/exporter the bank can act as their collecting agent. To the buyer/importer the bank can act as their paying agent.

Collection Basis Exporter (Kuala Lumpur) CONTRACT MERCHANDISE 1. Exporter ships the merchandise 2. and Collection Basis Exporter (Kuala Lumpur) CONTRACT MERCHANDISE 1. Exporter ships the merchandise 2. and presents documents to 3. his Bank for collection of payment DOCUMENTS 3. Agent Bank, Tokyo on scrutinizes documents. Informs Importer of arrival of import documents and requests importer to pay if documents are on sight basis or accept if documents are on usance basis Importer (London) (Tokyo) 4. Importer makes payment to the Agent Bank and take possession of documents MEMO OF BILL PAYMENT 2. Exporter’s Bank checks documents and sends 3. them to Agent Bank in Tokyo for collection BANK ABC KUALA LUMPUR (Exporter banker) DOCUMENTS AGENT BANK TOKYO

Trade Financing Facilities 1. 2. 3. 4. 5. Letter of Credit-I (LC-i) Trust Receipt-i Trade Financing Facilities 1. 2. 3. 4. 5. Letter of Credit-I (LC-i) Trust Receipt-i (TR-i) Shipping Guarantee-i (SG-i) Letter of Guarantee-I (LG-i) Islamic Accepted Bill-i (IAB-i)

Bills of Exchange Drawn under BANK ABC MALAYSIA BHD Letter of Credit No : Bills of Exchange Drawn under BANK ABC MALAYSIA BHD Letter of Credit No : 00183002 dated 8 nd July 2009 0001/2009 No………………… US$28, 572. 00 9 th July 09 EXCHANGE for…………………………………………………… 20……… SIGHT At………………………………………………………………. . Pay this First of Exchange ( Second being unpaid) to the order of XYZ Bank, Tokyo US Dollars : Twenty Eight Thousand Five Hundred Seventy Two Only ……………………………………………………………………. . …………………………………………………………………… Value received and charge the same to account of One Thousand units of Motor Parts ……………………………………………………………………. Jasa Trading Sdn Bhd To………………………………… Lot 101, Jalan Sungai Besi …………………………………. . . 57000 KUALA LUMPUR Tokyo Supplier Pt Ltd

Letter of Credit (LC) LC is a secured means of acquiring prompt payment for Letter of Credit (LC) LC is a secured means of acquiring prompt payment for the sale of goods. With the availability of LC facility, exporters can obtain quick, secure and guaranteed payment of goods from the banks. Offers an acceptable compromise by providing for payment to be effected against documents representing the goods and making possible the transfer of title to the goods from seller to the buyer.

Letter of Credit-i Provides the buyer with financial backing, better pricing and repayment terms. Letter of Credit-i Provides the buyer with financial backing, better pricing and repayment terms. Eliminates commercial risk of nonpayment to the supplier. Assured all documents are in order as payment is made upon once the terms have been complied.

Stage 1: Opening a Documentary Credit CONTRACT Exporter (Tokyo) 1. The importer and the Stage 1: Opening a Documentary Credit CONTRACT Exporter (Tokyo) 1. The importer and the exporter sign a 2. sales contract providing for payment 3. through a letter of credit 4. The advising bank informs the exporter that the letter of credit has been issued 2. - Importer (Kuala Lumpur) The importer instruct Bank ABC , KL. The Issuing bank-to issue a letter of credit in favor of the exporter APPLICATION FOR CREDIT DOCUMENTS 3. Bank ABC, Kl asks Agent bank to advise the credit to the exporter AGENT BANK TOKYO ADVISING BANK CREDIT BANK ABC KUALA LUMPUR ISSUING BANK

Stage 2 : Negotiation EXPORTER 1. MERCHANDISE IMPORTER Importer (London) Exporter ships the merchandise Stage 2 : Negotiation EXPORTER 1. MERCHANDISE IMPORTER Importer (London) Exporter ships the merchandise 4. Importer makes payment to the And presents documents to Bank and take possession 3. Negotiating Bank Tokyo 3. Bank ABC, KL scrutinizes documents. of documents If documents 4. for negotiation are in order, it will advise the importer and release the shipping documents upon DOCUMENTS payment by the importer MEMO OF BILL PAYMENT 2. 4. AGENT BANK TOKYO NEGOTIATING BANK 2. Negotiating Bank negotiates and pays the 3. exporter if all documents comply with the terms of Credit and debits account of Bank ABC, Kl 5. and sends documents to Bank ABC. KL DOCUMENTS & ADVICE OF DEBIT BANK ABC KUALA LUMPUR ISSUING BANK

Shariah Concepts for Letter of Credit-i The issuance of LC-i can be based on Shariah Concepts for Letter of Credit-i The issuance of LC-i can be based on the Shariah principles of: 1. Wakalah (Agency) 2. Murabahah (cost plus basis) 3. Musharakah (joint venture / profit /loss sharing)

Al-Wakalah LC-i (Agency) 1. The bank effectively acts a customer. 2. Before granting the Al-Wakalah LC-i (Agency) 1. The bank effectively acts a customer. 2. Before granting the facility, the will generally insist on a deposits from the customer up to the total cost of the goods in questions. 3. The deposits will be placed with bank under the Al-Wadiah Yad–Dhamanah principle.

3. Upon establishing the LC-i, the bank will pay the proceeds (from the deposit) 3. Upon establishing the LC-i, the bank will pay the proceeds (from the deposit) to the negotiating bank. 4. The bank will then release the documents to the customer, charging the customer a fee for its services.

Al-Murabahah LC-i (Cost plus) 1. The customer will negotiate his LC-i requirements with the Al-Murabahah LC-i (Cost plus) 1. The customer will negotiate his LC-i requirements with the bank on the basis he will purchase the goods from the bank under Al-Murabahah principle. 2. The bank will then establishes the LC-i and makes use of its own funds to pay the negotiating bank. 3. The bank subsequently sells the goods at the agreed profit margin. The customer is

Musharakah LC-i (Joint venture, profit/loss sharing) 1. On establishing the LC-i, the customer will Musharakah LC-i (Joint venture, profit/loss sharing) 1. On establishing the LC-i, the customer will place a deposit (under the Al-Wadiah Yad Dhamanah principle) for his agreed share of the cost of the goods in questions. 2. The bank then establishes the LC-i and pays to the negotiating bank. The customer’s deposits as well as the bank’s fund (for its share of the cost of the

3. The documents are released to the customer, who will dispose of the goods 3. The documents are released to the customer, who will dispose of the goods as agreed under the Al-Musharakah agreement. 4. The profits derived therefore will be shared between thebank and the customer as agreed.

Contents/Documents with Letter of Credit (LC) 1. Date of application. 2. Stamp Duty of Contents/Documents with Letter of Credit (LC) 1. Date of application. 2. Stamp Duty of RM 3. 00 is placed and cancelled. 3. Whether the LC is to be revocable, irrevocable, transferable or revolving. 4. Whether the LC is to opened by mail or telex/cable and whether telex/cable

5. Whether the advising bank is to add its confirmation. If so, to insert 5. Whether the advising bank is to add its confirmation. If so, to insert the clause “Please request your agent to add its confirmation. ” 6. Full and correct name and address of the applicant. 7. Full and correct name and address of the beneficiary and that the beneficiary is not

9. Trade terms – whether CIF, C&F or FOB etc. 10. Whether the draft 9. Trade terms – whether CIF, C&F or FOB etc. 10. Whether the draft is to be drawn at sight or usance. If drawn on usance basis, it should state “ 30 days after sight” or “ 30 days after date of bill of lading. ” 11. Expiry date of the LC and the country in which the LC is valid for negotiation are clearly

13. Types of documents required a) Signed commercial invoice No. of copies required & 13. Types of documents required a) Signed commercial invoice No. of copies required & to indicate Import License no. b) Certificate of origin Name country of origin c) Weight Note No of copies required d) Packaging list No of copies required e) Insurance policy/certificate FOB, CFR insurance to be covered by buyer f) Bill of lading/airway bills/ delivery order Authority to claim goods

14. The brief description of merchandise and quantity. 15. Shipment – Ports of origin 14. The brief description of merchandise and quantity. 15. Shipment – Ports of origin and destination. 16. The latest shipment date (must not be more than 21 days from expiry of the LC). 17. Whether partial shipments are allowed.

19. Presentation period of documents. 20. Any special instruction, e. g payment of charges. 19. Presentation period of documents. 20. Any special instruction, e. g payment of charges. 21. Authorised signature of the applicant 22. Terms and conditions imposed. 23. Submission of relevant forms e. g KPWP.

Letter of Credit operations LC established on 02 -01 -2009 to 30 -042009 Beneficiary Letter of Credit operations LC established on 02 -01 -2009 to 30 -042009 Beneficiary : Amount : Exchange Rate : Amount in RM : Commission : Period of LC : Profit rate : Postage : In Tokyo US 28, 571 -43 3. 50% RM 100, 000 -00 0. 1% per month 4 months 9% RM 37 -00

Charges on Letter of Credit Commission RM 4, 000 -00 Profit rate from the Charges on Letter of Credit Commission RM 4, 000 -00 Profit rate from the date of negotiation @ 8 days to-date of payment plus 10 remittance days 443 -84 • • Postage (courier) 37 -00 Stamp duty (application) 3 -00 40 -00 Total charges

Trust Receipt-i is a financing facility to finance domestic or international trade documents drawn Trust Receipt-i is a financing facility to finance domestic or international trade documents drawn against Letter of Crediti (under Murabahah concept) or Inward Bills for Collection-i (under Wakalah concept). It is facility granted to customers for financing their short-term working capital requirement by way of murabahah.

Process flow of Trust Receipt-i 1. The Bank appoints the customer as its agent Process flow of Trust Receipt-i 1. The Bank appoints the customer as its agent to purchase goods he requires on behalf of the bank. 2. Upon delivery of the goods, the Bank pays the exporter/supplier for the cost of the goods based on the invoice value.

 The Bank will purchase the goods from the customer at invoice value and The Bank will purchase the goods from the customer at invoice value and resell them to the customer on deferred payment terms at a price inclusive of the Bank's profit margin. The deferred payment terms of sale of goods granted to the customer constitutes a creation of debt. This is secured in the form of Bill of Exchange drawn by the Bank and accepted by the customer and

 The deferred payment terms of sale f goods granted to the customer constitutes The deferred payment terms of sale f goods granted to the customer constitutes a creation of debt. This secured in the form of Bill of Exchange drawn by the bank and accepted by the customer and payable on maturity. The Bank holds customer's Trust Receipt-i executed by him to signify his holding of goods in trust pending sale of the goods. Customer undertakes to settle the selling

Creation of Trust Receipt-i Amount of Bill Exchange rate Amount in RM Period of Creation of Trust Receipt-i Amount of Bill Exchange rate Amount in RM Period of Financing Profit rate Date of Inception Maturity • : : : : US 28, 571 -43 3. 5 RM 100, 000 -00 90 days 9% p. a 01 -03 -2009 29 -05 -2009 The bill amount in USD 28, 571 -43 will be converted to MR based on rate of exchange prevailing on the date payment is affected by the LC-i issuing bank.

Trust Receipt Selling Price Invoice face value FV 100, 000 -00 Profit rate r Trust Receipt Selling Price Invoice face value FV 100, 000 -00 Profit rate r 9% Tenor (days to maturity) t 90 Murabahah Selling price 102, 21918 Profit SP – FV 2, 219 -18 SP = FV x [1 +

Shipping Guarantee-i A negotiable instrument be used by consignee to take delivery of merchandise Shipping Guarantee-i A negotiable instrument be used by consignee to take delivery of merchandise at the port. The issuance of Shipping guarantee by the bank to indemnifies shipping company against all consequences and liabilities of any kind whatsoever should there be any claim on its rightful owners. It is signed by the importer and counter

 SG- i does not have any qualifying clauses as regards to the value SG- i does not have any qualifying clauses as regards to the value and time. The liability of the bank ceases only upon presentation of the original shipping documents in exchange for return of SG-i or perhaps by the law of limitation. Under LG-i operation , the issuing bank would normally advise that the shipping documents should be presented to the negotiating bak for negotiation within. Say 7 days from the date of shipment To

Al-Kafalah Letter of Guarantee (LG-i) A customer requires a Letter of Guarantee -i in Al-Kafalah Letter of Guarantee (LG-i) A customer requires a Letter of Guarantee -i in respect of say a loan procurement. The bank requires a deposits from the custmer which is place under Al-Wadiah Yad–Dhamanah principle. The Bank provided Al-Kafalah LG-i by charging a fee to the customers.

Islamic Accepted Bills (IAB) IAB is a mode of financing available for imports and Islamic Accepted Bills (IAB) IAB is a mode of financing available for imports and domestic sales; in the primary market, IAB-Import is concluded on the basis of murabahah, and IABExport is concluded on the basis of a sale of debt (bai’ al-dayn). IAB is also traded in the secondary market on the basis of bai’al dayn.

IAB – Purchase/Import The bank draws a Bill of exchange, which is a Certificate IAB – Purchase/Import The bank draws a Bill of exchange, which is a Certificate evidencing the debt, on and to be accepted by the customer. The amount drawn is the full selling price payable by the customer to the bank on the maturity date of the financing. The contract used is debt trading (bai aldayn).

 • The document essentially involves the creation of IAB as a security to • The document essentially involves the creation of IAB as a security to finance working capital in the form of cash purchase of raw materials at cost which is sold back to the customer inclusive of profit margin (murabahah), with the customer acting as an agent to the bank. • Upon acceptance by the customer, the bank may sell the bill to a third party (baial-dayan) at adiscunt (not less than te cost ) based on an agreed price.

Murabahah Selling Price Invoice face value 100, 000 -00 Islamic cost of fund icof Murabahah Selling Price Invoice face value 100, 000 -00 Islamic cost of fund icof Accepted commission rate Rate (spread) acr Profit rate r Tenor (days to maturity) t Murabahah Selling price 102, 219 -18 Profit SP – FV 7% 2% 9% 90

IAB DRAFT (Purchase/Import) BB 53 -1 Payable at ABC BANK BHD KUALA LUMPPUR ISLAMIC IAB DRAFT (Purchase/Import) BB 53 -1 Payable at ABC BANK BHD KUALA LUMPPUR ISLAMIC ACCEPTED . . . For and on behalf of IMPORTER SDN BHD Authorised Signatories Accepted on 3 -8 -2002 IAB NO: 001674 Br Ref No: LC 9993020224 IMPORTER SDN BHD To……………………………. . At Due Date: 1 -11 -02 90 days after sight without days of grace pay to the order of ourselves THREE HUNDRED TWENTY SEVEN THOUSAND SEVEN the sum of RINGGIT………………………………… HUNDRED NINETY FIVE ONLY ……………………… RM 327, 795 -00 IMPORTATION INTO MALAYSIA Drawn to finance………………………………… of goods described in the record of the drawing/accepting bank. For and on behalf of ABC BANK BHD 30 -2 -2008 Dated…………. . …………………… NO SIGNATURE /WRITING BELOW THIS LINE “ 001674” 40” 140141: 39

IAB – Export/Sale The exporter seeks finance from the importer by preparing the export IAB – Export/Sale The exporter seeks finance from the importer by preparing the export documents as required by the sales contract/letter of credit. The IAB-Exports is drawn to finance exports or domestic credit sales and it is payable on a specified future date. The customer sells the debt arising from his credit sales to importer/ local buyer to

 • On the maturity date, customer will settle the debt to the Bank. • On the maturity date, customer will settle the debt to the Bank. The IAB-Exports may be sold in the secondary market. A minimum amount of financing of RM 50, 000 is typically required. A bank discount the face value of the IAB issued in the primary market, and may sell it to third party in the secondary Islamic money market. The discount

 The discount rate offered by the Islamic money market dealer is 4% (as The discount rate offered by the Islamic money market dealer is 4% (as per table below). Debt trading is only applicable in Malaysia, as in the middle East a debt is deemed money owed and may not be traded to a third party at a discount.

IAB proceeds after discount IAB face value RM 102, 21918 Discount rate r 4% IAB proceeds after discount IAB face value RM 102, 21918 Discount rate r 4% Tenor (days to remaining) t 60 Proceeds 05 r*t/365] P 101, 547 - P = FV * [1 -

IAB DRAFT (Export/Sales) PAYABALE AT EXPORT IMPORT ISLAMIC BANK for and on behaof Hong IAB DRAFT (Export/Sales) PAYABALE AT EXPORT IMPORT ISLAMIC BANK for and on behaof Hong Leong Islamic Bank Authorised Signatories Accepted on 1/3/02 IAB NO: 001674 Br Ref No: Ad. Dayn 77009901 BB 53 -1 ISLAMIC ACCEPTED BILL EXPORT IMPORT ISLAMIC BANK To……………………………. . At Due Date: 1/09/2008 180 days after sight without days of grace pay to the order of ourselves One Hundred Thousand Only the sum of RINGGIT………………………………… MYR 100, 000. 00 SALES WITHIN MALAYSIA Drawn to finance………………………………… of goods described in the record of the drawing/accepting bank. For and on behalf of XYZ Corporation …………………… 1/3/2008 Dated…………. . NO SIGNATURE /WRITING BELOW THIS LINE “ 001674” 40” 140141: 44

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