Deposits : Tawarruq (Commodity Murabahah)

  • Contract : Tawarruq Arrangement or Commodity Murabahah Contract
  • Definition : monetization or Cost plus sale using commodities
  • Transaction : Sale
  • Category : Debt
  • Secondary contract : Musawamah (simple sale), Wakalah (agency)
  • Commonly used for : Fixed Deposits, Interbank Deposits, Structured Deposits, Current Account, Savings Account.

THE NEED FOR TAWARRUQ IN DEPOSIT STRUCTURES

While it is fairly common to see Tawarruq Arrangement (monetization of Murabahah sale-based transaction using Commodities) in financing structure, Tawarruq has also be widely used in deposit products in Malaysia, especially after the introduction of the Islamic Financial Services Act 2013 (IFSA). The biggest impact of IFSA is defining “Deposits” as structures where the Capital amount is guaranteed and “Investments” as structures where Capital amount is not guaranteed. Up to 2013, most of the deposit products are based on Wadiah (safekeeping) or Mudarabah (profit-sharing). With Mudarabah then classified as “Investments” as Capital is not guaranteed (resulting in loss of cover by PIDM ie the Deposit Insurers Association of Malaysia), the market demanded the introduction of a product where the Capital is guaranteed and for the purpose of income generation.

Thus, the industry evolved into offering Deposit products based on Tawarruq.

The Malaysian market now moved into Tawarruq for Fixed Deposit-i which has replaced the previous favourite, Mudarabah Fixed Deposits-i. The main objectives achieved by Tawarruq products are:

  1. Guarantee of Capital or Principal whereas under Mudarabah its is no longer guaranteed
  2. Fixing of Returns on Capital or Principal whereas Mudarabah was not able to fix returns based on the profit sharing concept
  3. Coverage by PIDM whereas coverage is no longer provided under Mudarabah
  4. Risk held by Banks whereas under Mudarabah the risks are solely borne by the customers (except in cases of proven negligence)

TAWARRUQ CURRENT ACCOUNT AND SAVINGS ACCOUNT

There are also Banks in Malaysia already offering Current Account and Savings Account based on Tawarruq, and moving forward, a lot more is expected to emerge in 2017-2018. The fore-runner of Tawarruq deposits is Hong Leong Islamic Bank (Malaysia), where a huge majority of its deposit and financing products are offered under the contract of Tawarruq.

Why is Tawarruq gaining more prominence in deposit space? In 2016, BNM issued the Qard guidelines and prior to that, the Investment Account guidelines. Both these guidelines require the Bank to ensure the following:

  1. Qard – the deposits taken shall be classified as a loan transaction, as the Bank tends to deploy the deposits into the interbank market. This means the contract of Wadiah (used for Current Account and Savings Account) is no longer suitable as there are questions of the allowance of the deposits to be used by the bank without obtaining consent from the customers. Without the consent, the bank is hard pressed to justify using the funds for banking purposes. With Qard, the arrangement is “loan” where the customer lends cash to Banks and transferring ownership to the Bank to deploy the sum. However, by virtue of loan, no returns can be promised or agreed up-front, and this pose a challenge to attract deposits. Marketing activities are limited for Qard, as there is no value proposition compared to other products.
  2. Wakalah / Mudarabah / Musyarakah under Investment Account – BNM had reclassified in 2014 the above products as “investment” where capital is not guaranteed. For customers who has been banking with Islamic Banks, they now realise under the above contracts, the capital is at risk. Returns are not guaranteed as well. The reliance of the performance of the venture may not be everyone’s cup of tea.

THE OPERATIONS OF TAWARRUQ DEPOSITS

Following the issuance of the BNM Policy Documents for Tawarruq in 2015, Banks has started to re-look at current practices to ensure compliance to the requirements. Over a period of time, Banks have been able to stabilise the operationalisation of Tawarruq in deposit products. BNM also conducts regular checks for compliance to the minimum requirements and while there have been lapses identified, it was promptly addressed by the Banks.

Some of the key requirements for offering Tawarruq Deposits to consumers, as follows:

  • The Bank should decide on a structure where it is either a single Wakalah (Agency) process or dual Wakalah (dual Agency) process. The Agency appointment must be stand-alone arrangements from the Murabahah agreement and the sequencing of such appointment must be strictly adhered to.
  • The deposits, when received, must be concluded as a Murabahah deal as soon as possible. If the transaction is not concluded on the same day, the deposits received must be treated as either Amanah (Trust) or Qard (Loan). Depending on how a Bank is set up internally and the selection of either Amanah or Qard, the rules for each treatment must be strictly followed
  • Any delays in transacting the Commodity trade should not exceed 2 days. In such circumstances, Hamish Jiddiyah (security deposit) can also be deployed by the Bank as guarantee to enter into Commodity trade at a later date.
  • Banks can choose either to purchase commodity based on incremental value only (with probably a higher ceiling purchase with rebate to adjust against actual daily amounts) or on actual daily end-of-day amount (trade done daily basis, irregardless if there is any incremental value to the deposit). In any structure, the bank’s internal processes and system must be able to support it adequately.
  • Each of the commodity trade must provide sufficient evidence in trade, and sufficient notification on the completion of trade, as well as the payout of the returns on the agreed dates of maturity.
  • The processes for Tawarruq must demonstrate the compliance to the minimum tenets of a valid sale ie. Buyer, Seller, Underlying Asset, Price and Offer/Acceptance (Aqad). The uncertainties of the above must be properly addressed by banks offering such products.

CRITICISMS IN OPERATIONALISING TAWARRUQ

  1. Interconditionality in Tawarruq arrangements. As mentioned above, one of the major criticism of Tawarruq’s predecessor i.e. Bai Inah structure is that the interconditionality of the 2 contracts. Under Bai Inah, the legal requirements imposes that the Customer must execute Contract #2 for the compulsory buy-back of the Asset by the Bank, failing which Contract #1 becomes invalid. This issue is however mitigated under Tawarruq as the Bank, using third party commodities, has no interest to impose a buy-back of the commodity from customer thus removing the need to impose controversial interconditionality clauses.
  2. Commodities used for transactions. Another concern is that the commodities used for the transaction has little value, obsolete or defective, requiring scholars to emphasis the evidence, valuation and good order of commodities must be ascertained before a transaction starts. There has also been concerns whether the commodity really exists in its current form in the stated commodities location. Efforts have been made to verify and authenticate the existence of those commodities with scholars taking the initiative to visit the location where the commodities are stored.
  3. Physical delivery of Commodities. The concern on the inability to deliver commodities to the Customer, should a delivery request be made, will render the arrangement of Tawarruq defective and is not in the right spirit of the contract. It may be construed as an economic trick. The condition, availability and location of the commodity are important factors to be addressed adequately by the Bank to ensure deliverability. However, the brokers and the various bourses have also built mechanism to prove the deliverability and existence of such commodities to provide comfort to the Shariah scholars. Most have been consistent in providing assurance to the scholars.
  4. Agency issues, including dual agency arrangements. There are opinions that the arrangement of dual agency (where customer appoints the Bank to conduct all transactions on their behalf by way of multiple agency appointments, thus removing any Customer interaction during the transaction) deems the arrangement as Organised Tawarruq (Tawarruq Masrafi) instead of Real Tawarruq (Tawarruq Haqiqi). Some prominent scholars, including Mufti Taqi Usmani and some countries (such as Oman) had criticized and/or rejected the use of “Organised Tawarruq”. Additionally, there are also contrasting opinions on the practice in a dual agency where a single person in the Bank acts as the agent to 1) purchase commodity (as customer’s Purchasing Agent) and 2) sells commodity (as customer’s Selling Agent) to himself (as Principal of the Bank). This allowance has been captured in BNM’s Tawarruq Policy Document but is still a talking point amongst practitioners. BNM has therefore put in strict requirements to comply with the adherence to rules of this practice. BNM also conduct detailed checks at banks to ensure compliance.
  5. Sequencing and Ownership. Under Tawarruq, the sequencing of the transfer of commodities are so critical that a break of sequencing have a domino effect for transactional defect. Many failed to see how important the sequencing are, because of commodities usually requires quick change in hands and ownership. Many cases we have come across showed breakage in sequencing and therefore rightful ownership to proceed with the transaction. Some cases we can rectify (for example in cases of Bay Fuduli i.e. Purchase made by unauthorised agent due to sequencing breakage), but some may require some drastic ratification, even resulting in loss or charity payments. But as the brokers and various bourses mature and became more efficient, the sequencing issues are largely mitigated and hard-structured into the system to ensure proper sequencing. The level of evidencing has also be increase to provide strong assurance to auditors and Shariah scholars.
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