International Trade: Exports and Imports
The most critical feature of international trade is lack of geographical proximity between trading partners.' This gives rise to a time lag between the confirmation of an order and the delivery of goods. Thus there is the problem of either the seller accepting a delay in payment or the buyer conceding advance payment for future delivery. In other words, for all practical purposes, die basic transaction in international trade is not an ordinary hand-to-hand trading deal but a forward transaction: either bai’ mu'ajjal or bai’ salam. Another label for the latter is bai’ istisna . These may be viewed as the primary transactions between exporters and importers. In principle, both have Sharfah sanction.
But three factors complicate matters in international trade. First, risks of nonpayment for exporters and nondelivery of goods for importers due to a lack of personal contact between the trading partners during all stages of a transaction. Second, separate legal systems. Third, separate currencies. These factors give rise to economically meaningful roles for other parties in the process of international trade. The role of banks lies somewhere between collection of funds on behalf of exporters and financing foreign trade operations.
The foreign trade process is governed by sales contracts between exporters and importers. Among other things, a sales contract specifics complete description of goods, the price of merchandise, the currency of payment and the payment terms — cash, draft, letter of credit and so on. The ownership of goods is controlled through the bill of lading for merchandise, issued by a freight company to the exporter. In a straight or non-ncgotiable bill of lading the merchandise is shipped directly in favour of the importer. In the case of an order or negotiable bill of lading, the ownership of goods is transferable to another party through proper endorsement. Except in case of cash in advance, payment is made by way of a draft or bill of exchange.
A draft is unconditional written demand of the exporter (seller) for payment by which he charges the importer (buyer). A draft is drawn either on the buyer himself or on the bank who assumes the legal obligation to pay under a letter of credit (L/C) arrangement. The tenor (maturity date) of a draft indicates when the payment is due. A draft payable upon presentation is a sight draft with tenor simply “at sight.’’ A draft payable on a specified or a determinable date is a time draft or usance bill. The period of time drafts usually depends on the time necessary for goods to reach their destination, be resold and the proceeds becoming available to importers to clear their obligations. The tenor of a time draft is stated as follows:
- June 30, 1992
- Payment is to be made on June 30, 1992 — a fixed date.
- At 60 days sight
- Payment is to be made after 60 days of presentation of the draft to the drawee (who may be buyer himself or his bank under an L/C).
- 30 days date
- Payment is to be made 30 days from the date of the draft.
Release of title documents to merchandise follows only after the payment of a sight draft or acceptance of a time draft. Thus the seller and/or his bank retains the control of goods until the buyer cither pays or acknowledges the obligation to pay. An acceptance is created when the drawee (the importer or his bank in the ease of an L/C arrangement) writes “accepted,” the date and his signature on the face of a time draft.
Drafts are negotiable instruments if they are made payable to order or to bearer. That is, they can be sold and the collection rights transferred, without any limit on the frequency of such transfers, by endorsement to another party termed the holder in due course. Whoever owns the draft at the maturity date presents it to the drawer (importer or his banker) for payment. If the drawer defaults on his payment obligation, the holder in due course has recourse through all previous endorsers in turn back to the drawer (seller) of the draft. The drawer has unconditional obligation to honour such a draft. Draft plays the key role in allocating risks between the exporter and importer when the importer docs not want to pay in advance and/or the exporter has doubts about payment. In this regard, two arrangements with draft at the centre are documentary collection and letter of credit.
A documentary collection transaction works as follows: the exporter ships his goods and submits the draft along with the title documents for the merchandise to his bank. The exporter’s bank may either directly or through an intermediary bank approach the importer. If it is a D/P (documents against payment) draft, the bank gets the payment, in return for the documents, from the importer and passes it on to the exporter. In ease of a D/A (documents against acceptance) transaction, the importer writes “accepted” and the date and signs across the face of the draft, thereby creating a trade acceptance. In this way, the exporter is assured about payment. The transaction closes only after the importer has discharged his obligation. However, the accepted draft becomes a negotiable bill of exchange. In a documentary collection, each intermediary bank claims fee for its services.
An L/C is a written undertaking issued by a bank at the request of an importer (buyer). According to it, the bank assumes the legal obligation to fulfil the importer’s payment commitment — within a prescribed timeframe — upon presentation of documents in line with the terms of the L/C. For all practical purposes, the L/C becomes a contract between the issuing bank and the exporter (seller or beneficiary). The bank is obliged to pay to the beneficiary if the latter fulfils all terms and conditions stated in the L/C. The bank’s obligation to pay under an L/C is at the discretion of the seller or beneficiary unless a revocable L/C is issued. The tenor of draft submitted to the bank corresponds to credit terms in the sales contract between the trading parties. Thus, it can be a sight draft or a usance bill.
The role of a bank under an L/C entails some commitments as well as some risks. Normally an importer is not required to deposit 100 percent of the L/C value with application. Thus, the bank practically becomes a creditor to the importer from the time of payment until its reimbursement by the latter. This exposes the bank to commercial credit risk of the importer. Sometimes the issuing bank may have the bill of lading consigned to itself. In this ease, the bank will be the owner of merchandise up to the time when the documents are transferred to the importer. If the importer (applicant) finds even a minute discrepancy, he can reject the documents and deny the bank reimbursement. The currencies in the importing and exporting countries can be different. This will lead to foreign exchange risk for the bank.
In practice, the L/C process has several roles for intermediary banks at the exporter’s end. These include advising the exporter on fulfilment of L/C formality by the importer, confirming an L/C, negotiating the bill of exchange with the exporter and bankers’ acceptance for exporters. Of course, the number of steps before the final settlement of a transaction increases in each case and so too the costs to parties seeking credit and/or reduction in risk.
In the case of confirmation, the confirming bank assumes the responsibility for reviewing the documents and the obligation of cashing the exporter’s draft. The confirming bank claims a payment commission — usually a percentage of the face value of the L/C for the duration of the confirmation — in addition to commissions for any other services.
In the negotiation ease, the intermediary bank purchases the draft and documents from the exporter, transmits them to the issuing bank and waits for reimbursement from that bank. The right to be reimbursed by the bank issuing L/C is transferred to the negotiating bank. Negotiation may be with a re- course, i.e. if the issuing bank fails to reimburse the negotiating bank for any reason, the latter can recover the funds from the exporter. Normally the negotiating bank buys the draft at a discount from the face value; the net amount is paid to the exporter. The negotiating bank may have a right to sell the draft and documents in the open market with the exporter’s agreement. As per the existing practices, the negotiating bank claims from the beneficiary negotiation fees, charges for a foreign exchange spread and interest for the period of time its funds are committed.
In the case of a bankers’ acceptance (BA), the bank establishes an acceptance facility and line of credit for the exporter before it accepts the draft. The bank discounts the draft presented by the exporter, i.e. it pays the exporter a sum less than the face value of the draft and creates the BA by stamping “accepted” on the face of the draft. The significance of BA is that it may be created in lieu of a time letter of credit or independently of it. In the second case, BA is similar to an export credit. BAs have a secondary market with the accepting banks, dealers and investors (individuals, commercial banks and central banks) as the players.
This completes our review of major transactions in lieu of exports and imports. In order to appreciate the picture from the riba angle and to identify probable solutions, it is important to understand the goals of various parties, their roles and risks faced by them in the transaction process. For the sake of simplicity, we assume all contracts to be carefully drafted and implemented and no foreign exchange or other controls in international trade. The key players in international trade are importer, exporter, the importer’s bank and the exporter’s bank. Their goals, roles and anticipated risks are summarised as follows:
The importer wants to serve a target market on profitable terms. He may face no shortage of funds. Or, he may be short of funds but hopes to meet his payment obligations cither as they become due or some time after he receives the goods and sells them. The importer also faces risks of no shipment of goods, damage during transit and foreign-exchange rate fluctuations.
The exporter has a profitable proposition in the form of a confirmed or expected order from a foreign importer. He may have all necessary funds. Or, he may be short of funds but hopes to pay back the acquired funds according to the tenor of draft. He also faces the risks of goods not reaching their destination, the importer delaying (even refusing) payment and foreign exchange rate fluctuations.
The importer’s bank provides simple funds transfer services and payment guarantees in the form of L/Cs. Its role may be direct or may involve an intermediary bank. While paying under an L/C, it effectively becomes a financier for the importer until the funds are reimbursed. It may even choose to directly finance the entire import operation. It also faces the commercial credit risk of the importer and the risk associated with foreign exchange rate fluctuations.
The exporter’s bank acts as intermediary between the exporter and the importer or the L/C issuing bank. It can help in cashing the cheque in simple funds transfer as well as act as agent of the exporter in documentary collection or payment under L/C. It can confirm the L/C and assume payment obligations according to the tenor of the draft. It may negotiate the collection rights and responsibilities for the bill of exchange with the exporter at a discount. In case of either confirming L/C or negotiating bill of exchange, the bank becomes a financier until the draft matures. A similar role is performed by creating bankers’ acceptance or providing loan to exporter against a confirmed (or expected) order. The risks faced by the exporter’s bank depend on the degree of its involvement. There may be only commercial credit risk of the importer’s bank in case of L/C confirmation. This risk will be compounded by the exporter’s credit risk in the case of negotiating the draft or creating bankers' acceptance. Direct lending to the exporter also entails the latter’s commercial credit risk. The risk of foreign exchange-rate fluctuations may also be relevant if the bank’s fund commitment involves currency conversion.
Wc can now proceed lo a formal analysis of the existing trade-related transactions from the riba angle. In the context of a sales contract, an export-import transaction involves many contracts among the four parties listed above as well as some others, such as shipping and insurance companies. Ultimate aims behind these contracts are mostly legitimate. Sometimes modalities for the goals may be questionable. But if one docs not lose sight of the goals, riba-free alternatives in such cases too become transparent. Whereas our principal concern is with riba, in passing wc also touch upon some other questionable aspects of the existing international transactions. One such example is as follows:
An exporter can safely carry his merchandise to the importer’s doorstep or contract shipping and safe delivery with another party for a lump sum freight and insurance payment. In this regard, there is no Shar'ie problem with the exporter signing a single shipping plus insurance contract with one party and letting it subcontract the insurance part to a third party. But the exporter’s entering into separate contracts with shipping and insurance companies needs some rethinking. See, when the same company provides transportation as well as safety services, safety is provided in lieu of transportation. But if the contracts for both purposes were independent, what would be the basis for the insurance company’s contract with the exporter? Will it not be selling something which primarily does not exist from its standpoint? As per the well-known Ahadith of 'Hakeem bin 'Hizam, such sales have been forbidden by the Prophet (pbuh). Anyhow, this is not a riba issue. Riba arises mostly in financial matters. Accordingly, we focus on the financial aspects of exports and imports and, in particular, the role of banks.
The banks provide communication channels and payments avenues for exporters and importers. Both the funds transfer and funds collection are legitimate functions whose expenses are claimable. The transfer costs to importers are over and above the sum transferred. This is understandable. The collection costs to exporters represent a slightly different case. These costs may be either paid by an exporter separately from the sum involved or treated as a discount on the face value of the bill of exchange. Moreover, the rights to payment for a bill of exchange can be transferred. Therefore, for all practical purposes usance bills can be treated as tradable instruments. What is wrong then? Nothing. The problem arises when banks’ role goes beyond collection and transfer of funds to financing of export-import operations.
At present, banks can directly opt for interest-based loan contracts with trustworthy exporters and importers to facilitate their operations. Practically, payments against approved L/Cs are loans against importers until they reimburse the banks. The same applies to payments by banks confirming L/Cs until the funds are recovered from banks issuing L/Cs. When negotiating banks buy drafts from exporters, they in fact purchase titles to merchandise and collection rights. Technically speaking, no loaning is involved here. This is also true for bankers’ acceptance created in lieu of an L/C. However, a bankers, acceptance created without an L/C represents a complex case. One has to concede cither that the bank is creating a loan or that it is buying something on paper only but with a high probability of materialising. This latter feature makes the transaction dubious on grounds of trading something nonexistent, while the loan aspect warrants caution against riba.
The case of riba in interest-based lending is clear. But in other instances, too, there are two important factors contributing to the problem of riba. First, once banks commit their funds, the next transaction along the line becomes a direct moncy-to-money exchange and any discrepancy makes the deal a ribawi transaction. Secondly, the way in which costs are appraised and defined in existing transactions also abet riba. The interest clauses in all standard bills of exchange reflect on the timing factor in payments — opportunity cost of tied funds. The rate of interest also provides cover for creditors against delays in repayment. Moreover, interest rates also embody premiums for commercial credit risks of debtors as well as risks of exchange-rate fluctuations. Let us now consider riba- cleansing of the existing transactions.
Dr Sayyid Tahir
Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.