Selected Riba-Safe Transaction Modes

When a bank chooses to extend its role from just a supplier of funds collection or transfer services to a financier as well, the likelihood of money-to-money transactions increases. This is the first step towards riba unless a bank can perform the impossible feat of providing zero-return loans. We list here some permissible modes of profitable transactions which are not direct money-to-money exchanges. Their actual use will depend on market conditions.

Pakistani banks may provide financing to exporters on a single-transaction mudarba or musharakah basis. In both cases the banks may also claim costs for their collection services in lieu of running expenses of the joint venture, in the manner explained earlier. A mudarba arrangement will be attractive if it is in the bank’s interest to dissociate itself from managerial obligations. While the musharakah option may enable the bank to monitor the export operation, it will call for the provision of funds collection services at bclow-markct rates. These differences in rights and responsibilities will affect die profit-sharing ratios and the degree of risk. Like any standard profit-loss sharing contract, the profit-sharing ratio in the bank’s favour can be set independently of its share in the enterprise’s capital; however, exposure to loss will be proportional to the funds committed. The bank may have a recourse to its funds if, and only if, the exporter docs not fulfil his contractual obligations. This, in turn, requires that the rights and responsibilities of the exporter should be clearly spelled out in the contract. This method has a great potential in the case of confirmed export orders. Additional risk-taking will be involved if banks choose to join hands with export houses on mudarba or musharakah basis, because the final sale of merchandise and reimbursement of funds to the bank will depend on market conditions.

The mudarba and musharakah techniques can be adopted by Pakistani banks for local imports, too. Of course, the banks may claim compensation for L/C operation and payment services in the manner explained above. However, the stakes for a bank will be higher than in export financing. The conclusion of an import operation will depend upon market conditions for the imported merchandise. Thus, the period of funds commitment at the bank level will become uncertain and risk for the bank increase. In the event of a loss, the bank may recover its funds only if the importer violates terms of the mudarba or musharakah contract.

A bank may also provide financial backup for export and import operations by acting as a trader. Let us consider the simple case of a confirmed export order. The bank can buy merchandise from the local exporter on the basis of bai’ salam and resell it to the foreign importer. Thus, two trading contracts involving the bank will replace the original sales contract between local exporter and foreign importer. Formalities at the foreign importer’s level will be completed in favour of the bank, rather than the exporter. The differential between the prices paid to the exporter and charged to the importer will cover all sorts of economic considerations from the bank’s point of view. Such a transaction process will ensure that exporters get necessary funds to fulfil their export orders. The ownership of merchandise will initially transfer to the bank and then to the foreign importer. The bank’s purchase may be on FOB or C&F basis. The insurance premium will have to be borne by the bank as the owner of merchandise (or the foreign importer — if the original sales contract has such a provision). If the export is not against a confirmed order, risks of undesired inventory accumulation at the bank level will increase. Banks can reduce such risks through exporting subsidiaries.

One can think of a more or less similar process with a bank entering the import process as a trader. The bank may initially act as importer from the foreign seller. It may provide payment guarantees through a letter of credit. But the contract between the bank and his local customer will be dial of bai’ muajjal. Both contracts can be concurrent. If there is no clear understanding with the importer about the acceptance of merchandise, the bank docs not need to commit itself to the foreign seller. But there is a catch here. If the Pakistani importer later on refuses to accept the merchandise, what recourse will the bank have to its funds? It can only sell the goods in the open market. This possibility should be regarded as the common entrepreneurial risk — a buyer not being available despite justifiable hopes.

The above-mentioned options differ in terms of risks for banks. But with more economic agents going for less risky options, the pattern of returns is bound to change. The market forces will then rationalise risk-return mixes along the entire spectrum of these and other options available to banks and their customers.

Dr Sayyid Tahir

Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.