Islamic trade financing

GROUP ASSIGNMENT OF ISLAMIC TRADE FINANCING
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1.0 INTRODUCTION
Trade was recognized to be an important tool in the economy activities. It was creating many
jobs and demands for trade financing including for import and export purpose. According to
the World Trade Organization, trade financing is a vital to the economy by supporting almost
of the global trade.
However, although the international trade was exist for centuries, the trade finance also
developed to support the requirement and needs of exporter and importer in their relation.
Trade financing can be defined as financing for trade which concerns for both domestic and
international transactions which involved a various activities of lending, factoring, insurance,
issuing letters of credit and export credit.
The trade financing would help to support by providing a various tools such as the letter
of credit which is to guarantee the payment of importer to the exporter which functioning to
maintain the contract without can be cancel in the future. By this way, it can remove the risk
from importer who may refuse to make payment for purchasing goods as agreed before.
Besides, an Islamic Trade Financing (ITF) activities was increase rapidly among the
members of business around the world. It was benefitted in the form of Syariah compliant
practices in the business which would support the development in Islamic economy and
finance. It is because, ITF provided a strength financing supports and offers many special
products which providing more benefits to the users.
As to support the ITF, the International Islamic Trade Finance Corporation (ITFC) was
established and commenced its operation in 2008. It is an autonomous entity within the
Islamic Development Bank Group who together encouraged intra-trade among the
Organization of the Islamic Conference (OIC). This corporation helps the member countries
such as Saudi Arabia, Bahrain and Malaysia to gain a better access in ITF by providing them
the necessary tools to compete in the global market.
On the other hand, various intermediaries such as banks and financiers, importers and
exporters, besides service providers will play a big role to run this trade financing by follow
the Syariah guidelines in their activities. Islamic banks and Islamic financial institutions will
help to support the transactions by giving trade financing parallel to the syariah.
Normally, the importer may wish to reduce risk when purchasing exporter goods
especially for unknown exporter, so it is necessary to ask exporter to document the good that

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have been shipped, while the importer required to prepay for goods shipped. So, the Islamic
bank may provide a various forms of ITF products such as an Islamic bank guarantee to built
a confident to the exporter.
It is important for global economy because most countries will rely to each other to
support their necessity such as be an importer to get the raw material which the cost would be
cheaper than local price.
So, in this assignment, we would like to discuss and explain more about Islamic trade
financing process which used among the members in economy activities and tools involved
such as letter of credit, bank’s acceptance, shipping guarantee and documentary collection.

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2.0 METHOD OF TRADE SETTLEMENT
Settlement (finance) of securities is a business process whereby a securities or interest in
securities are delivered usually against in simultaneous exchange for money, to fulfill
contractual obligation, such as those arising under securities trades. As part of performance
of delivery obligations entailed by the trade, settlement involves the delivery of securities
and the corresponding payment. On top of that, settlement at the various custodian is
increasingly moving towards the DvP method ( the simultaneous and irrevocable exchange
of security and cash), in order to minimize the seller’s and buyer’s risk of delivering one
asset without receiving the contra asset at the same time. This is sometimes referred to as
dependent deliveries of security or dependent payments of cash. In other words, the delivery
of security will not be affected without simultaneous payment of cash and vice versa.
So, in order to succeed in today’s global marketplace and wins sales against
international trade presents a spectrum of risks which causes uncertainty over the timing of
payments between the exporter (seller) and importer (foreign buyer). For exporters, any sale
is a gift until payments is received. Therefore, exporters want to receive payments as soon as
possible, preferably as soon as an order is placed or before the goods are sent to the importer.
For the importers, any payment is a donation until the good are received . Therefore,
importers want to receive the goods as soon as possible but to delay payment as soon as
possible, preferably until after the goods are resold to generate enough income to pay the
exporter.
2.1 Type Of Method Trade Settlement For Islamic Bank
The movements of cash and securities can occur in different ways such as cash in
advance (advance payments) or prepayments, documentary credits, documentary
collections, and open account.
2.1.1 Cash in advance/ Advance payment ( prepayments)
Under this term of settlement, the importer will pay to the exporter the
goods before the exporter delivers them. Although full payment in
advance is obviously most desirable for the exporter, he will only be able
to obtain such terms when there is a seller’s market or occasionally when
such terms are customary in that particular trade.

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In fact, this is a credit granted by the importer to the exporter. Being a
credit, the importer can ask the exporter the payment of an interest. This
term is very useful for the exporter. It is quite common for a sale contract
to require partial payments in advance. For example, the contract could
stipulate, say, 20% payable on the signing of the contract with the
remaining 80% payable, after dispatch of the goods under one of the other
means of payments.
The risks of the exporter is the goods of received can be specialized
goods and if the importers cancel the order before the payments is made,
the exporter cannot sells these goods easily. Meanwhile, the risk that will
be faced by the importer is sometimes the exporter does not send the
goods, the documents can be wrong, and the goods are sent with a delay or
to a wrong destination. Even though this terms give the risk to the
importer, but it also give advantages to the importer, such as, the importer
has the control over the timing of settlement and the method by which
funds are remitted, the inspections of the goods is usually possible before
the payments is made and a few arrangements have to be made other than
ensuring that funds are available to meets payments when they are due.
With cash-in-advance payments terms, the exporter can avoid credit
risk because payment is received before the ownership of the goods is
transferred. Wire transfer and credit cards are the most commonly used
cash-in-advance options available to the exporters. However, requiring
payment in advance is the least attractive option for the buyer because it
creates cash-flows problems. Foreign buyers are also concerned that the
goods may not be sent if payment is made in advance. Thus, the exporters
who insist in this payments methods as their sole manner of doing
business may lose to competitors who offers more attractive payments
terms. Last but not least, this method of settlement is also used between
the old partners with a long business relationship. Another method of
advance payment can be “ 30% of the value in advance and 70% of the
value will be paid upon the delivery”.

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2.1.2 Open Account
Generally, an open account transaction is a sale where the goods are
shipped and delivered before the payment is due which is usually in 30 to
90 days.
When a buyer and a seller agree to deal an open account term, it means
that the seller will dispatch his goods to the buyer and will also send an
invoice requesting payment. The seller loses control of the goods as soon
as he dispatches them. He trust that the buyer will pay in accordance with
the invoice.
Open account is the simplest method settlement. However, because the
exporter is delivering the goods without payments or some other absolute
means of insuring that payment is received, this method presents the
greatest risk.
Despites all of this, the majority of international trade transactions
continue to be settled this way. Open accounts settlements also have some
advantages that make them more attractive, for the exporter and importer
but there are also disadvantages for this type of terms. Obviously, this
option is the most advantageous option to the importer in term of cash
flows and cost but it is consequently the highest risk option for the
exporter.
Because of intense competitions in export markets, foreign buyers
often press exporters for open account terms since the extension of credit
by the seller to the buyer is more common abroad. Therefore, exporters
who are reluctant to extend credit may lose a sale to their competitors.
However, the exporter can offer competitive open account terms while
substantially mitigating the risk of non - payment by using of one or more
the appropriate trade finance techniques, such as export credit insurance.

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2.1.3 Documentary Collection ( Drafts/ Bills of Exchange )
A documentary collection (D/C) is a transaction whereby the exporters
entrusts the collection of a payment to the remitting the banks (exporter’s
bank), which sends documents to a collecting bank (importer’s bank),
along with the instructions for payments. Funds are received from the
importer and remitted to the exporter through the bank involved in the
collection in exchange for those documents.
D/Cs involve using a draft that requires the importers to pay the face
amount either at sight (documents against payment) or on a specified date
(documents against acceptance). The draft gives instructions that specify
the documents required for the transfer of title to the goods. Although
banks do acts as facilitators for their clients, D/Cs offer no verifications
process and limited recourse in the event of non- payments. Normally,
drafts are generally less expensive than letter of credits.
Futhermore, this type of method settlement provides some comfort to
the exporter, who will ship the goods and then arrange for the documents
of title and collection instructions. The documents may include a bill of
exchange drawn by the exporter on the importer for the amount of the
invoice and payable at the sight or at a fixed or future determinable time
( under British Law).
2.1.4 Documentary Credit
The documentary credit also called as a letter of credit which it is a
conditional guarantee payment in which is an overseas bank takes
responsibility for paying you after you ship your goods, and it will
provided you to present all the required documents such as documents of
titles, insurance policies, commercial invoices and regulatory documents.
Besides that, documentary collection also can be defines as international
trade procedure in which the credit worthiness of an importer is substitute
by the guarantee of a bank for a specific transactions.

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Under documentary credit arrangement, a bank usually undertakes to
pay for a shipment, provide the exporter submits the required documents
within a specific period. In US, this arrangement is called “ commercial
letter of credit”. On top of that, the documentary of credit is actually a
separate contract from an export contract. The parties to a documentary
credit deals with documents not the goods that the documents relate to.
The main steps in a typical documentary credit transaction are
consists of five steps. Firstly, after finalizes the export contract, the buyer
arranges with a bank to open the documentary credits in the buyer favour.
The foreign bank (issuing bank) will check the buyer credit worthiness.
Next, The issuing bank sends the documentary credit to an Australian
Bank (advising bank). The advising bank verify the authenticity of the
documentary credits and forward it to the buyer (beneficiary). Third step is
when the documentary credits set out the documents, the buyer must
present to receive the payments. When the buyer had ship the goods and
compiled all the necessary documents, the buyer lodge with negotiating
bank. Then, the negotiating bank checks the documents to ensure the
terms of the documentary credits have met and send the documents to the
issuing bank with a request payment. Lastly, if the issuing bank is satisfied
with the necessary documents that provided by the buyer in the exact form
of documentary credit, it will forward the payment to the negotiating bank,
which in turn pays to the buyer. Then, the documentary credit will state
whether you receive payment “at sight” or at an extended term.

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3.0 DOCUMENTARY COLLECTION
3.1 Definiton of Documentary Collection
Documentary collection is the collection by a bank of funds due from a buyer
against the delivery of documents. The bank, acting as agent for the seller
(exporter), presents documents to the buyer (importer) through that party's bank
and in exchange receives payment of the amount owed, or obtains acceptance of a
time draft for payment at a future date. The liability of the bank under a
documentary collection is primarily restricted to following the seller's instructions
in forwarding and releasing documents against payment or acceptance.
Islamic documentary collections typically based on wakalah. In the case of
a seller, for example, he nominates the bank as an agent to act on his behalf to
collect payment.
3.2 Different Between Documentary Collection an Letter Credit or Open Account
Unlike a letter of credit, the bank does not assume any liability to pay if the
buyer does not want or is unable to pay. Compared to open account sales, the
documentary collection offers more security to the seller, but less than a letter of
credit.
3.3 The Use of Documentary Collection
Numerous criteria are applied by businesses when determining which payment
instrument to offer as a term of sale. However, in general, a documentary
collection would be appropriate where:
 The seller and the buyer know each other to be reliable.
 There is no doubt about the buyer's willingness or ability to pay.
 The political and economic conditions of the buyer's country are
stable.
 The importer's country does not have restrictive foreign exchange
controls.

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3.4 The Advantages of a Documentary Collection
There are several advantages of Documentary Collection that will give the
benefit to the users and the applicant. Firstly, the Documentary Collection are
simple and inexpensive to handling compared to the letter of credit which is has
more expensive price.
Secondly, Documentary Collection also offer faster receipt of payment
compared to the open account terms which has many procedures to be handle in
receiving the payment and the applicant or the users also need to wait for a longer
time to receiving the money.
Thirdly, Documentary Collection also give the seller retain title to the
goods until the payment is or the acceptance is made by the buyer. Thus, it will
give opportunity to the seller to keep the title of the goods more longer.
3.5 The Disadvantages of Documentary Collection
The Documentary Collection also has its own disadvantages which is involve
with the payment. If the buyer refuses or is unable to pay, the seller has three
options, which could be expensive:
 Find another buyer.
 Pay for return transportation
 Abandon the merchandise.
3.6 The Parties Involved
In Documentary Collections, there are several party that involved in its
management:
Firstly is the principal.Generally, for the principal part, it will manage by the
exporter, seller, remitter, drawer of the draft.
Second is the Remitting Bank.For the remitting bank, usually the exporter's of the
bank will handling the collection

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Thirdly is the presenting or Collecting Bank.For the presenting or the collecting
bank, it will be handle usually by the buyer's bank.
Lastly is the Drawee. For the drawee, it will be handle and manage by the
importer, buyer, payee.
3.7 Types of Documentary Collections
Generally, there are several types of the Documentary Collection which is:
Firstly is the Documents against Payment (D/P) also known as "Sight
Draft" or "Cash against Documents” (CAD). Through this, the buyer must pay
before the collecting bank releases the title documents.
Secondly, is the Documents against Acceptance (D/A). In this document,
the buyer accepts a time draft, promising to pay for the goods at a future date.
After acceptance, the title documents are released to the buyer.
3.8 The Steps in Documentary Collection
There are several steps in the Documentary Collection that need to be follow by
the applicant and also the users.
Firstly, the buyer (importer) and seller (exporter) agree on the terms of sale,
shipping dates and that payment will be made on a documentary collection basis.
Secondly, the exporter, through a freight forwarder, arranges for the
delivery of goods to the port or airport of departure.
Thirdly, the forwarder delivers the goods to the point of departure and
prepares the necessary documentation based on instructions received from the
exporter.
Fourthly, the export documents and instructions are delivered to the
exporter's bank by either the exporter or the freight forwarder.

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Fifth, is following the instructions of the exporter, the bank processes the
documents and forwards them to the buyer's bank.
Sixth, is the buyer's bank, on receipt of documents, contacts the buyer and
requests payment or acceptance of the trade draft.
Next, after payment or acceptance of the draft, documents are released to
the buyer, who utilizes them to pick up the merchandise.
Then, the buyer's bank remits funds to the seller's bank or advises that the
draft has been accepted.
Lastly, on receipt of good funds, the seller's of a bank credits the account.

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4.0 LETTER OF CREDIT
Letter of Credit (LC) play an important role in international trade and can be said as the
lifeblood of international commerce. Issued by banks, transacted through banks and largely
funded by banks, the banking sector across the world is directly involved in financing
international trade through LC.
The LC is one of the payment mechanism used in international trade. It is used widely,
especially in trade transactions where the seller and the buy do not reside in the same
country. A far distance between both parties may invites worry because it is very difficult to
trust each other. Both parties involves in this transaction will be reluctant to give any
commitment unless they are assured that their positions are protected. So, the LC play on
important tool to overcome the problem of trustworthiness between such person. Thus, LC
play role and functions as to provide efficient payment through the bank as reliable
paymaster for advance payment. The seller is directly paid once he presents to the bank
documents which strictly comply with the credit requirement, and the buyer will only have to
pay when all the documents required under the LC have been declared in conformity with the
term and condition of the LC. This mechanism is used in Malaysia by many trades and the
business community especially when involve with international trade.
4.1 Islamic Letter Of Credit
A Letter of Credit can be said as an instrument of international trade and it is one of the
most secure method for seller to be paid. Normally, Letter of credit is used in business
practise for long distance trade and particularly important commission earning service for
any bank. ISRA (2003) defined Islamic Letter of Credit (ILC) is written undertaking
given by the Islamic Bank (IB) ,to the seller (the beneficiary) at the request and on the
instructions of the buyer (the applicant), to pay at sight or at a determinable future date,
a stated sum of money withiin a prescribed time limit and against stipulated documents
which must comply with terms and conditions. There are several contract used by IB to
offer ILC such as Wakalah (agency), Murabahah (cost-plus profit) and Musyarakah
(Partnership).All this three concept can exist at the same time in one single ILC
transaction.

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4.1.1 Wakalah Islamic Letter of Credit
Through the principle of Wakalah the IB act as the agent of the customer,
the customer will ask the bank to issue the ILC by providing a written instruction
to the seller. Then, the bank will ask the customer to place the amount of the price
of the goods in place the amount of the price of the goods in the bank as security.
Next, the bank create the ILC in favour of the exporter and collects its
commission and other charges involved. After negotiation of the document, the
issuing bank will pay the negotiation bank utilising the customer’s deposit. Later,
the bank release the document to the buyer and charge fee for its services under
the principles of Ujrah (fee).
4.1.2 Musyarakah Islamic Letter of Credit
Through principle of Musyarakah, the IB issues the ILC and both the
financier and customer involves to the purchase price under ILC. Next, the will
share the profit of the business venture based on the pre-agreed profit sharing
ratio. But, losses are borne proportionate to the capital contribution. Likewise, to
the Wakalah ILC, the first procedure involve in establishing the Musyarakah ILC
begins with the customer informs the IB of his ILC requirement and negotiates
the term of Musyarakah financing for his requirement. Then, the customer deposit
enough money with the bank for his share of the cost of good to be purchased or
imported as per the Musyarakah agreement which the IB accepts under the
principle of Wadiah Yad Dhamanah. Later, IB create the ILC and pays the
proceeds to the negotiating bank, Utilising the customer’s deposit as well as its
own shares of financing. After that, IB release the documents to the customer.
Lastly the customer take possession of the goods and disposes of these in the
agreed manner.

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4.1.3 Murabahah Islamic Letter of Credit
Under this principle the IB will provides a financing facility to customer
that unable to pay the purchase price to the exporter. Then the bank will resells
the good at a higher price agreeable to the customer. The new price will include
mark-up of certain profit. In summary, the procedure start when the customer
informs the IB of his ILC requirement and request the IB to purchase or import
the good by executing an aqd in writing. The customer be appointed by IB as an
agent to purchase the required goods. Later, the IB will sells the goods to the
customer at a sale price comprising its cost and profit margin under the principle
of Murabahah for settlement on a deferred time.
4.1.4 Difference between Murabahah Letter of Credit and Musyarakah Letter of
Credit Operation
Trade transaction can be carried either by Murabahah or Musyarakah
principles. The role, or involvement, of a bank in a particular business venture
would determine whether Murabahah or Musyarakah is applied. For example, if
the bank contributing to the capital investment jointly with the buyer, then it said
that the principle of Musyarakah exists. However, if the bank is not one of the
parties in a particular trade carried out by the buyer, the principles of Murabahah
is applied. The banker-customer relationship in Murabahah transacting is best
described as seller-buyer relationship.
Murabahah is a credit business transaction where the amount of purchases,
or ‘deb’, is paid after the goods are sold to the final buyer. The bank would
acquire the goods from the exporter for its customer. This is done through issuing
a guarantee for payment instrument to the exporter, which is an LC. In
Murabahah LC the bank has no management right and only benefits from the total
capital invested where it earns some profit. The Bank is not liable for any loss in
business venture and only customer is responsible to honour the selling price to
the bank on the agree date.

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In contrast, Musyarakah witnesses the investment of the bank in a
particular business venture carried out by the buyer with both capital investment
and roles played by the bank. The bank will involve in the business venture with
capital will be invested in an agreed proportion. Through this investment, the
bank jointly own the business with its customer. Currently the bank provide
consultation and advise on the management of funds and the customer runs the
daily business operations. Both parties will sharing the profit in accordance to the
ratio of the invested capital. In both transaction, the LC is used as the payment
mechanism. But, under the Murabahah trade transaction, the bank does not have
any control over the business venture, the type of good involved is restricted to
inventory and stock, such as, sugar, flour, spare parts and commodities. This is to
make sure that they are disposed of within the shortest time period. On the other
hand, in Musyarakah, the bank has some power to control the business venture.

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5.0 TRUST RECEIPT
This Mechanism is a written legal document between a bank and a person borrowing from that
bank. On the document shares that the bank will give merchandise to the borrower but bank will
still retain the little to the merchandise and can repossesses it if the buyer does not uphold the
terms decided upon in the trust receipt. At the same time, borrower must keep the merchandise
and any profits made from that merchandise separate from normal business expenses and if the
bank repossesses the items, the borrower will return the items or the money made from selling
the merchandise. In daily transaction, item used in trust receipts are large items with social
numbers that are easy to record and keep track of. For instance, radios, refrigerator, television,
large appliances and trailer can all be given to a borrower by signing a trust receipt. Then, the
borrower promises to pay the loaner back an amount of money worth the property loaned to him.
Concept of trust receipt can be said as similar to a loan where the borrower provides a
type of collateral to the bank or other business loaning him the money. However this type of loan
is considered a secure loan because an item, known as the collateral, is listed as part of the
arrangement. In case, the borrower does not repay the loan, the lender has the right to take the
collateral item and sell it to cover the money the borrowed owed him. But, the difference
between a trust receipt and a standard loan is that in a trust receipt the items being borrowed,
and any money made from selling them also serve as the collateral for the loan.
5.1 Islamic Trust Receipt
It is one of mechanism to help finance domestic or international trade document drawn
against ILC or Wakalah inward bills for collection. Islamic Trust Receipt ( ITR) is issued by
IB to the customer based on the concept of Murabahah for financing the purchase of goods.
ISRA (2003) assert, it is document of trust signed by the customer (importer):, the strength
on which the Islamic bank allows the customer (importer) to obtain release of the
merchandise but makes a lump-sum payment at a later date.
The first procedure involve in modus operandi of ITR is the customers must first have an
approved ITR line. The request for financing must include submission of relevant
documentary evidence of the underlying transactions and compliance to the terms of the
facility.Secondly, the customer informs the bank of his letter of credit requirement and

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request the bank to purchase the goods. Thirdly, The Islamic bank retains the legal title to
the goods but relinquishes physical possession to the buyer or importer. Then, the IB
appoints the customer as its agent to purchase the good that the customer requires on behalf
of the IB. Next, upon delivery of the goods, the Islamic bank pays the exporter /supplier for
the cost of the goods based on the invoice value. The IB will resell the goods from the
customer at invoice value and resell them to the customer on deferred payment terms at a
price inclusive of the IB’S profit margin. If the IB appoints the customer as its agent, then
the IB cannot purchase from the customer. The deferred payment terms of sale of goods
granted to the customer constitutes a creation of debt. This is securitised in the form of a bill
of exchange drawn by the IB and accepted by the customer and payable on maturity. Lastly,
the IB holds the customer’s ITR executed by him. This is to signify his holding of the goods
in trust pending the sale of goods and the customer undertakes to settle the Selling Price on
the expiry date.

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6.0 BANKER’S ACCEPTANCE (BA)
It is countersigning (endorsement) of a bill of exchange by the buyer’s/importer’s of bank. A bill
of exchange drawn by importer to their order, payable on a specific future date and then, bank
will accept it for financing trade transactions such as import, export or domestic. Bankers
acceptance establishes that payment of the bill on its maturity date is now guaranteed by the
endorsing bank. If bank felt confident with buyer’s financial strength and stability, and on
payment of the acceptance fee. So, bank will agree to counter sign a bill of exchange.
According to the 1930 convention providing a uniform law for bill of exchange and
promissory notes held in Geneva, a bill of exchange must contains the term bill of exchange, an
unconditional order to pay a determinate sum of money, the name who is to pay(drawee), a
statement of the time of payment, a statement of the place where payment is to be made, a
statement of the date and of the place where the bill is issued, the signature the who issues the
bill (drawer).
Usually, the banker’s acceptance provides a short -term financing for 30, 60,90, 120, 150
or 180 days. Moreover, the maximum financing is always less than a year. Whereas the 30 to
90 day periods are the most common financing periods, and the 180 days and above period are
rare.BA available for exporter on document against payment(D/P ),since it takes more than 21
day. BA also available for exporter /seller who export/sell goods under document against
acceptance (D/A).
Features of banker’s acceptance:
 BA is governed by the “Guidelines on Banker’s Acceptance” issued by BNM
 Minimum period of financing is 21 days, and maximum is 365 days
 Minimum amount of financing is RM 50,000
 Bunching of documents to reach the minimum of RM50 000 is allowed
 Separate bunching for domestic sales and foreign sales.
 Usance draft drawn by the buyer or seller and discounted by the bank

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As a conclusion,the banker acts as intermediary in connecting the exporter, importer and
the investor.As intermediary,the banker accepts,on behalf of his importing or exporting
customer,the obligation to repay the investor on maturity date of BA.Hence,financing
transaction is code-named Banker’s Acceptance.
6.1 Islamic Banker’s Acceptance
Islamic banker’s acceptance well known as accepted bills-i. Accepted bills-I ( AB-
i) previously known as Islamic accepted bill (IAB) were introduced in 1991 through this
islamic financing mechanism can encourage and promote both foreign and domestic
trade. AB-I is a bill of exchange,which is drawn by bank and excepted by importer/buyer
creating a debt owing to the bank .
The AB-i formulated based on 2 shariah concepts consists of Bai’ dayn (debt
trading) and murabahah(cost plus). As our information,Bai’ dayn refers to the sale of a
debt arising from a trade transaction in the form a trade transaction in the form a trade
transaction in the form of a deferred payment sale.While, Murabahah refers to the selling
of goods at a price based on cost plus profit margin agreed to both parties.
There are 2 types of financing under the AB-I facility:
 Imports and local purchases
 Exports and local sales.
Under import and local purchases an applicable mechanism under this type of
financing is the working capital financing under murabahah. The bank will appoints
customer then purchases the required merchandise from the seller on behalf of the
bank. Then, bank will pay the seller and resell the merchandise to the customer at a
price, comprehensive of a profit margin. In additions, upon maturity of the murabahah
financing, the customer can pay bank the cost of goods plus the bank’s profit margin.
Moreover,the good news is customer is allowed a deferred payment term of up to 365
days.
The sale of goods by the bank to the customer on deferred payment term
constitutes the creation of debt. The debt is securitised in the form of a bills of exchange
drawn by the bank(drawing bank) on and accepted by the customer(acceptor) for the full

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amount of the bank’s selling price payable at maturity. If the bank decides to sell the
AB-i to a third party, AB-i will be sold under the concept of bai’ dayn.
Under Export and Local Sales . They uses the type of financing facility bai’ dayn
comply with the shariah concept. The customer prepares the sale documents as required
under the sales contract or letter of credit. Next the sale documents are sent to the
purchaser’s bank. The customer draws on the bank a new bill of exchange as a
replacement bill that represents the AB-i. The bank will purchase the AB-i at a mutually
agreed price using the concept of bai’ dayn and the proceeds will be credited to the
customer’s account.

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7.0 SHIPPING GUARANTEE (SG)
Shipping guarantee is a form of bank guarantee made available for the importers. It is not a form
of loan. Bank does not give any money, just a guarantee which is a commitment to pay. SG a
document that allows a customer to take possession of shipped goods before the shipping
company receives the bill of lading, indemnifying the shipping company from any loss in case
the customer fails to pay. SG is typically arranged by banks, which require a cash margin or
other assurance of payment from customer.
With SG, bank certifies that the importer is the rightful/legal owner of the goods.
Remember, the importer cannot prove himself to be the rightful owner, since he has no bill of
lading and other shipping documents to show. So, the bank’s SG the shipping company(or the
custom authority or any other parties to whom the SG is addressed to)will allow the importer to
take delivery of the goods.
Nevertheless, importer must have a line of Trade Finance Facilities to obtain SG.
Moreover, SG does affect the Basel CAR, such as bank needs to have sufficient capital in order
to cover the risk/potential loss due to issuing the SG. However, the risk is minor, and, being off-
balance sheet item, the impact on capital under Basel CAR too is minor. In fact, if the SG is
given to the high-rated customer, the risk under Basel CAR is treated as zero which means the
impact of SG on capital too is zero. As we know SG comes in the pre-printed form, so
immediately available on request.
7.1 Islamic Shipping Guarantees (ISG)
Islamic shipping guarantees well known as Shipping Guarantee-I is one of facility that
the Islamic trade financing provided. This facility is a document issued by the bank to the
shipping company that allows the importer/buyer to collect the goods from that shipping
without the presentation of the original Bill of lading. It is issued under the Kafalah
contract. It can defined as a surety provided by a party to the owner of the goods,who
deposited his goods with the shipping company, whereby any subsequent claim by owner
for his goods must be met by the guarantor(the bank).

22
As we all know under kafalah ,in case default is function as a contract of
performance or financial guarantee given by one party to set free liability of third
party.There are several advantages when using shipping guarantees-I product such as it
will make clear goods without having to wait for a complete sets of import documents. Of
course,this brilliant facility make importer/buyer felt comfortable and cosy because
enables they to sell the goods without delays. Moreover,it will helps you avoid any
demurrage or other port charges.So, we don’t have worried about the good conditions and
the charges is affordable to importer.

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8.0 BANK GUARANTEE (BG)
Bank guarantee (BG) is a promise by a third party to carry out obligation owed by one person to
another in the event of default. It is performed by a bank and also can be from other lending
institutions which to use it as to cover the loss if any default on loan or payment by a borrower or
applicant.
BG is actually an undertaking or promise given by a bank on behalf of their applicant to
the beneficiary. The bank performs their responsible after agreed to the applicant if he failed to
fulfill his obligation to beneficiary caused of problem in financial or performance as agreed with
the beneficiary before. The bank who act as guarantor of applicant (guarantee) will make
payment according to the amount agreed upon receipt of claim by beneficiary. This BG’s
applicant, enable and benefits him proceeding the purchase and expand entrepreneurial activities
once the company had problem to perform it.
According to Agasha Mugasha (2003), the developments of bank guarantees in
particularly England and other common law countries where there were no terminological
restrictions, the function of standby letters of credit was performed by similar instruments issued
by banks which is known as BG. BG means a guarantee issued by banks which may be
performance bond or guarantee, a repayment or tender guarantee. The bank will pay money to
beneficiary if the terms of guarantee are complied with. It is useful when the bank’s customer or
applicant failed to perform his contract with the beneficiary which then the bank will present for
it.
Even BG’s characteristics look same as the letter of credit, there are some different things
that make their functions not used in the same purposes. BG will ensure the liabilities of debtor
will meet if their applicant failed to settle the debt while for letter of credit, the bank pays the
amount to beneficiary once the obligation of production documents on the fulfillment of contract.
So, before making any contract, the applicant must recognize and identify about the actual
functions and for what purpose of the letter of credit and bank guarantee will perform for.
As the conclusion, BG plays a big role for the applicant and bank economy performances
especially in import and export activities because it is a way to help the unable applicant
proceeding their payment due to their financial constrains.

24
8.1 Islamic Bank Guarantee (IBG)
Islamic bank guarantee (IBG) is a special guarantee which created to replace the
functions of conventional bank guarantee based to its specifications. According to ISRA
(2013), “Under a Syariah, and in accordance with the principal of kafalah, an Islamic
bank may issue, at the request of the customers, an Islamic Bank Guarantee (IBG) to a
beneficiary named by customers”.
Basically, IBG is an irrevocable written obligation which involved Islamic
Contract known as Kafalah. The Islamic Bank will assure the payment in case of demand
by beneficiary and act as guarantor to the customers. The benefits of IBG are it is widely
acceptance besides can be leveraged to enhance the applicant reputations. It is also
capable to unlock the applicant capital from required any deposits or payment in the
future.
The kafalah principles used in IBG is actually a surety given by an Islamic Bank
who agree to bears a liability of beneficiary in the case of the applicant or the bank’s
customers are default in fulfill their obligations to the beneficiary. The applicant is
required to place certain amount in the Islamic Bank as deposit for this facility which is
under the Islamic principles of wadiah (safe-custody). IBG also may fall into some
categories such as performance guarantee, guarantee of sub-contract and guarantee of
exemption of custom duties.
Although most of Islamic Banks tend to charge some fee for their service of
issuing letters of guarantee, some of Syariah scholars believe this charge is actually
against the Syariah. These scholars stated that this facility is an act of guarantee so no
need to impose any fee when issuing the letter.
Table 1 : Comparative of Islamic Bank Guarantee and Islamic Letter of Credit
Islamic Bank Guarantee Islamic Letter of Credit
Definition A legal instrument executed by
Islamic bank on behalf of its
An instrument issued by Islamic
bank on behalf of and for the

25
customer or applicant to the
beneficiary in connection with the
contract entered between the
applicant and beneficiary.
account of the buyer of goods.
Feature Two types of guarantee :
 Financial Guarantee
 Performance Guarantee
Islamic bank undertake the bills of
exchange and trade documents of
seller when drawn or presented
according to the terms of the credit
document will be duly honoured.
Sources of Fund Islamic bank fund will not tied-up
and the liability is contingent upon
the failure of applicant’s obligation.
 Wakalah Islamic Letter of
Credit (fund is from the
customer to the buyer)
 Murabahah Islamic Letter
of Credit (fund is from
Islamic bank via financing)
Syariah principle  Kafalah (guarantee)
 Wakalah Bi Al-Istihmar
(investment agency) and
kafalah (guarantee)
 Wakalah (agency)
 Murabahah (Cost plus
profit sale)
(Source: ISRA 2013)
8.2 Example Process
Company A which is a small and unknown company would like to purchase RM
3 million of kitchen equipment from Company B who is the beneficiary. To build a
confident by Company B, Company A comes to the Bank Islam by showing a contract
with Company B to apply for Bank Guarantee-I (BG-i).
After checking the contract of Company A, Bank Islam issues the (BG-i) and
forwards it to the Company A. Company A then forward the original guarantee to the
Company B. If the Company A is able to settle the payment, Company B will send back

26
the (BG-i) to the Company A so that Company A can cancel the guarantee from Bank
Islam.
However, if the Company A defaults in the payment, Bank Islam will take action
to fulfill the obligation on behalf of Company A to company B according to the claim
amount before.

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9.0 INCOTERMS
9.1 Definition of The Incoterms
Incoterms is an abbreviation of International Commercial terms. In term of
definitions, terminology incoterms is a series of those used in international trade
transactions. Incoterms is a set of rules issued by the institution of private trade,
the International Chamber of Commerce (ICC). Thus the positions of this
incoterms are independent, because it is not a product of the government of any
country. Historically, Incoterms were first published in 1936 after the First World
War. Later in the journey, several times amended.
These changes are always made by the ICC in order to adopt trade practices
most updated. The first change was made in 1953, known as incoterms1953.
Further changes were made on a regular basis, so it is known incoterms versions
in accordance with the amendments, namely: incoterms 1967, incoterms 1976,
incoterms 1980, incoterms 1990, 2000, and the last is incoterms 2010, which
came into effect from 1 January 2011. Incoterms provides a set of terms of trade
clause that essentially three things: cost (cost), risk (risk) and the responsibility
for the maintenance task (responsibility). In general terms, Incoterms regulate
matters relating to the CRR (cost, risk and responsibility).
9.2 Four Basic Categories of Incoterms
There are several basic categories of the Incoterms that need to be know
by the applicant:
Firstly, is the E terms, which is used when the seller will make goods
available to the buyer on the seller’s own premises. Secondly is the F terms, and
it will be used when the seller will be required to deliver goods to a carrier
appointed by the buyer. Thirdly is the C terms, that will be used when the seller
will be required to contract for carriage, but will not assume risk of loss or
damage to goods, or of additional costs that may occur after shipment and

28
dispatch. Lastly is the D terms, which is require the seller to bear all costs and
risks needed to bring goods to the place of destination.
In general, incoterms base the interpretations on the party who is the
best equipped to handle the task.
9.3 Rules for any mode of transport
There are several rules for the transport that have different types of mode which
are :
1) Ex Works (EXW)
2) Free Carrier (FCA)
3) Carriage Paid To (CPT)
4) Carriage and Insurance Paid To (CIP)
5) Delivered at Terminal (DAT)
6) Delivered at Place (DAP)
7) Delivered Duty Paid (DDP)
9.3.1 Ex Works
Ex Works Seller delivers when it places the goods at the disposal of buyer
at the seller’s premises or another named place for example works,
factory, and warehouse. Seller does not need to load the goods on any
collecting vehicle, nor does it need to clear the goods for export, where
such clearance is applicable.
9.3.2 FCA
Free Carrier is a seller delivers the goods to the carrier or another person
nominated by the buyer at the seller’s premises or another named place.
Seller does clear goods for export; import formalities are buyer’s
responsibility. Seller may contract for carriage at buyer’s expense and risk.

29
9.3.3 CPT
Carriage Paid To Seller delivers the goods to the carrier or another person
nominated by the seller at an agreed place (if any place is agreed between
the parties) and the seller must contract for and pay the costs of carriage
necessary to bring the goods to the named place of destination.
9.3.4 CIP
Carriage and Insurance Paid To Seller delivers the goods to the carrier or
another person nominated by the seller at an agreed place (if any such
place is agreed between the parties); seller must contract for and pay the
costs of carriage necessary to bring the goods to the named place of
destination.
9.3.5 DAT
Delivered at Terminal is a seller delivers when the goods, once unloaded
from the arriving means of transport, are placed at the disposal of the
buyer at a named terminal at the named port or place of destination.
“Terminal” includes any place, whether covered or not, such as a quay,
warehouse, container yard or road, rail or air cargo terminal.
9.3.6 DAP
Delivered at Place is a seller delivers when the goods are placed at the
disposal of the buyer on the arriving means of transport ready for
unloading at the named place of destination. The seller bears all risks
involved in bringing the good to the named place.

30
9.3.7 DDP
Delivered Duty Paid is a seller delivers the goods when the goods are
placed at the disposal of the buyer, cleared for import on the arriving
means of transport ready for unloading at the named place of destination.
The seller bears all the costs and risks involved in bringing the goods to
the place of destination and has an obligation to clear the goods not only
for export but also for import, to pay any duty for both export and import
and to carry out all customs formalities.
9.4 Benefits of using Incoterms rules.
Firstly, the benefit of using the Incoterm is it will  standardize how you do
on the business. This is because, by using the incoterms, the applicant or the users
will have the knowledge on how to standardize the business and the applicant also
know types of standards that need to be place for the business which can make a
greater and many profit for the business as well.
Secondly, the benefit for using the Incoterm is, it will  strengthen internal
control. Through this, if the applicant use the Incoterm for their business and
management which is it will provide security for the internal business as well as
for the applicant and the users itself.
Besides that, the benefit for the applicant and the users in getting involve
with the Incoterm is can avoid the delay that caused by the documentation
problem. This is because, the Incoterm will provide the security to the users from
any problem or mistake which can affect the efficiency of the business and
management.
Futhermore, the other advantages of using the Incoterm is, it will prevent
the disputes over the payee that is “ who pays for what”. Through this, the
Incoterm will protect the payee or the buyer that buy the goods from other country
in receiving their goods which give more secure for the goods itself and also to
avoid the buyer from pay something for that they not receive.

31
On top of that, by using the Incoterm, it also can protect the applicant or
the user ability in getting involve with the business. In this case, by using the
Incoterm, it will give security for the applicant that want to create a business
internationally which is selling the goods to other country.
Lastly, the advantage for using the Incoterm is, it will declare the correct
value for makes the differences in imports and exports for the first time and
between success and failure. This is because, the mistake or miscorrect in the
difference of the value in import and also export will cause a big mistake to the
business and also management of the company. Thus, it will definitely cause a
loss to the company and also for the users and applicant.

32
11.0 CONCLUSION
Islamic Trade Financing (ITF) was plays a big role in supporting the development and
strength of international trade activities. Besides offers many special products which
providing more benefits to the users, it was benefitted in the form of Syariah compliant
practices in the business which would support the development in Islamic economy and
finance.
There are various intermediaries who help in running this type of trade financing by
follow the Syariah guidelines in their activities such as banks and importers and they are
interdependencies among each others as to maintain their interest in this trade besides to
achieve profit based from the shariah guidelines. For example, in Islamic Bank Guarantee
(IBG), the Islamic bank agreed to bears the liability if the applicants were default in fulfill
their obligations to the beneficiary while the applicants of the Islamic bank would be
benefiting to proceed the business and run their trading activities with the beneficiary during
their financial constrains.
Besides, the most vital functions of ITF are to provide the smooth and efficient shariah
compliance of international trade financing. As the increment of Muslim traders around the
world, the existence of ITF would help to achieve the maqasid shariah and help them to
choose the financial products and involved in activities that allowed by shariah. The Islamic
Letter of Credit (ILC) for example, is not only islamic instrument of international trade used
in business practise for long distance trade and particularly important commission earning
service for any bank, but it also provide the shariah type of contract which mean surely valid
and applicable based from Islamic perspectives such as ILC of Wakalah (agency) and
Musyarakah (Partnership).
The last one is, ITF is a dynamic and flexible of trade financing. It is not only specialized
for muslim traders, however the non-muslim also welcomed to apply this ITF products as to
helping to run their business. ITF which concerns about the public interest would be able to
attract the non-muslim customers with the multi-financial products besides also applicable to
use in the local and international trade. Islamic Trust Receipt (ITR) is one of mechanism to
help finance domestic or international trade document drawn against ILC or Wakalah inward
bills for collection while Banker Acceptance (BA)

33
As a conclusion, ITF brings a bright future for the local and international trade financing.
Malaysia should be proud because aggressively providing and offering a variety of trade
financing products to help the effectiveness of business activities around the world. This keen
offer at the same time will improve and strengthen the Islamic economy of Malaysia
globally.

34
12.0 REFERENCES
12.1 Book
 International Shari’ah Research Academy for Islamic Finance (ISRA) (2013) “Islamic
Financial System, Principles & Operations”, Kuala Lumpur, Malaysia, pg 343-349
 Agasha Mugasha (2003) “The Law of Letter of Credit and Bank Guarantee”, The
Federation Press, pg 46&47
 Adiwarman Azwar Karim (2005) Islamic Banking Fiqh and Financial Analysis,
Jakarta : Indonesia, pages 113-124
 A. K. Daud Vicar(2010), Islamic Finance: Understanding its Principles and
Practices.Marshall Cavendish International Asia Pte Ltd. pg 257-258.
 J. S. Sak Onkvisit(2008), International Marketing: Strategy and Theory Taylor &
Francis. pg506.
12.2 Internet
 Islamic Banking Operation, Retrieved at3.31pm, 23 Sep 2014 from
http://www.financialislam.com/islamic-banking-operations.html
 Definition of Bank Guarantee, Retrieved at 3.32 pm, 23 Sep 2014 from
http://www.investopedia.com/terms/b/bankguarantee.asp
 Bank Guarantee, Retrieved at 3.33 pm, 23 Sep 2014 from
http://www.investinganswers.com/financial-dictionary/debt-bankruptcy/bank-guarantee-
4864
 Islamic Banking and Its Operations, Retrieved at 3.35 pm, 23 Sep 2014 from
http://www.islamic-banking.com/Banking_Operations.aspx
 Malika Akhatova. Islamic Banking System: A Viable Alternative? Retrieved at 3.39 pm,
23 Sep 2014 from http://www.inceif.org/research-bulletin/islamic-banking-system-
viable-alternative/
 What is ITFC, Retrieved at 10.51 am, 26 Sep 2014 from http://www.itfc-
idb.org/en/content/what-itfc
 Bank Guarantee-I (BG-i), Retrieved at 6.38 pm, 26 Sep 2014 from
http://www.bankislam.com.my/en/pages/BankGuarantee-i.aspx?tabs=1

35
 Ahmad Azam Othman, Rosmanan Che Hashm & Aktar Zaite Abdul Aziz. (2010).An
overview of Shariah issues regarding the application of the Islamic letter of credit
practise in Malaysia. ISRA international Journal of Islamic Finance, 2 (2),Retrived 1
October 2014.from, http://irep.iium.edu.my/3011/1/An overview of Sharia’h issues
regarding the application of the Islamic letter of credit practise in Malaysia.pdf
 What is Trust Receipt?(2013).Retrieved 2 Oktober 2014,from,
http://www.wisegeek.com/what-is-a-trust-receipt.htm
 Method of Payment Settlement. Retrieved at 2.30 p.m, 26 September 2014 From,
http://www.ligiagolosoiu.ro/content/BB/vol2/BB2-chapter4-
Methods%20of%20payment%20or%20settlement.pdf
 Trade Settlement Method of Export Finance. Retrieved at 2.45 p.m, 26 September 2014.
From,
http://www.slideshare.net/charurastogi/unit-4-trade-settlement-methods-export-finance-
international-sources-of-finance?next_slideshow=1
 Documentary Credit of Method Trade Settlement. Retrieved at 12.00 a.m, 25 October
2014. From,
http://www.exportfinance.gov.au/Pages/Documentarycredit.aspx#content
 What is definition of Documentary Credit. Retrieved at 12.30 a.m, 25 October 2014.
From,
http://www.businessdictionary.com/definition/documentary-credit.html
 Shipping Guarantees , Retrieved at 5.31pm, 26 Sep 2014 from:
www.businessdictionary.com/definition/shipping-guarantee
 Banking Acceptance, Retrieved at 5.31pm, 27 Sep 2014 from:
www.investopedia.com/terms/b/bankersacceptance.asp
 Bank Negara Malaysia, Retrieved at 5.10pm, 27 Sep 2014 from:
https://fast.bnm.gov.my/fastweb/public/files/BA_Apr2004_Updated.pdf
 Shipping Guarantee-I, Retrieved at 5.10pm, 27 Sep 2014 from:
www.bankislam.com.my/en/pages/ShippingGuarantee-i
 Vong, M. N. (2013, December 17). Retrieved October 18, 2014, from

36
http://www.tni.my/tradefinancing.php
 RISHI, S. B. (2012, April 21). Retrieved October 18, 2014, from
http://www.slideshare.net/SoobianAhmed/incoterms-2010-12631600

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