TAWARRUQ CONTRACT 2024
TAWARRUQ FACILITY DEFINITION

TAWARRUQ CONTRACT 2024

TAWARRUQ FACILITY DEFINITION TAWARRUQ CONTRACT 2024

Tawarruq contract is by definition a financial concept within Islamic finance where an individual buys a commodity on a deferred payment basis and then sells it to a third party for cash at a lower price, aiming to obtain liquidity without engaging in interest-based transactions, which are prohibited in Islam.

Tawarruq facility involves two separate transactions: the first is the purchase of the commodity by the individual from a seller or an Islamic bank on a deferred payment basis, and the second is the immediate sale of that commodity to another party for cash.

The key objective of Tawarruq is to facilitate cash liquidity for individuals or businesses while adhering to Shariah principles, avoiding the direct exchange of money for more money with added interest.

In a typical Tawarruq transaction, the commodity involved is usually a metal or another asset that can be easily liquidated, ensuring that the process can be completed swiftly to meet the liquidity needs of the individual.

To ensure compliance with Islamic law, the transactions must be genuine, with the commodity being real and capable of being delivered, and not merely a financial trick to disguise interest as a sale.

The difference between the deferred price at which the individual buys the commodity and the lower cash price at which it is sold results in a loss that represents the cost of obtaining liquidity, which is considered permissible in Islamic finance.

Tawarruq has become a popular mechanism in Islamic banking and finance for providing personal financing, working capital, and liquidity management solutions that are in compliance with Islamic jurisprudence.

The use of Tawarruq contract in 2024 is subject to scrutiny and debate among Islamic scholars to ensure that it does not replicate the economic effect of interest-based borrowing and adheres strictly to the principles of Shariah.

ALL ABOUT TAWARRUQ CONTRACT

  1. What types of Tawarruq contract are available with description?

    Types of Tawarruq Contracts

    1. Monetization Tawarruq (Personal Tawarruq)

      This type of Tawarruq is initiated by an individual seeking liquidity. The individual buys a commodity on deferred payment terms and then sells it for cash. It's commonly used for personal financing, such as for managing cash flow or consolidating debts, within the bounds of Islamic finance.

    2. Commodity Tawarruq

      In Commodity Tawarruq, the transaction involves commodities traded on a commodity exchange. The buyer purchases the commodity on credit from a broker and sells it on the spot market to obtain cash. This type is often used by Islamic financial institutions for liquidity management and by individuals for personal finance.

    3. Reverse Tawarruq

      Reverse Tawarruq is the opposite of Commodity Tawarruq, where an Islamic bank or financial institution buys a commodity and sells it to the customer on a deferred payment basis. The customer then sells the commodity on the spot market. This type is used by banks for liquidity management and investment purposes.

    4. Institutional Tawarruq

      Institutional Tawarruq is used by businesses and financial institutions to generate working capital or liquidity. It operates similarly to personal Tawarruq but on a larger scale, involving larger transactions meant for corporate financing or institutional liquidity needs.

  2. What are the operational steps of Tawarruq contract?

    1. Identification of Need

      The client identifies a need for liquidity and approaches an Islamic financial institution to initiate a Tawarruq transaction.

    2. Selection of Commodity

      A commodity that is Shariah-compliant and easily marketable is selected for the transaction, ensuring that it can be quickly sold for cash.

    3. Purchase Agreement

      The client agrees to buy the selected commodity from the financial institution or a third party on a deferred payment basis, with the terms clearly stated in a contract.

    4. Payment of Purchase Price

      The financial institution pays the seller the purchase price of the commodity on behalf of the client, taking possession of the commodity either directly or through constructive possession.

    5. Sale of Commodity

      The client then sells the commodity to a third party (not the original seller) at the current market price, either directly or through the financial institution acting as an agent.

    6. Receipt of Sale Proceeds

      The sale proceeds are given to the client, providing them with the liquidity they were seeking.

    7. Repayment Schedule

      The client agrees to a repayment schedule with the financial institution to settle the deferred payment for the commodity purchase, completing the Tawarruq transaction.

    8. Completion of Transaction

      Once the client fulfills all payment obligations to the financial institution under the agreed terms, the Tawarruq contract is successfully concluded.

  3. How does Tawarruq ensure compliance with Shariah principles?

    • Tawarruq ensures compliance by avoiding interest (riba) and engaging in genuine trade transactions involving real commodities, adhering to the principles of Islamic jurisprudence.
    • The transaction involves actual possession and transfer of goods, distinguishing it from interest-based transactions and ensuring it meets Islamic ethical standards.

  4. What commodities are typically used in Tawarruq transactions?

    • Commodities used in Tawarruq transactions are usually metals or other easily liquidated assets, ensuring swift completion of the transaction for liquidity purposes.
    • The chosen commodities should be real, deliverable, and of a nature that does not contradict Islamic principles.

  5. What are the key benefits of Tawarruq contracts?

    • Tawarruq contracts provide a Shariah-compliant way to achieve liquidity, making them beneficial for individuals or businesses needing cash without resorting to interest-bearing loans.
    • They offer a flexible financing solution that can be tailored to different financial needs, such as personal loans, working capital, or liquidity management.

  6. Can Tawarruq be used for personal financing in Islamic banking?

    • Yes, Tawarruq is widely used in Islamic banking for personal financing, allowing individuals to access cash for personal needs while adhering to Islamic finance principles.
    • It provides an alternative to conventional loans, enabling consumers to finance purchases or meet financial obligations in a Shariah-compliant manner.

  7. What are the potential risks associated with Tawarruq transactions?

    • Potential risks include market risk related to the fluctuation in commodity prices and the risk of non-compliance if the transaction does not adhere strictly to Islamic principles.
    • Operational risks also exist, such as delays in the transfer or delivery of commodities, which can affect the transaction's validity and effectiveness.

  8. How do Islamic banks manage Tawarruq transactions?

    • Islamic banks manage Tawarruq transactions by ensuring that all aspects of the deal, from the selection of commodities to the sale process, comply with Shariah laws and principles.
    • They typically use standardized contracts and work with trusted partners to ensure the smooth execution and delivery of commodities, minimizing risks and ensuring compliance.

  9. What is the difference between Tawarruq and Murabaha?

    • The main difference is that Tawarruq involves an individual purchasing a commodity to sell it for liquidity, whereas Murabaha involves a purchase and resale agreement where the buyer knows the original cost and agreed profit.
    • Tawarruq is designed for liquidity generation, while Murabaha is used for financing specific purchases with a transparent profit margin for the financier.

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