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.