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
What types of Tawarruq contract are available with description?
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.
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.
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.
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.
What are the operational steps of Tawarruq contract?
The client identifies a need for liquidity and approaches an Islamic financial institution to initiate a Tawarruq transaction.
A commodity that is Shariah-compliant and easily marketable is selected for the transaction, ensuring that it can be quickly sold for cash.
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.
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.
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.
The sale proceeds are given to the client, providing them with the liquidity they were seeking.
The client agrees to a repayment schedule with the financial institution to settle the deferred payment for the commodity purchase, completing the Tawarruq transaction.
Once the client fulfills all payment obligations to the financial institution under the agreed terms, the Tawarruq contract is successfully concluded.
How does Tawarruq ensure compliance with Shariah principles?
What commodities are typically used in Tawarruq transactions?
What are the key benefits of Tawarruq contracts?
Can Tawarruq be used for personal financing in Islamic banking?
What are the potential risks associated with Tawarruq transactions?
How do Islamic banks manage Tawarruq transactions?
What is the difference between Tawarruq and Murabaha?
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