COMPILED BY HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance)

1. COMPILED BY HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance) Certified Professional Trainer (MIM) Industry Expert INCEIF HJ MAHMUD HJ BUNTAT, MBA(AUOL, UK), DBM (Swansea Inst., UK), CIL (UIA) Part-time Lecturer (INCEIF) Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd IB1005DEPOSITS AND FINANCING PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS CHAPTER 12 : TRADE FINANCING

2. Refers to the various forms of financial support and financial transactions used in international trade. • The facility is used to mitigate the financial risks for both exporter and importer. • Banks may assist by providing various services such as letter of credit, collection of payment upon presentation of certain documents or advancing payment on the basis of export contract. Chapter 12 – Trade Financing

3. In many countries, trade finance is often supported by quasi-government entities known as export credit agencies that work with commercial banks and other financial institutions.

4. Once the terms of contact have been agreed, the two parties have to appoint a bank on their behalf to effect transactions. • To seller/exporter the bank can act as their collecting agent. • To the buyer/importer the bank can act as their paying agent. Bank as Collection Agent

5. Exporter (Kuala Lumpur) CONTRACT CONTRACT Importer (London) Importer (Tokyo) MERCHANDISE 4. Importer makes payment to the Agent Bank and take possession of documents • Exporter ships the merchandise • and presents documents to • his Bank for collection of payment DOCUMENTS MEMO OF BILL PAYMENT 3. Agent Bank, Tokyo on scrutinizes documents. Informs Importer of arrival of import documents and requests importer to pay if documents are on sight basis or accept if documents are on usance basis • Exporter’s Bank checks documents and sends • them to Agent Bank in Tokyo for collection BANK ABC KUALA LUMPUR (Exporter banker) AGENT BANK TOKYO DOCUMENTS Collection Basis

6. Trade Financing Facilities 1. Letter of Credit-I (LC-i) 2. Trust Receipt-i (TR-i) 3. Shipping Guarantee-i (SG-i) 4. Letter of Guarantee-I (LG-i) 5. Islamic Accepted Bill-i (IAB-i)

7. Drawn under BANK ABC MALAYSIA BHD Letter of Credit No : 00183002 dated 8nd July 2009 0001/2009 No………………… US$28,572.00 9th July 09 EXCHANGE for………………………………………………………………………………………………………20……… SIGHT At………………………………………………………………………………………………………………………………..Pay this First of Exchange ( Second being unpaid) to the order of XYZ Bank, Tokyo ……………………………………………………………………………………………………………………………………….. ………………………………………………………………………………………………………………………………………… US Dollars : Twenty Eight Thousand Five Hundred Seventy Two Only Value received and charge the same to account of ……………………………………………………………………. ……………………………………………………………………. To………………………………………………………………… …………………………………………………………………... One Thousand units of Motor Parts Tokyo Supplier Pt Ltd Bills of Exchange Jasa Trading Sdn Bhd Lot 101, Jalan Sungai Besi 57000 KUALA LUMPUR

8. Letter of Credit (LC) LC is a secured means of acquiring prompt payment for the sale of goods. With the availability of LC facility, exporters can obtain quick, secure and guaranteed payment of goods from the banks. Offers an acceptable compromise by providing for payment to be effected against documents representing the goods and making possible the transfer of title to the goods from seller to the buyer.

9. Provides the buyer with financial backing, better pricing and repayment terms. • Eliminates commercial risk of non-payment to the supplier. • Assured all documents are in order as payment is made upon once the terms have been complied. Letter of Credit-i

10. Exporter (Tokyo) CONTRACT CONTRACT Importer (Kuala Lumpur) • The importer and the exporter sign a • sales contract providing for payment • through a letter of credit • The importer instruct Bank ABC ,KL. • The Issuing bank-to issue a letter of • credit in favor of the exporter 4. The advising bank informs the exporter that the letter of credit has been issued DOCUMENTS APPLICATION FOR CREDIT 3. Bank ABC, Kl asks Agent bank to advise the credit to the exporter AGENT BANK TOKYO BANK ABC KUALA LUMPUR CREDIT Stage1: Opening a Documentary Credit ADVISING BANK ADVISING BANK ISSUING BANK ISSUING BANK

11. EXPORTER IMPORTER Importer (London) MERCHANDISE • Exporter ships the merchandise • And presents documents to • Negotiating Bank Tokyo • for negotiation 4. Importer makes payment to the Bank and take possession of documents 3. Bank ABC, KL scrutinizes documents. If documents are in order, it will advise the importer and release the shipping documents upon payment by the importer DOCUMENTS MEMO OF BILL PAYMENT • Negotiating Bank negotiates and pays the • exporter if all documents comply with • the terms of Credit and debits account of Bank ABC, Kl • and sends documents to Bank ABC. KL AGENT BANK TOKYO BANK ABC KUALA LUMPUR DOCUMENTS & ADVICE OF DEBIT Stage 2 : Negotiation NEGOTIATING BANK ISSUING BANK

12. The issuance of LC-i can be based on the Shariah principles of:- 1. Wakalah (Agency) 2. Murabahah (cost plus basis) 3. Musharakah (joint venture / profit /loss sharing) Shariah Concepts for Letter of Credit-i

13. 1. The bank effectively acts a customer. 2. Before granting the facility, the will generally insist on a deposits from the customer up to the total cost of the goods in questions. 3. The deposits will be placed with bank under the Al-Wadiah Yad–Dhamanah principle. Al-Wakalah LC-i (Agency)

14. 3. Upon establishing the LC-i, the bank will pay the proceeds (from the deposit) to the negotiating bank. 4. The bank will then release the documents to the customer, charging the customer a fee for its services.

15. 1. The customer will negotiate his LC-i requirements with the bank on the basis he will purchase the goods from the bank under Al-Murabahah principle. 2. The bank will then establishes the LC-i and makes use of its own funds to pay the negotiating bank. 3. The bank subsequently sells the goods at the agreed profit margin. The customer is entitled to settle his liabilities on an agreed deferred term. Al-Murabahah LC-i (Cost plus)

16. 1. On establishing the LC-i, the customer will place a deposit (under the Al-Wadiah Yad Dhamanah principle) for his agreed share of the cost of the goods in questions. 2. The bank then establishes the LC-i and pays to the negotiating bank. The customer’s deposits as well as the bank’s fund (for its share of the cost of the goods) will be utilised Musharakah LC-i (Joint venture,profit/loss sharing)

17. 3. The documents are released to the customer, who will dispose of the goods as agreed under the Al-Musharakah agreement. 4. The profits derived therefore will be shared between thebank and the customer as agreed.

18. 1. Date of application. 2. Stamp Duty of RM3.00 is placed and cancelled. 3. Whether the LC is to be revocable, irrevocable, transferable or revolving. 4. Whether the LC is to opened by mail or telex/cable and whether telex/cable advice to be the operative credit instrument. Contents/Documents with Letter of Credit (LC)

19. 5. Whether the advising bank is to add its confirmation. If so, to insert the clause “Please request your agent to add its confirmation.” 6. Full and correct name and address of the applicant. 7. Full and correct name and address of the beneficiary and that the beneficiary is not domiciled in Israel. 8. Amount of the LC and the ISO currency code are clearly stated.

20. 9. Trade terms – whether CIF, C&F or FOB etc. 10. Whether the draft is to be drawn at sight or usance. If drawn on usance basis, it should state “30 days after sight” or “30 days after date of bill of lading.” 11. Expiry date of the LC and the country in which the LC is valid for negotiation are clearly stated (UCP 500 Article 42). 12. Whether the draft is to be drawn against 100% invoice value or for a lesser percentage. The draft is to be drawn on the issuing bank [UCP 500 Article 9(a) and (b)].

21. a) Signed commercial invoice b) Certificate of origin c) Weight Note d) Packaging list e) Insurance policy/certificate f) Bill of lading/airway bills/ deliveryorder No. of copies required & to indicate Import License no. Name country of origin No of copies required No of copies required FOB, CFR insurance to be covered by buyer Authority to claim goods 13. Types of documents required

22. 14. The brief description of merchandise and quantity. 15. Shipment – Ports of origin and destination. 16. The latest shipment date (must not be more than 21 days from expiry of the LC). 17. Whether partial shipments are allowed. 18. Whether transhipment is allowed.

23. 19. Presentation period of documents. 20. Any special instruction, e.g payment of charges. 21. Authorised signature of the applicant 22. Terms and conditions imposed. 23. Submission of relevant forms e.g KPWP.

24. LC established on 02-01-2009 to 30-04-2009 Beneficiary : In Tokyo Amount : US28,571-43 Exchange Rate : 3.50% Amount in RM : RM100,000-00 Commission : 0.1% per month Period of LC : 4 months Profit rate : 9% Postage : RM37-00 Letter of Credit operations

25. Commission RM4,000-00 • Profit rate from the date of negotiation @ 8 days to-date of payment plus 10 remittance days 443-84 • Postage (courier) 37-00 • Stamp duty (application) 3-00 40-00 Total charges 4,483-84 Charges on Letter of Credit

26. Trust Receipt-i is a financing facility to finance domestic or international trade documents drawn against Letter of Credit-i (under Murabahah concept) or Inward Bills for Collection-i (under Wakalah concept). • It is facility granted to customers for financing their short-term working capital requirement by way of murabahah. Trust Receipt-i

27. 1. The Bank appoints the customer as its agent to purchase goods he requires on behalf of the bank. 2. Upon delivery of the goods, the Bank pays the exporter/supplier for the cost of the goods based on the invoice value. 3. The bank will purchase the goods from the customer at invoice value and resell them to the customer on deferred payment terms at a price inclusive of bank’s profit margin. Process flow of Trust Receipt-i

28. The Bank will purchase the goods from the customer at invoice value and resell them to the customer on deferred payment terms at a price inclusive of the Bank's profit margin. • The deferred payment terms of sale of goods granted to the customer constitutes a creation of debt. This is secured in the form of Bill of Exchange drawn by the Bank and accepted by the customer and payable on maturity

29. The deferred payment terms of sale f goods granted to the customer constitutes a creation of debt. This secured in the form of Bill of Exchange drawn by the bank and accepted by the customer and payable on maturity. • The Bank holds customer's Trust Receipt-i executed by him to signify his holding of goods in trust pending sale of the goods. • Customer undertakes to settle the selling price on the expiry date

30. Amount of Bill : US28,571-43 Exchange rate : 3.5 Amount in RM : RM100,000-00 Period of Financing : 90 days Profit rate : 9% p.a Date of Inception : 01-03-2009 Maturity : 29-05-2009 • The bill amount in USD28,571-43 will be converted to MR based on rate of exchange prevailing on the date payment is affected by the LC-i issuing bank. Creation of Trust Receipt-i

31. Invoice face value FV 100,000-00 Profit rate r 9% Tenor (days to maturity) t 90 Murabahah Selling price 102,219-18 Profit SP – FV 2,219-18 SP = FV x [1 + r*t/365] Trust Receipt Selling Price

32. A negotiable instrument be used by consignee to take delivery of merchandise at the port. • The issuance of Shipping guarantee by the bank to indemnifies shipping company against all consequences and liabilities of any kind whatsoever should there be any claim on its rightful owners. • It is signed by the importer and counter signed by the bank. Shipping Guarantee-i

33. SG- i does not have any qualifying clauses as regards to the value and time. • The liability of the bank ceases only upon presentation of the original shipping documents in exchange for return of SG-i or perhaps by the law of limitation. • Under LG-i operation , the issuing bank would normally advise that the shipping documents should be presented to the negotiating bak for negotiation within. Say 7 days from the date of shipment To ensure speedy delivery all documents be sent by courier service

34. A customer requires a Letter of Guarantee-i in respect of say a loan procurement. • The bank requires a deposits from the custmer which is place under Al-Wadiah Yad–Dhamanah principle. • The Bank provided Al-Kafalah LG-i by charging a fee to the customers. Al-Kafalah Letter of Guarantee(LG-i)

35. Islamic Accepted Bills (IAB) IAB is a mode of financing available for imports and domestic sales; in the primary market, IAB-Import is concluded on the basis of murabahah, and IAB-Export is concluded on the basis of a sale of debt (bai’ al-dayn). IAB is also traded in the secondary market on the basis of bai’al dayn.

36. IAB – Purchase/Import The bank draws a Bill of exchange, which is a Certificate evidencing the debt, on and to be accepted by the customer. The amount drawn is the full selling price payable by the customer to the bank on the maturity date of the financing. The contract used is debt trading (bai al-dayn).

37. The document essentially involves the creation of IAB as a security to finance working capital in the form of cash purchase of raw materials at cost which is sold back to the customer inclusive of profit margin (murabahah), with the customer acting as an agent to the bank. • Upon acceptance by the customer, the bank may sell the bill to a third party (baial-dayan) at adiscunt (not less than te cost ) based on an agreed price.

38. Invoice face value 100,000-00 Islamic cost of fund icof 7% Accepted commission rate Rate (spread) acr 2% Profit rate r 9% Tenor (days to maturity) t 90 Murabahah Selling price 102,219-18 Profit SP – FV 2,219-18 SP = FV x [1 + r*t/365] Murabahah Selling Price

39. IAB DRAFT (Purchase/Import) IAB NO: 001674 Br Ref No: LC 9993020224 BB53-1 ISLAMIC ACCEPTED IMPORTER SDN BHD 1-11-02 To………………………………………………………. ………………………………………………………….. At days after sight without days of grace pay to the order of ourselves the sum of RINGGIT………………………………………………………………… …………………………………………… Due Date: 90 THREE HUNDRED TWENTY SEVEN THOUSAND SEVEN HUNDRED NINETY FIVE ONLY RM327,795-00 3-8-2002 IMPORTATION INTO MALAYSIA For and on behalf of IMPORTER SDN BHD Authorised Signatories ............................................ Payable at ABC BANK BHD KUALA LUMPPUR Drawn to finance…………………………………………………………………… of goods described in the record of the drawing/accepting bank. For and on behalf of ABC BANK BHD ………………………………………… Accepted on 30-2-2008 Dated…………………….. NO SIGNATURE /WRITING BELOW THIS LINE “001674” 40”140141: 39

40. The exporter seeks finance from the importer by preparing the export documents as required by the sales contract/letter of credit. • The IAB-Exports is drawn to finance exports or domestic credit sales and it is payable on a specified future date. • The customer sells the debt arising from his credit sales to importer/ local buyer to the Bank at discount (bai al-dayn) IAB – Export/Sale

41. On the maturity date, customer will settle the debt to the Bank. The IAB-Exports may be sold in the secondary market. • A minimum amount of financing of RM50,000 is typically required. • A bank discount the face value of the IAB issued in the primary market, and may sell it to third party in the secondary Islamic money market. The discount

42. The discount rate offered by the Islamic money market dealer is 4% (as per table below). • Debt trading is only applicable in Malaysia, as in the middle East a debt is deemed money owed and may not be traded to a third party at a discount.

43. IAB face value RM102,219-18 Discount rate r 4% Tenor (days to remaining) t 60 Proceeds P 101,547-05 P = FV * [1 - r*t/365] IAB proceedsafter discount

44. IAB DRAFT (Export/Sales) IAB NO: 001674 Br Ref No:AdDayn77009901 BB53-1 ISLAMIC ACCEPTED BILL EXPORT IMPORT ISLAMIC BANK To………………………………………………………. ………………………………………………………….. At days after sight without days of grace pay to the order of ourselves the sum of RINGGIT………………………………………………………………… …………………………………………… 1/09/2008 Due Date: 180 One Hundred Thousand Only MYR100,000.00 Authorised Signatories PAYABALE AT EXPORT IMPORT ISLAMIC BANK 1/3/02 for and on behaof Hong Leong Islamic Bank SALES WITHIN MALAYSIA Drawn to finance…………………………………………………………………… of goods described in the record of the drawing/accepting bank. For and on behalf of XYZ Corporation ………………………………………… Accepted on 1/3/2008 Dated…………………….. NO SIGNATURE /WRITING BELOW THIS LINE “001674” 40”140141: 44

45. For any queries please call 019-3893846 or e-mail to: mahmudbuntat@yahoo.com • Have a good day  • May God bless you • Thank you & Wassalam