What is Islamic Trade Finance?
Islamic teachings provided guidelines for Muslim nations to set up their economies and infrastructure. This meant their systems differed from western economies- making it difficult for them to collaborate. In order to overcome some of these differences in the world on finance, around the year 1950, Islamic trade finance products came into being. Islamic trade also uses the principles of forex trading in Islam, and it is administered in a manner that complies with Islamic laws and teachings.
Based strongly around morals and religious belief, Islamic trade finance products avoids the involvement of ‘riba’ which translates to interest- which Islamic laws (i.e. Sharia) strongly prohibit. In order to systematize international trade to an Islamic economy, several credit techniques have been developed to substitute the role interest within transactions.
Evolution of Islamic Trade Finance?
To help support Islamic trade finance, the International Trade Finance Corporation (ITFC) was established in the year 2008. The purpose of this organization was to aid countries such as Bahrain and Saudi Arabia in adopting the practices of Islamic trade finance products. It does this by providing them with the necessary tools to compete in the international market and develop methods to provide banks with incentive to partake in the system.
‘Murabahah’ is one of the ways organizations incentivize banks whilst remaining within the limits of Shariah. It is the amount which becomes the bank’s return when that good is sold to a customer for payment at a later date. With both the buyer and seller, agreeing on a specific profit margin added to the cost, this is not seen as interest; rather it is a technique of profit and loss sharing. This product is also rising Islamic banking in Europe.
7 Key Differences between Conventional and Islamic Trade Finance:
Islamic Trade Finance
Conventional Trade Finance
- In compliance with the principles of Islam.
- Does not consider any religious principles.
- Does not involve the role of interest.
- Heavily relies on an interest-based environment.
- Trade operations may be financed through profit and loss techniques.
- Trade transactions are financed exclusively through credit.
- Administers technique of profit and loss sharing Transactions almost always involve interest.
- Both parties decide on the profit margin Sellers primarily decide on the profit margin.
- Uses Murabaha, Ijarah and Diminishing Musharakah to incentivize sellers/exporters.
- Uses interest-generating opportunities to incentivize banks.
- Is mostly practiced in Muslim countries
Islamic Trade Finance Products:
Wide range of tools and instruments regulate how cash, credit, investments and other assets can be utilized for trade. Students of AIMS’ cife certification and diploma Islamic banking students study the detailed theory and practical implementation of trading products. They include but are not limited to:
- Letters of credit.
- Trust Receipts.
- Accepted bills.
- Shipping guarantees.
- Working capital financing.
- Export credit financing.
Understanding Forex Trading in Islam:
When it comes to transactions in foreign currencies, Islamic banks tend to exchange these currencies on the spot. Forex trading in Islam may be carried on, by several Islamic banks, on the basis of contracts or currency arbitrage. While Islamic banks incorporate a profit margin into the contract or transaction, forex trading in Islam sticks to the values of profit-loss sharing, as per the Islamic Shariah law.