Islamic Trade Finance & Forex Trading in Islam

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 developing methods to provide banks with incentives to partake in the system.

Conventional Trade Finance VS. Islamic Trade Finance:

Based strongly on morals and religious belief, ITF products avoid 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 of interest within transactions.

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	Is practiced worldwide.

Islamic Trade Finance Products:

Some common Islamic trade finance products include the following:

1. MURABAHAH:

‘Murabahah is one of the ways organizations incentivize banks whilst remaining within the limits of Shariah. It is a cost-plus financing structure where the bank purchases goods and resells them to the customer at a marked-up price, with the profit being shared between the bank and the customer. 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.

2. IJARAH:

An Islamic leasing structure is where the bank purchases an asset and leases it to the customer, with the customer having the option to purchase the asset at the end of the lease period.

3. MUSHARAKAH:

A partnership structure is where the bank and the customer jointly invest in a project or business, with profits and losses shared according to a pre-agreed ratio.

Islamic Trade Finance Instruments:

A wide range of tools and instruments regulate how cash, credit, investments, and other assets can be utilized for trade. They include but are not limited to the following:

1. LETTER OF CREDIT:

L/C is a type of financial instrument commonly used in Islamic trade finance. They are used to provide a guarantee from the buyer’s bank to the seller’s bank that payment will be made for goods or services that have been shipped.

2. TRUST RECEIPTS:

They are a type of Islamic finance instrument that is used to provide financing for the import of goods. In this type of financing, the bank holds the imported goods in trust for the buyer and releases them once the buyer has fulfilled their financial obligations.

3. ACCEPTED BILLS:

Type of bill of exchange that has been accepted by the seller. This type of instrument is commonly used in ITF as a form of payment for goods or services.

4. SHIPPING GUARANTEES:

Type of guarantee provided by a bank or other financial institution to cover the cost of shipping goods. This type of guarantee is often used in Islamic trade finance to protect the seller in case the buyer is unable to pay for the goods or services that have been shipped.

5. WORKING CAPITAL:

Working capital financing is a type of financing used to provide funds for a company’s day-to-day operations. This type of financing is commonly used in Islamic banking and finance to help businesses meet their short-term financial needs.

6. EXPORT CREDIT FINANCING:

It is a type of financing used to provide funds for companies engaged in exporting goods or services. This type of financing is commonly used in Islamic trade finance to help businesses meet the costs associated with exporting their products.

Islamic Trade Finance Challenges:

In spite of its numerous benefits, it faces several challenges that need to be addressed to further its growth and development:

1. LACK OF AWARENESS

Many businesses and individuals, even within Muslim-majority countries, are not fully aware of its nature and benefits. This lack of understanding hinders its adoption and expansion.

2. REGULATORY CHALLENGES

It operates under a unique set of Shariah principles, which often contradicts conventional regulatory frameworks. Striking a balance between these two systems is often challenging.

3. RELATIVELY HIGH COSTS

The cost of Islamic trade finance products can be higher than conventional ones due to the additional processes involved, such as ensuring Shariah compliance.

4. LACK OF STANDARDIZATION

There is a lack of standardization in the interpretation and application of Shariah laws in different countries. This creates complexity and uncertainty, making it difficult for businesses to adopt ITF on a global scale.

5. LIMITED RANGE OF PRODUCTS

While there are some innovative Islamic trade finance products in the market, the range is still relatively limited compared to conventional finance. To attract more businesses, there needs to be continual innovation and development of new products.

6. RISK MANAGEMENT

Risk management in Islamic trade finance can be complex due to the unique risk-sharing principles of Islamic finance. Developing effective risk management strategies that align with Shariah principles is a significant challenge.

What is the International Islamic Trade Finance Corporation (ITFC)?

The International Islamic Trade Finance Corporation (ITFC) is a member of the Islamic Development Bank (IsDB) Group. ITFC plays a role in Islamic trade finance by providing trade financing and other financial services to its member countries. Its main goal is to promote cross-border trade among its member countries by providing trade financing, trade guarantees, and other trade-related services. It also provides funding for infrastructure and development projects in member countries.

Benefits of the International Islamic Trade Finance Corporation

ITFC brings along a multitude of benefits to the global Islamic trade finance landscape:

1. Promotion of Trade Cooperation: The ITFC actively works to enhance economic integration and foster trade cooperation among the member countries, thereby promoting intra-OIC trade and Islamic trade globally.
2. Financing Trade: By providing trade finance, the ITFC assists in filling the gap in trade financing, especially for small and medium enterprises (SMEs) in member countries.
3. Capacity Building: The ITFC offers capacity-building initiatives to improve the trade-related skills and knowledge of institutions and individuals involved in trade in member countries.
4. Advisory Services: The ITFC provides advisory services to member countries to help them improve their trade policies and regulations, thereby enhancing the overall trade environment.
5. Promotion of Shariah-Compliant Products and Services: The ITFC promotes the use of Islamic Trade Finance products and services, thereby encouraging ethical trade practices and contributing to the growth of Islamic finance.
6. Risk Management: The ITFC helps businesses mitigate the risks associated with international trade, particularly in volatile markets.
7. Social Impact: By relying on ethical principles of trade, the ITFC contributes to socio-economic development, poverty reduction, and the achievement of sustainable development goals.

These benefits collectively underscore the pivotal role of the ITFC, not only as a financier of trade but also as a catalyst for development and economic integration within the Islamic trade finance ecosystem.

Conclusion:

Islamic Forex trading is a way for Muslims to participate in the foreign exchange market in a manner that is compliant with Islamic law and principles. It’s important to note that there are different opinions among Islamic scholars regarding the permissibility of Forex trading, and some may consider it haram. Therefore, individuals need to consult with their own Islamic scholars or financial advisor for guidance.