Key Islamic banking contract under fire

MANAMA Wed Feb 6, 2008 9:03am EST

Managing Director, Regional Head of Middle East Structuring at Deutsche Bank Geert Bossuyt speaks during the Reuters Islamic Finance Summit in the Reuters offices in Dubai February 4, 2008. REUTERS/Jumana El Heloueh (UNITED ARAB EMIRATES)

Managing Director, Regional Head of Middle East Structuring at Deutsche Bank Geert Bossuyt speaks during the Reuters Islamic Finance Summit in the Reuters offices in Dubai February 4, 2008.

Credit: Reuters/Jumana El Heloueh (UNITED ARAB EMIRATES)

MANAMA (Reuters) - The Islamic finance industry is seeking alternatives to a key contract -- commodity murabaha -- as scholars and bankers grow more vocal in their concerns the deal that once powered the industry is increasingly unsuitable.

Commodity murabaha involves a bank buying a commodity for a client, and the client paying the bank back the cost of the commodity plus a bank charge or "profit rate" at a later date.

Islam bans interest, and stipulates that deals must be based on tangible assets -- money cannot be made from money alone.

However, in a form of commodity murabaha known as tawarruq, the contract can also be used to secure cash when the client sells the commodity on again, effectively buying money from the bank for the cost of the profit rate.

"Tawarruq ... is one of the most critical internal and ideological challenges the Islamic banking industry is facing," top Islamic scholar Hussain Hassan said in a private report seen by Reuters.

"Tawarruq...contradicts the fundamental purpose of Islamic banks," he continued. Hassan sits on the Islamic law, or sharia, boards of several Islamic financial institutions, including Dubai Islamic Bank and Deutsche Bank.

"The fear is that sometimes the commodity doesn't exist and the broker could be cheating," Osaid Kailani, head of Abu Dhabi Islamic Bank's sharia division said, referring to Islam's ban on interest requirement that deals are based on tangible assets.

"The broker may also sell the same commodity to more than one bank at the same time. This has been discovered in some cases, but there are brokers committed to sharia law," he added.

Others say the deal is a near instant paper transaction with little relation to the underlying commodity, which they say breaks the rule that profit must be gained from physical assets.

"The Islamic banking industry is evolving ... in terms of commodity murabaha the question arises whether commodities of the required magnitude actually exist," Ikbal Daredia, head of capital markets and institutional banking at Bahrain's Unicorn Investment Bank said.

ALTERNATIVES

Aside from compliance with Islamic law, many bankers say the booming industry can longer rely so heavily on one type of contract, which no longer suits the sector's needs.

"A commodity murabaha cannot be done overnight. A lot of liquidity requirements are overnight, or short term. I think the Islamic banking industry is in high need of an alternative," Geert Bossuyt, head of sharia structuring at Deutsche Bank said.

Deutsche aim to launch an alternative within weeks, he said.

Other bankers and sharia scholars said it would be difficult to replace the commodity murabaha contract and that better supervision of brokers could make the contract more acceptable.

"You can say maybe some institutions are not fulfilling the conditions of sale. Let us fix this problem, but let us not say that this is not permissible without any evidence," said Sheikh Nizam Yaquby, one of the world's top Islamic scholars, who backs the contract's compliance with Islamic law.

Yaquby sits on the sharia boards of several banks, including HSBC and BNP Paribas. He also advises Dow Jones.

"You can say that some people think it's not a very intelligent way of investing liquidity, but it is a tool," Yaquby told the summit in Manama, home to the Islamic world's most widely accepted standards body.

Both Hassan and Yaquby sit on its board.

"If you say that something is not permitted...there must be evidence. We do not have any such evidence available," he added.