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Islamic Trade Financing: Tools for Trade Competitiveness Presentation by: Asnulhadi Yeop Aziz Wholesale Banking for: Seminar on Islamic Banking & Capital.

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Presentation on theme: "Islamic Trade Financing: Tools for Trade Competitiveness Presentation by: Asnulhadi Yeop Aziz Wholesale Banking for: Seminar on Islamic Banking & Capital."— Presentation transcript:

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2 Islamic Trade Financing: Tools for Trade Competitiveness Presentation by: Asnulhadi Yeop Aziz Wholesale Banking for: Seminar on Islamic Banking & Capital Market: Products & Instruments 1

3  Islamic Trade Financing: An overview  Types of Products & Instruments & Shariah Principles/contracts  Letter or Guarantee  Letter of Credit  Working Capital Financing  Islamic Accepted Bills (AB-i)  Islamic Export Credit Refinancing (IECR)  Prospects & Challenges Presentation Outline 2

4 Trade Financing : An Overview Trade Financing : An Overview Manufacturer (Exporter) Buyer (Importer) Merchandise Payment Advanced Payment Documentary Collection Open Account Letter of Credit Modes of Payment: Which comes first?

5 Trade Financing : An Overview Trade Financing : An Overview RECEIVABLE RAW MATERIAL CASH FINISHED GOODS Cash Operating Cycle of both Exporter & Importer

6 Trade Finance Tools Trade Finance Tools  Bank Guarantee  Letter of Credit  Overdraft  Trust Receipt  Bankers Acceptance 5

7 Bank Guarantee Bank Guarantee Bank Guarantee Manufacturer (Exporter) Buyer (Importer) Merchandise Payment

8 Bank Guarantee Bank Guarantee Types of Guarantee 1.Tender Guarantee/Bond4. Customs Guarantee 2. Performance Guarantee5. Utility Payment Guarantee 3. Advanced Payment Guarantee6. Others Islamic Bank Guarantee Based on the principle/contract of Kafalah or Dhamanah (guarantee) Operationally, there is no difference between conventional and Islamic guarantee where bank charges commission/fee (ujr) for the guarantee. Certain Islamic banks adopt pro-rated commission (i.e. based on actual number of months) 7 Differences Between Pro-rated vs Per annum Commission Amount:RM200, Commission:e.g. 1% p.a. Tenor: 6 months Pro-rated Basis Per Annum Basis Commission: RM2, RM1,000-00

9 Letter of Credit Letter of Credit Written undertaking by a commercial bank to seller (beneficiary) to effect payment on behalf of the buyer if terms & conditions of the LC (i.e. terms of credit) have been complied with. Advantages Provides importer with credit backing & eliminates buyer risk to exporter Importer may get better pricing & payment terms Importer is assured documents presented are as per requirement and duly examined by experts in the field as per UCP500. Exporter may get sale proceeds faster (via negotiation of LC) 8

10 Letter of Credit- The Mechanics Letter of Credit- The Mechanics EXPORTERIMPORTER ISSUING BANK ADVISING/ NEGOTIA- TING BANK 2. Issue LC 1.Apply LC & place 100% deposit 3.Advise LC 4.Client provide document & receive payment 5.Forward document 7.Client receive document 6. Payment reimbursement

11 Letter of Credit Letter of Credit Islamic Letter of Credit Based on the principle/contract of Wakalah If deposit is placed upfront by client, it will be placed under wadiah. Customer will pay commission/fee (ujr) for the service Operationally, no difference from conventional LC. Main advantage: No interest payment on Settlement Period. Settlement of LC via upfront wadiah deposit placement via Murabahah Working Capital Financing via Equity Financing namely Mudharabah or Musyarakah financing. 10

12 Letter of Credit Letter of Credit 11 DIFFERENCES IN COSTS BETWEEN CONVENTIONAL & ISLAMIC LC Assumption LC issued on 1 Apr 2006 and expires on 30 May 2006 Beneficiary:In the USA LC Amount:USD100, Foreign Exchange:3.60 Amount in MYR:RM360, Commission:0.1% p.m. Tenor:2 Months Foreign Interest :6% SWIFT Charge:RM25.00 CONVENTIONAL LC RM ISLAMIC LC RM Commission (RM360,000 X 0.1% X 2) Interest from date of negotiation to date of 8 days + 10 remittance days (RM360,000 X 6% X 18/365 1, SWIFT Charges25-00 TOTAL CHARGES 1,

13 Working Capital Financing Working Capital Financing The money that is required to circulate within a business in order to finance its business/operating cycle. (It can also be used to settle LC) Nature Short period – according to business/operating cycle Self-liquidating Financing relates to specific asset (eg stock, receivable) Forms  Overdraft  Trust Receipt - Document of trust signed by importer, the strength on with bank allows the importer to obtain release of the merchandise but making payment at a later date.  Bankers Acceptance (Import/Export) - Usance Bill of Exchange drawn by client on the bank for acceptance/discount. The proceeds will be utilised to finance the merchandise imported. 12

14 Financing of Purchase/Import - Murabahah Financing of Purchase/Import - Murabahah 13 BANK CLIENT SUPPLIER 1. Bank appoints Client as Purchasing Agent 2. Purchase Order 3. Supply of goods 4. Payment of Purchase Price 5. Sale of Goods 6. Payment of Sale Price on Maturity Sale Price = Cost + (Cost X Profit rate X Tenor) 36500

15 Islamic Accepted Bills (AB-i) (Purchase/Import) Islamic Accepted Bills (AB-i) (Purchase/Import) 14 BANK CLIENT SUPPLIER 1. Bank appoints Client as Purchasing Agent 2. Purchase Order 3. Supply of goods 4. Payment of Purchase Price 5. Sale of Goods 6. Payment of Sale Price on Maturity Securitisation of the Debt : AB-i. Sale of AB-i to another party is under Bai’ Dayn

16 Financing of Sales/Exports - Bai’ Dayn Financing of Sales/Exports - Bai’ Dayn 15 BANK CLIENT SUPPLIER 2. Supplier will pay on end credit term 1. Client sells goods 3. Sale of Debt 4. Payment via cash 5. On maturity, Client collect debt and pay to Bank

17 16 BANK CLIENT SUPPLIER 2. Supplier will pay on end credit term 1. Client sells goods 3. Sale of Debt 4. Payment via cash Islamic Accepted Bills (AB-i) (Sale/Export) Islamic Accepted Bills (AB-i) (Sale/Export) Securitisation of the Debt : AB-i. Sale of AB-i to another party is under Bai’ Dayn 5. On maturity, Client collect debt and pay to Bank

18 AB-i (Purchase or Sale) AB-i (Purchase or Sale) Transactions Allowed to be Securitised under AB-i Tangible and non-haram goods (eg. raw materials, semi-finished goods or finished goods) Selected services – 1.Purchase of computer software licence, 2.Companies involved in trade-related logistic services such as warehousing, forwarding & shipping, or 3.Purchase of electricity such as Independent Power Producer (Exemption given on case to case basis) (Source: BNM AB-i Guideline) 17

19 Working Capital Financing Working Capital Financing Trust Receipt & Bankers Acceptance (BA) Financing for Purchases/Imports & Islamic Accepted Bills (AB-i) Tenor30 – 180 days Payment of Interest/Profit Upfront  Requires Overdraft Facility On maturity (in arrears)  Coincides with operating cycle  Not requires Overdraft Facility  Lower effective rate Financing Amount100% under Trust Receipt Round Down to nearest thousand for BA 100% of invoice amount Acceptance Commission Available under BA FacilityNone even under AB-i Facility

20 Cost Comparison Between BA and AB-i Cost Comparison Between BA and AB-i BANKERS ACCEPTANCE - CONVENTIONAL InvoicesRM384, Discount Rate / Accepted Commission3.0%, 0.5% Tenor120 Days Discounted Amount RM384, x 3.0% x 120/365 = RM3, Acceptance Commission Amount RM384, x 0.5% x 120/365 = RM OD Rate BLR + 1.5% Upon Issuance BA Draft Amount = RM384, Current Account/ OD Debited RM RM3, RM =RM4, Up front Charges RM4, OD Interest RM4, x 7.5% x 120/365 = RM Upon Maturity RM384, (BA Amount + OD Interest) Overall Charges RM388, (Upon Issuance + Upon Maturity)

21 Cost Comparison Between BA and AB-i Cost Comparison Between BA and AB-i ACCEPTED BILLS - ISLAMIC InvoicesRM384, Profit Rate3.5% Tenor120 Days Profit Amount RM384, x 3.5% x 120/365 = RM4, Upon Issuance BANK PURCHASE PRICE=RM384, BANK SELLING PRICE=RM388, Upon Maturity RM388, (Bank Selling Price) Overall Charges RM388, (Upon Issuance + Upon Maturity)

22 Islamic Export Credit Refinancing Scheme (IECR) Islamic Export Credit Refinancing Scheme (IECR)  Special government scheme to promote export of Malaysian manufactured products, agriculture products & primary commodities via participating commercial banks.  IECR Pre-shipment and Post-Shipment  AB-i uses the prevailing profit rate in the market while IECR allows banks to resell the debt to EXIM Bank at a special rate. EXIM Bank will notify the refinancing rate from time to time.  Uses the principle/contract of Bai’ Dayn. 21

23 Islamic Trade Financing : Prospect Islamic Trade Financing : Prospect Trends in Islamic Trade Financing in Malaysia In Malaysia, Islamic Trading Finance has gradually gained acceptance due to the distinct advantages. 22 Source : BNM GROWTH OF TRADE BILLS IN MALAYSIA (in RM’Mil)

24 Islamic Trade Financing : Challenges Islamic Trade Financing : Challenges 1. Differential in views of Islamic scholars on Bai’ Dayn Scholars in the Middle East have different views on bai’ dayn. 2. Interest on Remittance Days of LC Establishing LC where no interest is payable on remittance days. 3. Differential in Rates between BA and AB-I Currently, AB-I rate is lower than BA rate due to the liquidity in Islamic Banking. The position may be different in the future. 23

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