Islamic Contract – Application of Tawarruq in Islamic Finance

​Islamic Contract – Application of Tawarruq in Islamic Finance
1. What Is the Application of Tawarruq in Islamic Finance?
Answer
Tawarruq is:
one of the most widely used Sharī‘ah contracts in contemporary Islamic finance.
It is extensively utilised to structure:
✅ deposits;
✅ financing facilities;
✅ liquidity management;
✅ debt restructuring;
✅ ṣukūk;
✅ risk management;
✅ hedging products.


2. Why Is Tawarruq Popular in Islamic Finance?
Main Reason
Tawarruq is popular because:

• it provides:

liquidity and cash financing
through:

• sale-based structures.

It also offers:
✅ operational flexibility;
✅ scalability;
✅ standardisation for banking products.


3. Practical Applications of Tawarruq
A. Deposit Products
Islamic banks use tawarruq to structure:

• fixed deposits;
• term deposits;
• investment accounts.

Case Scenario 1 – Tawarruq Deposit
A customer deposits:

• RM100,000
  with Islamic bank.

The bank:

• purchases commodity;
• sells commodity to customer on deferred basis;
• customer sells commodity for spot cash.

The deferred sale price includes:

• bank’s profit.

Example
Spot Commodity Price
RM100,000
Deferred Sale Price
RM105,000


Profit
105{,}000 - 100{,}000 = 5{,}000
105{,}000 - 100{,}000 = 5{,}000


Result
The customer:
✅ receives investment return.
The bank:
✅ obtains funding liquidity.


B. Personal Financing
Tawarruq is widely used in:

• Islamic personal financing;
• home financing;
• business financing.

Case Scenario 2 – Personal Financing
A customer needs:

• RM50,000 cash financing.

The Islamic bank:

1. purchases commodity;
2. sells commodity to customer:
   • RM60,000 deferred;
3. customer sells commodity in market:
   • RM50,000 spot cash.

Profit
60{,}000 - 50{,}000 = 10{,}000
60{,}000 - 50{,}000 = 10{,}000


Result
The customer:
✅ obtains liquidity.
The bank:
✅ earns financing profit.


C. Liquidity Management
Islamic banks use tawarruq for:

• short-term liquidity placement;
• interbank financing;
• treasury management.

Example
An Islamic bank with excess liquidity:

• enters tawarruq transaction with another bank
  to:
• place short-term funds.

D. Debt Restructuring
Tawarruq may be used:

• to restructure existing financing obligations.

Case Scenario 3 – Debt Restructuring
A customer struggles to repay:

• existing financing of RM200,000.

The bank restructures debt through:

• tawarruq arrangement
  with:
• revised deferred payment schedule.

E. Ṣukūk Structuring
Tawarruq structures may support:

• issuance of Islamic investment certificates (ṣukūk).

F. Risk Management and Hedging
Tawarruq may also facilitate:

• Sharī‘ah-compliant hedging;
• liquidity balancing;
• treasury operations.

4. Why Has Tawarruq Become Dominant?
Operational Advantages
Tawarruq provides:
✅ liquidity generation;
✅ predictable cash flow;
✅ ease of implementation;
✅ compatibility with modern banking systems.
Thus:

• Islamic financial institutions heavily rely on it.

5. BNM’s Concern Regarding Tawarruq Dominance
Regulatory Concern
Bank Negara Malaysia has expressed concern that:
tawarruq has become excessively dominant in Malaysian Islamic finance.


Financial Sector Blueprint 2022–2026
BNM highlighted:
Islamic financial institutions should diversify Sharī‘ah contracts.
The objective is:
✅ broader economic impact;
✅ value-based finance;
✅ wider social benefit.


Why Does BNM Want Diversification?
Overreliance on tawarruq may:

• reduce product innovation;
• narrow Sharī‘ah diversity;
• create excessive dependence on:

debt-based financing structures.


Critical Analysis
Some critics argue:

• excessive tawarruq usage may:
  • replicate conventional financing outcomes;
  • weaken trade-based economic substance.

Example of Criticism
In many tawarruq transactions:

• commodities are merely traded briefly;
• parties primarily seek:

cash financing.
Thus:

• critics argue:

the commodity sometimes functions only as an intermediary mechanism.


6. Practical Shift Encouraged by BNM
BNM encourages Islamic banks to expand usage of:
✅ mushārakah;
✅ muḍārabah;
✅ ijārah;
✅ salam;
✅ istisnā‘;
✅ wakālah-based financing.


Objective of Diversification
The goal is:
to develop a more authentic and socially impactful Islamic finance ecosystem.


7. Critical Sharī‘ah Debate on Tawarruq
Supporters’ View
Supporters argue:
✅ tawarruq fulfils legal Sharī‘ah requirements;
✅ contracts remain valid individually;
✅ commercial necessity exists.


Critics’ View
Critics argue:

• excessive organised tawarruq may:

replicate conventional lending in substance.


Main Sharī‘ah Concern
The debate centres on:
whether tawarruq represents:

• genuine trade,
  or
• synthetic liquidity generation.

Overall Conclusion
Tawarruq remains:
one of the most important and widely used contracts in Islamic finance.
It is heavily utilised for:

• financing;
• deposits;
• liquidity management;
• treasury operations.

However:

• regulators such as BNM increasingly encourage:
  ✅ diversification of Sharī‘ah contracts;
  ✅ stronger value-based finance;
  ✅ reduced dependency on tawarruq-dominated structures.