Islamic Trade Finance – What Happens to Ownership When a Letter of Credit (LC) Is Issued?

Islamic Trade Finance – What Happens to Ownership When a Letter of Credit (LC) Is Issued?
Short Answer
Issuing a Letter of Credit (LC) alone:
does NOT automatically transfer ownership of the goods to the bank.
Ownership depends on:

• the underlying sale contract;
• when ownership transfer occurs;
• who purchased the goods.

The LC itself is mainly:
a payment undertaking by the bank.


Important Principle
Letter of Credit (LC)
➡️ payment mechanism.
Bill of Lading (B/L)
➡️ control/possession document.
Sale Contract
➡️ determines ownership.


Chronological Ownership Explanation
Example Scenario
A Malaysian customer wants to import:

• a Toyota car from Japan.

Car Price
RM200,000
The customer requests:

• Islamic bank financing through murābahah.

STEP 1 — Customer Requests Financing
Customer asks:
“Please finance the import of this car.”
At this point:
❌ nobody new owns the car yet.
The exporter still owns the car.


STEP 2 — Islamic Bank Issues Letter of Credit
The Islamic bank issues:
a Letter of Credit (LC)
to exporter.


IMPORTANT POINT
At this stage:
❌ ownership still does NOT transfer to bank merely because LC is issued.
Why?
Because:

• LC is only a promise to pay;
• not a sale contract by itself.

Thus:
✅ exporter still owns the car.


STEP 3 — Exporter Ships the Car
Exporter loads car onto ship.
The shipping company issues:

• Bill of Lading (B/L).

The B/L names:

• Islamic bank;
  or
• “to the order of Islamic bank.”

Does B/L Automatically Transfer Ownership?
Not necessarily.
The B/L mainly gives:
✅ control over delivery/access to goods.
Ownership depends on:

• underlying purchase contract;
• commercial terms.

STEP 4 — Bank Pays Exporter
After exporter submits compliant documents:

• Islamic bank pays exporter.

Now we ask:
Did the bank purchase the car from exporter?


IF YES → Ownership Transfers to Bank
In Islamic murābahah financing:
usually:
✅ the bank purchases the goods from exporter first.
Thus:

• ownership transfers to bank;
• bank bears ownership risk;
• bank controls B/L.

Now:
✅ bank owns the car during shipment.


STEP 5 — Bank Sells Car to Customer
The bank later sells:

• the car to customer through murābahah.

Example:

• Bank cost = RM200,000
• Murābahah price = RM230,000

Profit
230,000 - 200,000 = 30,000



STEP 6 — Ownership Transfers to Customer
After murābahah sale:
✅ ownership transfers to customer.
The bank then:

• endorses/releases B/L to customer.

The customer:

• collects car at port.

VERY IMPORTANT DISTINCTION
LC Alone Does NOT Create Ownership
Issuing LC only means:
“The bank promises to pay.”
It does NOT automatically mean:
“The bank owns the goods.”


Ownership Comes From Sale Contract
Ownership usually transfers when:

• bank actually purchases goods from exporter.

Role of B/L
The B/L helps establish:
✅ constructive possession (qabd hukmī)
and
✅ control over delivery.
But:

• B/L itself is not always the sole determinant of ownership.

Simplified Ownership Timeline
Before LC
Exporter owns car.
⬇
After LC Issued
Exporter STILL owns car.
⬇
After Bank Purchases Goods
Bank becomes owner.
⬇
During Shipment
Bank usually owns and controls goods through B/L.
⬇
After Murābahah Sale
Customer becomes owner.
⬇
After B/L Endorsed
Customer collects car.


Islamic Finance Perspective
This distinction is crucial because:

• Islamic banks cannot merely:
  • lend money with profit.

Instead:
✅ bank must genuinely:

• purchase goods;
• own goods;
• bear ownership risk;
• then resell goods.

Otherwise:
❌ transaction may resemble ribā-based financing.


Important Principle
LC
➡️ payment guarantee.
B/L
➡️ control and constructive possession.
Ownership
➡️ determined by actual sale contract and transfer of ownership rights.