Operational Mechanisms of Islamic Accepted Bill

©Prof. Dr. Mohd. Ma’sum Billah1

Introduction

Islamic Accepted Bill (IAB) is one of the Islamic financial instruments that are traded in

Islamic Inter-bank Money Market (IIMM).2 IABs are traded based on Murabahah and

Bay’ al Dayn concepts similar to the other financial instruments such as Green-bankers

acceptances, Islamic mortgage bonds and Islamic private debt securities. The IIMM, in

turn, is the place where a set of activities are carried out including purchase and sale of

Islamic financial instruments among market participants, inter-bank investment activities

and a cheque clearing and settlement.

1 Professor of Islamic Financial Regulations, King Abdul Aziz University, Jeddah. Professor of Islamic Financial Applications, University of Camden, USA. Assoc. Professor of Law (Insurance, Takaful, Islamic Banking, Finance & E-Commerce), Faculty of Economics and Management Sciences, International Islamic University Malaysia. He is also an Adviser and Consultant to several Companies and Institutions (Internationally & Locally ) on Insurance, Banking, Financial and IT regulations, Wealth & Asset Management, Islamic Bond Market, Gold Dinar and so on under both modern principles and Shari’ah Discipline. Also the author of http//.www.islamic-insurance.com. E-mail: masum2001@yahoo.com

2 Nor Mohamed Yakob, Money Market in Islamic Banking: The Problems of Thin Trading, Paper presented in the conference on SPTF and Islamic Banking Products, December 1995

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Islamic Accepted Bills arises from the situation when the customer on behalf of a bank

buys goods that he or she wants while the bank sells them back to the customer at a

deferred payment basis. The bank makes payment in lump sum for the goods purchased

by its customer on its behalf and sells those goods to the customer on the deferred

payment basis. These due payments represent profit for the holders of the Islamic

Accepted Bills that are traded in the secondary market. Islamic Accepted Bills are mostly

used to finance imports and export or local purchases and sales, provided that the traded

goods are halal.

This paper will analyze Islamic Accepted Bills in terms of structure and operations. First

of all, we define Islamic Accepted Bills and show what its operational procedures. Next,

we present some of the guidelines imposed on trade and issuance of Islamic Accepted

Bills. The third part will explain how Islamic Accepted Bills are traded in the secondary

market, who are the users and traders and what basis of pricing used. Finally, we address

the Shari’ah point of view on Islamic Accepted Bills in terms of their acceptability.

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Understanding Islamic Accepted Bills

Islamic Accepted Bill is one of the instruments traded on Islamic Inter-bank Money

Market (IIMM) and based on the concept of Al-Murabahah/Bai’ Al-Dayn.3 Islamic

Accepted Bills is an order to a bank by its customer obliging it to pay a certain amount of

money to the holder of the acceptances bill. The bank makes payment in lump sum for

the goods purchased by its customer on its behalf and sells those goods to the customer

on the deferred payment basis. These due payments represent profit for the holders of the

Islamic Accepted Bills that are traded in the secondary market to another party. It attracts

a very attractive price because it is a negotiable instrument. The customer is, therefore,

financed at a very attractive rate.

Islamic Accepted Bill is similar to Bankers Acceptance. Bankers Acceptance is a bill

with a certain face value issued by a bank to the customer at a discount.4 The discounted

value of the bill is credited to the customer’s account while the customer pays back the

face value at the maturity date. For example a Bankers Acceptance Bill might have a

face value of RM 2 million, while the amount of money credited to the customer’s

account is RM 1.9 million. The difference between the face value and the discounted

value (the amount of money credited to the customer’s account) represent interest

payment. Bankers Acceptances are used for project financing and traded on the

secondary market. The Islamic Accepted Bill is introduced as an alternative to Bankers

Acceptance in view of the need to provide customers an Islamic alternative.

The difference between the Bankers Acceptance and Islamic Accepted Bill is the absence

of interest payments in the case of Islamic Accepted Bill. Interest is not allowed in Islam

and, therefore, the profit in Islamic Accepted Bill is said to be derived from trading which

is permissible. The profit by trading is derived through the contracts of Murabahah.

Murabahah refers to the sale of a good at a price based on cost-plus profit margin agreed

by the both parties. Here the Islamic bank appoints a customer as agent to purchase the

3 Nor Mohamed Yakob, Money Market in Islamic Banking: The Problems of Thin Trading, Paper presented in the conference on SPTF and Islamic Banking Products, December 19954 Saiful Azhar Rosely, Islamic Project Financing in Malaysia, A collection of his articles on “Islamic Banking and Finance”, 2003

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goods at cost. The bank guarantees the payment to the supplier. Then, the bank sells the

goods to the customer where credit to be settled in say, 90 days. The selling price

includes cost and profit which is called a mark-up price. The bank then draws a bill on

the customer who accepts the bill at the mark-up price. The holder of the bill, i.e. the

bank can sell the bill to the third party at a price not less than the cost.5 Such sale is based

on the bay’ al dayn contract. Bay’ al dayn refers to the sale of a debt arising from a trade

transaction with a deferred payment.

Islamic Accepted Bills are widely used in financing imports and exports. It is an

alternative to the Bankers Acceptance Bill that is used to finance purchases and sales by

conventional banks. Islamic Accepted Bill, however, is used only in transactions

involving halal goods and services. Examples of using Islamic Accepted Bills in imports

and exports are as follows:

Islamic Accepted Bill-Imports (Al-Murabahah/Bai’ Al-Dayn)

The customer can approach the bank to provide financing for his working capital

requirements to import inventories or raw materials. The bank purchases the required

goods and settles the purchase price from its own funds. Then, the bank sells the goods to

the customer at an agreed price comprising its purchase price and a profit margin and

allows the customer to settle this sale price on a deferred term of 30 days, 60 days or 90

days. Lastly, on the due date the customer pays the Bank the agreed sale price on

maturity date of the financing. The sale of goods by the bank on deferred payment term

constitutes the creation of debt. This debt is securitized in the form of a bill of exchange

drawn by the bank on the customer for the full amount of the bank’s selling price payable

at the maturity. Islamic Accepted Bills are traded in the secondary market based on bay’

al dayn concept. This makes them an attractive financing instrument with low cost.

Islamic Accepted Bill – Exports or Sales ( Bai’ Al-Dayn )

5 Saiful Azhar Rosely, Islamic Project Financing in Malaysia, A collection of his articles on “Islamic Banking and Finance”, 2003

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The bank finances exports and sales under the principle of Bai Al-Dayn. Under this bill,

an exporter who wishes to avail himself of this facility, prepares export documents as

required under the sale of contract or letter of credit. He represents these documents to

the Bank to be purchased. As the export documents have to be sent to the buyer overseas,

the exporter is requests by the bank to draw another Bill of Exchange drawn on the bank.

This bill is known as Islamic Accepted Bill-Exports (IAB-Exports). The IAB-Exports can

be traded in secondary market.

Determining the Price of Islamic Accepted Bill

The holder of the Islamic Accepted Bill may resell it to any other person. The price of an

IAB used for financing sales is determined using the following formula6:

P = FV ( 1 – rt / 36500 )

Where,

P = Market Price or sale proceeds

FV = Face or maturity value

r = Annual rate of profit (in percentage)

t = Number of days remaining to maturity

The price of an IAB used for financing purchases is determined using the following

formula:

P = IV ( 1 + rt / 36500 )

Where,

P = Market Price or sale proceeds

IV = Invoice value

r = Annual rate of profit (in percentage)

t = Number of days remaining to maturity

A certain commission may be charged for services related to IAB acceptance. In case of

IAB for sales, the drawer of an IAB may pay to the bank the commission of acceptance 6 Bank Negara Malaysia, Guidelines on Interest-Free Accepted Bills, March 4, 1993

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service. On the other hand, in case of IAB for purchases, the drawer may charge the

acceptor a commission for the drawing services. Where such a commission is payable,

the rate of commission shall be determined on the basis of the agreed proportion of the

maturity face value of the IAB, expressed in percentage per annum.

Features of the Islamic Accepted Bill

As mentioned earlier, Islamic Accepted Bills are similar to Bankers Acceptance and but

were introduced as an alternative for Islamic institutions that can get the same benefits of

Bankers Acceptance facility used by conventional banks. There are a number of features

that make Islamic Accepted Bill distinct from Bankers Acceptance. Some of these silent

features of Islamic Accepted Bill are as shown below:

1. There are two types of financing under Islamic Accepted Bill facility, namely: Imports

and local purchases; and Exports and local sales.

2. The financing would be done under Murabahah concept whereby a customer purchases

the required goods from the seller on behalf of the bank which pays for the goods and

resells them to the customer at a price inclusive profit margin and based on deferred

payment. The maximum time allowed for a deferred payment is up to 200 days.

3. The deferred payment constitutes a creation of debt. This debt is securitized in the

form of bill of exchange drawn by the bank and accepted by the customer for the full

amount of the bank’s selling price including cost and profit margin payable on the day of

maturity. Islamic Accepted Bill can be sold in the secondary market at an agreed price

using the concept of bay’ al-dayn. Here, it is the bank that draws an Islamic Accepted Bill

while the importer or purchaser becomes the acceptor.

4. Similar to letter of credit arrangement, an exporter who wants to use Islamic Accepted

Bill prepares and sends export documents to the importer’s bank. The exporter draws on

the domestic bank a new bill of exchange and this becomes an Islamic Accepted Bill. The

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bank purchases the Islamic Accepted Bill at a mutually agreed price using the concept of

bay’ al-dayn. The proceeds will be credited to the exporter’s account. In this case, it is

the exporter who draws the Islamic Accepted Bill and the bank is an accepting party.

5. Islamic Accepted Bills can be purchased and sold using forward purchase and forward

sales agreements. Forward Purchase is a separate agreement whereby the purchasing

party agrees to purchase Islamic Accepted Bills at an agreed price on a future specified

date. On the other hand, Forward Sale is an agreement to sell Islamic Accepted Bills at an

agreed price on a future specified date. There shall be two undertaking agreements in

forward purchase and forward sale transactions.

Guidelines and Regulations on Islamic Accepted Bills

After its introduction in 1991, Islamic Accepted Bill facility became very popular in the

areas of trade and finance. With such a significance development in that product, in 1992,

the Bank Negara saw a need to revise the Guidelines on bankers Acceptance and

undertaken a full review to revise the Islamic Accepted Bill guidelines issued first in

1989. These guidelines are briefly presented below:7

1. An IAB can be drawn on and accepted by a bank or purchaser under the following

circumstances only:

a) The IAB is drawn to finance geniuine trade transactions

b) The drawer, in case of IAB sale, makes a declaration that he has not obtained

or will not obtain another source of financing.

c) The goods involved in the trade transaction are tangible and halal goods.

Services will not be eligible unless specifically provided for in Guidelines.

d) Adequate documentary evidence must be presented to the accepting or drawing

bank.

2. An IAB may be drawn to finance a trade transaction between two related companies,

provided that:7 Bank Negara Malaysia, Guidelines on Interest-Free Accepted Bills, March 4, 1993

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a) The related companies are separate legal entities

b) The transaction was undertaken resulting in a genuine transfer of title to the

goods concerned, evidenced by the proper and documents.

3. An IAB shall not be drawn to finance any trade transaction between two business

entities of sole proprietorships where the proprietor is the same person or between two

business entities of partnerships where the majority of partners are the same persons.

4. An IAB shall not be drawn to finance a sales transaction on which the seller has

provided a leasing, hire purchase or factoring facility to the buyer for the settlement of

that transaction.

Application of Islamic Accepted Bills

As we already mentioned earlier, there are two types of financing under Islamic Accepted

Bill (IAB) facility:

1. Imports and local purchases; and

2. Export and local sales

Imports and Local Purchases

The financing of this contract will be under al-Murabahah working capital mechanism.

For this concept, the bank appoints the customer as the purchasing agent for the bank.

The customer then purchases goods required from the seller on behalf of the bank, then

the bank pays the seller and resells the goods to the customer at a price inclusive of a

profit margin. The customer will be allowed for a deferred payment term up to two

hundred days. After maturity of al-Murabahah financing, the customer will pay the bank

the cost, original plus the profit margin8.

Al-Murabahah Working Capital Financing

8 Bank Negara Malaysia, Guidelines on Interest-Free Accepted Bills, March 4, 1993

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Export and Local Sales

The bank finances exports and sales according to the concept of Bay’ al-Dayn. Bay’ al-

Dayn or debt financing is a short term financing facility. It is where the bank purchases

the customer’s right to the debt which is normally securitized as Islamic Accepted Bill.

The customer’s account will be credited with purchase price less bank’s charges. The

price of al-dayn will be agreed upon the customer and the bank. After this, al-dayn may

be sold to a third party.

The sale of goods on a deferred payment term creates debt. This debt in the form of a bill

of exchange drawn by the bank on and accepted by customer for the full amount of the

bank’s selling price payable at maturity. The bank may sell the Islamic Accepted Bill to a

third party, then the concept of Bay’ al-Dayn will be used whereby the bank will sell the

Islamic Accepted Bill at an agreed price9.

The purchase of debt by the bank will at the current financing rate at the market.

However, Bank Negara Malaysia, in its effort to encourage exports from Malaysia, has

9 Bank Negara Malaysia, Guidelines on Interest-Free Accepted Bills, March 4, 1993

Supplier ofGoods

Customer Acting On Behalf Of Bank as A an Agent for Bank

Bank

1) Purchase order

2) Supplies goods to the customer

4) Bank Sells Goods on

Deferred Basis

5) Pays the Bank Cost+ Profit Margin

3) Pays cash

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introduced a scheme known as the “Export Credit Refinancing Scheme”, using this

scheme the bank may resell this debt or al-dayn to Bank Negara Malaysia at a special

price. Bank Negara Malaysia, however, limits the availability of this financing scheme to

certain goods only.

Shari’ah Point of View on Islamic Accepted Bills

We have seen in the above section that the application of Islamic Accepted Bill creates

debt or al-dayn and in this section of our assignment we will discuss Shari‘ah point of

view regarding the sale of al-dayn.

The Nature of Bay` Al-Dayn

The issue of bay’ al-dayn arises when the IAB are traded in the secondary market.

We may now discuss Bay` al Dayn to show its nature according to Islamic point of view.

According to al-Majallah10, dayn defines as the thing due i.e the amount of money owed

by a certain debtor. So also a sum of money not existing is considered a debt, as also a

certain sum of money from things which exist or are present, or from a heap of wheat

which is present before it is separated from the mass. Al-Dayn can be either monetary, or

a commodity, like, food or metal. Based on the aforementioned of al-Dayn, and the literal

meaning of Bay’ al-Dayn we can define it as the sale of payable right either to the debtor

himself, or to any third party. This type of sale is usually for immediate payment or for

deferred payment (al Nasi’ah).

Sale of Al-Dayn to a Third Party

According to most of Hanafis, Hanbalis and Shafis jurists11, it is not allowed to sell al

Dayn to non-debtor or a third party at all. Such opinions are based on the forbidden sale

of al Kali Bil al Kali, sale of a Gharar, sale which the seller does not possess.

10 Majallah al-Ahkam al c Adliyyah, Art. No. 158.11 Al-Zuhili, Bay’ al Dayn in the Shari’ah, pp. 35/6

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A prophetic tradition which clearly states: “Do not sell what you do not possess”

Selling al-Dayn to a third party is allowed with conditions

As an exception Malikis, Hanafis and some Shafi’s jurists allowed selling al-dayn to a

third party. They said that there is no authentic source which prohibits such kind if

selling. Therefore, it should be allowed and permitted since the Dayn is Mustaqir

(confirmed debt). Since the creditor has the right to sell it to the debtor, as well as he has

the right to sell it to a third party provided the following rules must be observed:

a) The Dayn must be Mustaqir (confirmed debt) and the contract must be performed on

the spot, not deferred in order to avoid any relationship with the sale of a debt for a debt

which is prohibited by Islamic law.

b) The debtor must be a financially capable, must accept and recognize the sale, in order

that he will not deny the sale. This condition aims to avoid any dispute between the

parties, and the debtor must be easily accessible so that the creditor knows whether he has

the capacity to pay his debt or not.

c) The sale should not be based on selling gold with silver or opposite, because, any

exchanges between these items necessitates the immediate possession, and if the debt is

money, its price in another debt should be equal in terms of amount of quantity.

Furthermore, the selling of al-dayn must avoid the occurrence of Riba between the two

debts, and must also avoid any kinds of Gharar which may be raised at the level of

inability of the buyer from possessing what he bought, as it is not permitted that the buyer

sells before actual receipt of the purchased item.

It is important to note that Muslim scholars have unanimously prohibited the trading of

debt (bay` al-dayn) at anything other than face value. Where the price paid for a debt is

not the same as the face value of that debt, the transaction would be tantamount to riba

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al-Nasi’ah and is therefore prohibited. Any profit created from the sale and purchase of a

debt is riba.

"And whatever riba you give so that it may increase in the wealth of the people, it does

not increase with Allah." [Ar-Rum 30:39]

Prophet Muhammad (S.A.W) said: “That every loan entailing benefit is usury”12

The IAB would have been acceptable from an Islamic point of view if the application of

the mode of financing would be based on the legal maxim of al-Ghunmu bil ghurmi13

meaning that no person is allowed to invest in a way that generates profit without

exposing himself to the risk of loss. It would expose both parties to the outcome of their

deal, be it a profit or a loss, and thus avoid of usury as matter of Islamic principle.

12 Al-Shirazi, al-Muhadhab, vol. 1, p. 304.13 Majallah al-Ahkam, Art. 87.

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Conclusion

Islamic Accepted Bills is indeed a low cost financing for businesses in purchases and

sales of inventories, raw materials and finished goods. The low cost is due to the

exchange of Islamic Accepted Bills in the secondary market. After its introduction in

1991, Islamic Accepted Bill facility in Malaysia became very popular in the areas of

trade and finance.

A set of guidelines were issued by the Bank Negara of Malaysia in regulating the

transactions involving Islamic Accepted Bills. Islamic Accepted Bills are based on

Murabahah and Bay’ al Dayn concepts. Consequently, the Shari’ah ruling for Islamic

Accepted Bills is similar to the one applied to Bay al Inah which involves Bay’ al dayn.

That is, majority of ‘ulama in the Middle East do not agree with such transactions, while

some of the ‘ulama, have accepted them based on the valid external evidence of sale.

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