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Institutional Tawarruq - A Prohibited Practice

Institutional Tawarruq - A Prohibited Practice

(Dr. Hussain Hamed Hassan)


Islamic banking has achieved a significant and notable growth in the recent past throughout the world from east to west. More important to note is its contribution to the development of the society by participating in the investment activities such as international trade, real estate, infrastructure and industrial development, aviation, and telecommunications etc.


In its journey towards growth, the Islamic banking industry has faced numerous challenges internal as well as external and ideological as well as practical; some it was successful to overcame and some it is still facing.


In my opinion, Tawarruq, as is being practiced by a handful of Islamic banks and financial institutions, is one of the most critical internal and ideological challenges Islamic banking industry is facing. This is because such banks are still not convinced with the fact that there is a substantial difference between the Islamic banks and conventional banks and applying Tawarruq in Islamic banking practices does contradict the fundamental purpose Islamic banks exist for. This is in spite of strong criticism against such illogical and unscientific approach of these banks and a series of pronouncements and resolutions from well-known Sharia scholars, Sharia regulatory bodies and academies.


In this paper we will analyse, from the perspective of Islamic jurisprudence, the point of view of those who are in favour of practicing Tawarruq in Islamic banking transactions.



Tawarruq is a terminology we find in the books of Hanbali school of thought and it applies when a person needs cash and purchases a commodity at a price higher than its market price on deferred payment terms so that he may sell it to a third party at a lower price on cash basis. The intention of that person here is to purchase a commodity which he does not need at all. He only needs cash by selling that commodity.


In the above meaning, Tawarruq is permissible for individuals with the difference of opinions among jurists. It was mentioned that one of the opinion of Imam Ahmed is that it is not permissible. Omer Ibn Abdul Aziz told that it was the real riba (interest).


Tawarruq and Islamic banks

Based on the permissibility of Tawarruq by some jurists for individuals, some banks started using it as a new and friendly product to their customers to facilitate obtaining the cash against a higher value of cash on deferred payment basis by adopting a series of purchase and sale contracts. The basis of the opinion of those who advocated such practice was, in addition to the above permissibility for individuals by some jurists, was that they interpreted and applied some verses of Quran (Ex. “Allah has allowed trade and forbidden interest”) and a few traditions of Prophet Muhammad (PBUH) (Ex. Hadeeth about dates) in their generality. The idea behind deriving such opinion was their concern that Islamic banking has no alternative to advance cash to the customers, ignoring the fact that Islamic banks are the institutions which are investors and not the financial intermediaries or cash providers.


However, the advocates of the above opinion ignored that the intention of the jurists, who wrote about Tawarruq, was to provide guidance in a situation where an individual person purchases a commodity on deferred payment basis at a price higher than its spot price and sell the same on cash at a price less than that of its deferred price. This was permitted by some jurists while it was prohibited by others. However, no single scholar from both points of view did refer or intend that such a practice should be structured as a regular product and institutionalized by those financial institutions whose aim is to collect the savings of people and to direct the same towards investments to serve the economic development of the human society. This is because such financial institutions were not present at those times; and if they were present, the opinion of the jurists would have been different. In my opinion, as was opined by authentic jurists like Ibne Taymia and his student Ibn Al Qayyim, Tawarruq is prohibited whether it is individual or institutional due to its contradiction with the objectives of Sharia and its basic principles, although its permissibility was expressed with some insignificant Sharia arguments and evidences.


It is evident from the above comment that the institutional Tawarruq is totally different from Tawarruq practiced by individuals, and one can’t apply the rules of individual Tawarruq prescribed in Fiqh books on institutional Tawarruq.


It should also be noted that the permissibility for a newly formed Islamic window/division of a conventional bank to execute a Tawarruq transaction with those customers who had borrowed from that bank early and want to shift to the Islamic banking window/division by repaying the loans, can not be a sufficient evidence for Islamic banks to adopt Tawarruq because there is a substantial difference between the two.


As to the general interpretation and application of verses of Quran and the traditions of Prophet (PBUH), this is a void and unscientific approach because the Sharia evidences interpret and bind each other. It is the basic requirement from a Mujtahid (a competent jurist who achieves, with hard work and thorough knowledge in Sharia, an ability to derive law independently from it sources) to analyse and study the other evidences, Sharia objectives and general rules of jurisprudence.  Al Shatibi emphasizes that it is also necessary for a jurist to consider the circumstances and situations wherein an act is being performed.


As to the opinion that Islamic banks should be able to advance cash as financial intermediaries, there is no need to explain how baseless and wrong is such approach. The Islamic banks are in no sense financial intermediaries. They are Mudarib in favour of the depositors and a Mudarib is never allowed to work as a financial intermediary but to invest the capital of Rab Al Mal, along with its shareholders’ capital to earn profit and to distribute, if any, as per the agreed terms.


The basis and raison d’etre of Islamic banks and their legitimacy is that they collect the savings of the people and divert the same to large-scale development of the society by utilizing Sharia compliant modes of investment. Islamic banks never exist to extend mere financing or to provide credit, utilizing the available liquidity of the customers by way of adopting certain measures to get it repaid with a fix return after a certain period. This practice i.e. lending is easier and more convenient for the conventional banks. In other words, as is correctly mentioned by a few scholars, commodity brokerage is convenient for conventional banks with more efficiency and speed by adopting certain agreements and arrangements with selected companies.


Therefore, it is obvious that if the Islamic banks start doing this practice then it shall be understood that they have lost the foundation of their existence because the conventional banks are sufficient and capable enough to do this.


A Few Basic Sharia Principles   

Let us note, before we proceed to examine the issue in more detail, that Sharia lays down some basic principles which a Mukallaf (One who is required to perform an act as per the guidance of the Lawgiver) has to follow before making a judgment in any act for which there is no specific Sharia guidance or precedence. These are as follows: 


Principle of Consideration of Outcome

This principle requires that the judgment of being beneficial or harmful on any act or agreement performed by a Mukallaf will be taken after consideration of the outcome of that particular act or agreement, not after consideration of itself or its nearest outcome. Al Shatibi (in Al Muwafaqat 4.195) has explained this principle as follows:


“It is a valid Sharia requirement to consider whether the outcome of an acts is permissible or prohibited. The judgment will be applied on an act on the basis of its outcome. This is because the Lawgiver does not make judgment on an act of the people, whether it is an act performed or an act refrained from, but only after considering the result coming from such act. Such act itself may be sometimes permissible for a benefit to be achieved or for a harm to be avoided, but its result may be opposite to what it is intended for by itself.” Then he says further, “This is a challenging task to perform for a Mujtahid but at the same time it is a pleasant exercise which leads to an admirable outcome being applicable according to the objectives of Sharia.


Principle of Sadd Al Zaraai’ (Plugging of lawful means to unlawful ends)

Al Qarafi has defined this principle as, “To cut the substance of means to harmful ends. If the act itself is harmless but it leads towards what is harmful, then it shall be prohibited”. 


Principle of Prohibition of An Artifice Which Demolishes Primary Sharia Rules

Al Shatibi defines it as, “Performing an act which appears to be permitted for the purpose of demolishing an established Sharia rule and converting it apparently to another rule. For example, a Mukallaf donates his money shortly before the completion of the year to avoid paying Zakat.”


It was mentioned in the book “Elaam Al Muwaqqi’een” (3/125) that “If a person wants to sell 100 Dirhams against 120 Dirhams on deferred basis and for that purpose gives goods on deferred terms of payment and purchases the same on cash basis, whereby no party has any kind of interest in the goods, but it is as Abdullah Ibn Abbas said “Dirhams against Dirhams entered a piece of silk therein”, and there is no difference, neither in Sharia, nor in logic and nor in customs, between the above sale exercise with an artifice and a sale of 100 Dirhams against 120 Dirhams without such artifice. In fact, the harm for which interest was prohibited is still existent with artifice but increased because it neither could be eliminated nor be decreased. It is unimaginable that the Sharia of Allah, the Greatest of all judges, on one hand prohibits interest as an evil, curses on one who involves in it, declares the war of Allah and His prophet against him, gives him severe warning and on the other hand allows artifice to achieve the same with presence of the same evil, but its increase with effort of adopting an artifice towards disobeying and cheating Allah and His prophet. Sharia was not revealed for such acts.” “What a surprise! Is there any difference between the sale of 100 Dirhams against 120 Dirhams openly and inserting a commodity which is not intended but in fact comes in to go out? That is why the contracting party neither asks about the type, nor the quality, nor the price, nor the defects no matter it is a torn piece of cloth or an ear of sheep or a stick from firewood and this is to get interest permitted. This is because these people think the buyer has no interest in the commodity and therefore they say that any commodity available and agreed is sufficient for this artifice like any living being agreed and available for them in the chapter of marriage.”


The book “Elaam Al Muwaqqi’een” (1/124) also mentions, “Our teacher, Ibne Taimiya says, “The reason behind what Imam Ahmed said is that when Allah prohibited fat of ox and sheep for Jews, they pretended to use it in a way that they are not called to be using it prima facie and therefore they made it up with an intention to remove the name of fat from it and then utilized its price so that apparently this use does not become prohibited. Then, adopting this artifice, they thought they came out, having adopted such artifice, from the prohibition with these two methods. But Allah cursed them through the words of prophet Muhammad (PBUH) for such artifice considering the outcome and intention and to the fact that the wisdom behind the prohibition does not differ whether the fat is solid or is liquid and that it is a replacement and substitution. The fat, by melting it, was no more the word ‘fat’ but became ‘plump’ and likewise the interest, by pretending, is no more a word ‘interest’ but became ‘sale’. This is because the contracting parties have no interest whatsoever in the commodity. The Jews did not utilize the fat itself but utilized its price. This indicates that what is important is the outcome or the result.


Principle of Impermissibility of an intention against the intention of the Lawgiver

It is a well-established Sharia principle that the intention of Mukallaf should be in accordance with intention of the Lawgiver during the legislation of that act. If intention of that person in doing so is contrary to that of the Lawgiver in legislating so, then the intention of that person will be void and the intention of the Lawgiver will be valid and therefore, that contrary act will be void and shall have no effect like the marriage of a traitor or the donation of the amount of Nisab (the eligible amount to pay Zakat) before end of the year or Bail Al Inah (two sales in one sale contract). 


Al Shatiby says in his book ‘Al Muwafaqat’ (2/231), “The intention of the Lawgiver from Mukallaf is that Mukallaf’s intention in acting should be in conformity with the Lawgiver’s intention in legislation. This is evidenced from legislation of Sharia for the benefits of Mukallaf on a general and universal basis and what is desired from the Mukallaf is that he should streamline his acts accordingly and should not intend against what is the intention of the Lawgiver.”


He further says (Al Muwafaqat 2/233), “All those who intend in the legislation of Sharia against what it was intended for, they have contradicted Sharia and all those who contradict Sharia, their act in such contradiction is void and therefore every one who intended in the legislation of Sharia what it was not intended for, his act will be void.”


Al Shatiby also mentioned that all Sharia compliant contracts were legislated to achieve the benefits for all contracting parties. If the contracting parties intend, by such contracts, what these contracts are legislated for, they will be valid and otherwise they will be void. The Sharia rule of permitting the sale was given for benefit of the people because the Lawgiver does not legislate the orders uselessly as was mentioned in the principles of considering the benefits in legislation. The benefit, in a sale contract, is the need of a buyer for the goods and the need of the seller for the price. If a person purchases a commodity on deferred payment basis and then sells it on cash at a lower price intending to get cash against a higher amount of deferred cash without having need to trade in or to use that commodity and without taking care of its type or quality, he has contradicted, in this intention of him, the intention of the Lawgiver in legislating such act and therefore such intention of that person will be void and that sale contract will be prohibited.


Al Shatibi has given some examples of those contracts whereby the contracting parties intend to achieve what is contrary to the intention of the Lawgiver. Following are a few of them:


a.            The intention of the Lawgiver by legalizing the sale contract is the fulfillment of the need of the purchaser for goods and that of the seller for the price. If a person seeking Tawarruq purchases a commodity he does not need, neither for use nor for trade, but he intends to get cash on terms that he will pay a higher amount after a given period, he has, in his intention, contradicted the intention of the Lawgiver in legislating the sale contract.


b.            If the person seeking Tawarruq does not intend from his sale contract what the intention of the Lawgiver is, i.e. fulfillment of need of the purchaser for goods either to use or to trade for example, he will be intending against the intention of the Lawgiver. Such contrary intention, i.e. getting cash, is obvious and the contradiction with the intention of the Lawgiver is void.


c.            Allah has legislated gifting / donation for the benefits like upbringing of soul to attain generosity, openhandedness and kindness, cleansing of the soul from miserliness and greed and strengthening the relationship of love, affection and cordiality as was told by prophet Muhammad (PBUH) “Offer gifts, increase love”. If a person donates his money shortly before the completion of one year to avoid payment of Zakat, such donation is void because the intention of such person by donating is contrary to the intention of the Lawgiver. In fact, the intention of this person here is to deprive the poor of his right and this is misery and greed not the generosity, openhandedness and kindness. The other aspect is that escaping from Zakat and avoidance from its payment is prohibited and a criminal offense. Donation was not legislated to escape from paying Zakat and likewise, sale was not legislated to get 10 Dirhams on cash basis against 20 Dirhams on deferred payment basis. Such a contract, in fact, will be a contract of loan with interest which is prohibited and that is why such person has fabricated this by adopting some purchase and sale agreements and contracts for commodities which are not needed while the sale was legislated to fulfill the need of the purchaser for the goods either to use or to trade. 


d.            Allah has prescribed marriage for certain benefits and objectives which are well known from a number of evidences of Sharia. These are chastity, peace, love, mercy, covering, reproduction and upbringing of the children etc. When a person marries a woman for the purpose of making it legal for her to marry her previous husband (who has divorced her three times) then such a marriage is void and such a person is a rented animal. This is because the purpose of this person is against the purpose of the Lawgiver in prescribing the marriage. The marriage was not prescribed to legitimize what is prohibited but was prescribed for other benefits which aim at permanent relationship and the purpose of such person is to cut such relationship and its survival.


Tawarruq Contradicts Established Sharia Principles

Even if we say that Tawarruq is allowed between individuals, we can not say that it is a Sharia compliant mode of financing. This is because the objective of Tawarruq is to get cash and the activity in itself is not an investment activity. Saying that one who practices Tawarruq would use the cash in some investment project is far from reality and does not conform to scientific approach. The chain of agreements and contracts among the institutions which practice Tawarruq, are not the investment contracts with Sharia compliant method but they are intended for one objective and that is to provide cash to a customer.


If we say that Tawarruq by itself is allowed, in individual cases and among the people for the benefit of one who practices Tawarruq, Islamic banks can not adopt it by claiming that it is a mode of investment. This is because by using a set of agreements and contracts and involving some institutions in its execution, Tawarruq causes to loss larger benefits and effects to bring severe harms and damages and therefore is prohibited considering its outcome. This is established principle derived from a number of Sharia provisions and all of its evidences which all together are sufficient to be authoritative.


Institutional Tawarruq is a prohibited artifice (heela) because it is aimed to legalize what is prohibited, i.e. to get cash on spot basis against its repayment on deferred basis with a higher value. To achieve this, some financial institutions adopted a set of agreements and contracts which have no objective and intention for those who seek Tawarruq but are a link which connects various contracts in a single contract although it is not mentioned clearly but is known by the context, circumstances and the nature of the transaction.


Islamic banks in their nature and essence are meant to invest their shareholders’ equity and their depositors’ capital into the direct investment activities. They are not the financial brokers to provide liquidity to the customers. They make investment to produce goods and services through contractual partnerships representing the real investment modes like Musharaka and Mudaraba, or through sale contracts on deferred payment basis like Murabaha, Istisna and Salam where the customer purchases goods from the bank on deferred or Murabaha basis whereby the ownership of goods transfers to him to use it or to sell it. The customer does not get cash by purchasing the goods at a price lower than its deferred price without knowledge of the bank or its support or instruction which is the nature of Tawarruq.


Sometimes, a customer purchases manufactured goods from the bank against a purchase price and he does not receive any cash from the bank.


Sometimes, the customer purchases goods by way of Salam for the bank by receiving the purchase price so that he can utilize such amount for his production process and to deliver the goods on a future date.


All the above are direct investment modes wherein the bank performs an activity of investment, production and services which further contribute towards the development of the society which is the objective of the Islamic banks whose objective is not to provide or extend a cash facility to its customers.


Tawarruq requires the signature of three sale contracts:


1.      A contract between the bank and the company which sells to the bank the product or the commodity. The bank will never purchase the commodity without confirming that it would be sold to his clients who seek Tawarruq.


2.      A contract between the bank and the individual seeking Tawarruq. It is crystal clear that the individual seeking Tawarruq will not purchase the commodity unless he makes sure that the bank would sell the same in order to procure cash for him. The evidences and circumstances surrounding such practice lead to realize the relation between these contracts.


3.      A sale contract between the bank as an Agent on behalf of the individual seeking Tawarruq and the company that will purchase the commodities. Definitely there are also prearranged agreements between the bank and the company with an agreed price.


There is no doubt that all three contracts are correct only if all conditions were fulfilled and the payment was done, i.e. the bank’s purchase contract of the commodity and the purchase contract for individual seeking Tawarruq for that same commodity, and the bank’s sale contract for the commodity to a third party. These are all valid if they were to be looked upon separately without the existing relation between them as one transaction for a single purpose.


In fact there is that relation between such set of contracts and agreements which make this combination of numerous sale contracts into one sale contract and not only the two sale contracts. The bank purchases the commodity based on an agreement with a company with specific sale terms. In addition, the bank will not purchase the commodity without individuals requesting Tawarruq and ready to go through the transaction. Further more, the Individual seeking Tawarruq will not purchase the commodity without making sure that he would sell what he had bought with a deferred payment with immediate cash less than the purchase price. The final third party buyer, which might also be the first buyer, is purchasing the document from the bank. This entire transaction should be considered as one transaction with many parties and contracts are involved without evaluating each step of the transaction separately. We should look at the aim of the transaction, facilitated by all parties involved willingly to provide cash amounts the customers who will pay more in the future. They will also assign the roles, profit and commissions between them. This is one transaction as per the aim, and if handled on a separate level, it would not serve the ultimate goal mentioned above.


Each of the above two sale contracts, in itself, is permitted since it fulfills all basic elements and conditions but their combination is prohibited. Such a combination is an indication sufficient enough to know that this practice is aimed at getting cash on spot basis and its repayment at a higher value on deferred basis. It means that the good is a Muhallil (a temporary tool to legitimate what is prohibited) like the Muhallil of marriage.


Divorce is legal at any time and it has certain conditions and consequences like discontinuation of marital relationship and disqualification of divorcee woman to inheritance. But, when the circumstances indicate in case that a person is in his last illness and he divorces her irrevocably without her demand then such a combination is clear evidence that such person did not intend while divorcing what the Lawgiver has intended while legalizing divorce. This is a negative treatment and disaffection which makes the family relationships hopeless but in fact, the intention of the husband is to deprive his wife of his inheritance and divorce was not prescribed as a tool to fulfill such an objective.


Sale is permitted if it fulfills its conditions. But prophet Muhammad (PBUH) prohibited two sale contracts in one sale contract and he prohibited Bai Al Ina although each of the two sale contracts is permitted separately.


The militants who wage war against Allah and the peaceful Islamic state and spread mischief, will be put on war and will be killed including all those who accompany them like their guards and cooks although cooking and guarding in itself is not a reason to be killed or to be hanged or for an exile from the land. But the Lawgiver has seen all these acts as one single criminal act and Ali (R.A) decided that those who support in killing would be killed even some of them had not killed directly.


If a bank wants to provide facilities for its customer to get cash so that they repay it with a higher amount on deferred basis, it adopts, to achieve this, a way which appears to be permitted and which itself in its essence is permitted by taking certain procedures and signing a few agreements and contracts with some financial institutions. All such institutions are responsible for participating in elimination of the foundation of Islamic banks because Islamic banks are the banks for investment and large-scale development. Islamic banks invest the contribution of their shareholders and depositors into direct investment projects by way of Sharia compliant modes of investment based on the well-established principles of Sharia consisting of participation in profit and loss and sharing the risk and gain. This is the distinctive feature of Islamic banks and their line of difference from those conventional banks that provide their customer with cash facilities against a higher value on deferred basis. Such acts, at the same time, cause to affect the credibility, raison d’etre, legal status and authority of the Islamic banks. If the Islamic banks start doing the above then what is the need for their establishment? Conventional banks can do the same practice with similar procedures and the same contracts providing cash within a day or two which is a period shorter than that is required to grant a loan with interest.


We are already having complaints that Murabaha, which does not directly help achieving the real objective of Islamic banks, represents greater ratio of the activities in some Islamic banks and we have complaints of commodity Murabaha and of other similar products with suspicious investment and low returns which are not helpful for the development of society. If we add Tawarruq to the above list, we have nothing left in the account of the Islamic banks as real modes of investment and development.


Benefits lost and evils gained from Tawarruq

There are continuous and hard efforts to divert Islamic banks to such investment activities which may contribute towards the development of the society. This is by way of investing into developmental projects by way of Mudaraba, Musharaka, Salam, Istisna, Ijara and Murabaha. If Islamic banks adopt the vehicle of Tawarruq as a mode of financing to provide cash facility to the customers, help them and make for them easy to get an amount of cash to repay a greater amount of it after a period of time, then majority of the customers of Islamic banks will prefer to adopt it. This will lead to diversion of customers of Islamic banks from real investment modes of financing (like Musharaka and Mudaraba) which contribute towards the development.


A number of research centers were established and seminars, conferences and workshops were held to develop new investment modes on base of participation in gain and loss. If Islamic banks adopt Tawarruq, such efforts shall be forced to discontinue and the Islamic banks will become like the conventional banks in providing cash to their customers who seek Tawarruq.