Both traditional and Islamic banks have to deal with short term cash issues. They either have too much cash which needs to be invested to maximize return or they need cash to fund a project at hand. Traditional banks can borrow and lend cash through money market instruments which involve interest based transactions. Islamic banks do not have this luxury, yet they have to devise ways to deal with this situation in order to compete with traditional banks.
The Islamic banks have developed reverse and organized Murabaha instruments to manage liquidity issues. The former is used to obtain or receive cash from another institution or a customer while the latter is used for disposing of excess cash. In reverse Murabaha, a customer (or another bank) purchases a commodity at spot price and immediately sells it to the bank at an agreed deferred price which is higher than the purchase price. The bank then sells this commodity back to obtain the cash. In organized Murabaha, the roles are reversed and the bank buys a commodity at spot price and sells it to a customer or another bank for a deferred, higher price. The customer then sells the commodity at spot price and obtains cash. Appropriate transaction charges and broker commissions are also charged according to the contract. The following figures illustrate the two techniques.
These instruments are frequently used by Islamic banks in interbank operations to manage cash flow. The banks utilize brokers to buy and sell the commodities. Sometimes no actual transactions take place but it is just an entry in the computer or on paper. It is imperative for Shari’ah compliance that banks actually take ownership of the commodity and assume market risk, however brief, otherwise it might be considered a simple interest based transaction.
Shari’ah scholars have warned against this practice. Standard setting bodies for Islamic financial institutions have set limits on this kind of transactions. For example, they do not allow organized Murabaha with traditional banks if the money would be used for lending on interest. OIC Islamic Fiqh Academy encourages establishment of Qard Hasan funds for the benefit of customer so they do not have to resort to Tawarruq for short term cash needs.
