Understanding tawarruq: a simple guide

In the realm of Islamic finance, the term ‘tawarruq’ holds significance as a financial arrangement designed to meet the principles of Shariah law. For those unfamiliar with Islamic finance, the concept may seem complex, but in simple terms, tawarruq is a structured transaction that enables individuals to access liquidity without violating Islamic prohibitions on riba (usury or interest).

What is Tawarruq?

Tawarruq involves a sequence of transactions that allow a person to obtain cash or credit without directly involving interest. The process typically includes three parties: the individual in need of funds, a financial institution, and a commodity market.

Step 1: Request for cash

The person in need of funds approaches an Islamic financial institution (e.g. a bank) to request a certain amount of cash or credit. This could be for various purposes, such as purchasing a home, starting a business, or covering unexpected expenses.

Step 2: Purchase of a commodity

The financial institution then purchases a tangible commodity, such as metals, from a commodity market. The purchase is usually made on a deferred payment basis, meaning the financial institution agrees to pay for the commodity at a later date.

Step 3: Selling the commodity

Once the financial institution owns the commodity, it sells it to the individual who initially requested funds. The sale is conducted at a higher price than the deferred payment amount, and the buyer agrees to pay in installments.

Step 4: Repayment

The individual repays the financial institution over an agreed-upon period, effectively settling the debt. The higher selling price is not considered interest but rather serves as compensation for the deferred payment and risk taken by the financial institution.

Key Principles
  1. Avoidance of Riba (Usury): Tawarruq is structured to ensure that there is no interest involved in the transaction, aligning with Islamic finance principles.
  2. Tangible Commodity: The use of a tangible commodity in the transaction makes the process compliant with Shariah, as Islam encourages transactions involving physical assets.
  3. Deferred Payment: The deferred payment aspect allows individuals to access funds without resorting to conventional interest-based loans.

In essence, tawarruq is a financial tool rooted in Islamic finance principles, providing individuals with a Shariah-compliant means of accessing liquidity.

By navigating the complexities of financial transactions through the purchase and sale of tangible commodities, tawarruq offers an alternative to conventional interest-based systems, allowing individuals to meet their financial needs while adhering to Islamic principles.

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