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.
- Avoidance of Riba (Usury): Tawarruq is structured to ensure that there is no interest involved in the transaction, aligning with Islamic finance principles.
- Tangible Commodity: The use of a tangible commodity in the transaction makes the process compliant with Shariah, as Islam encourages transactions involving physical assets.
- 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.