Current Legal Issues

Letter of Credit

1. Import

When someone intends to import foreign merchandise, he approaches the bank to open a letter of credit (L/C). The bank gives an undertaking to handle the papers of the imported goods, deliver it to the L/C holder and pay the exporter the cost thereof. Of course, this could be done after the completion of the transaction between the importer and the exporter, be it through exchange of communications or through the agent in the country of origin. Dispatch of documentation containing specifications and quantity of the goods, and conditions agreed should also have been concluded between the two parties. Also, the importer should have paid, in part, the cost of the goods to the bank. Only then would the bank receive the whole gamut of documentation and pay the cost to the exporter.

2. Export

Export L/C differs from the Import L/C in name. That is, the foreign importer goes through the whole process as explained above in the country that imports the goods.
In essence the two L/Cs do not differ. The crux of the matter is the undertaking given, by the bank, to the seller [exporter] to (a) settle the debt of the buyer [importer], which is the price of the goods bought, and (b) receive the documentation from the seller and deliver them to the buyer.
However, there is another type of L/C, where the exporter sends the documentation to the bank or its branch in the [country of origin] without prior correspondence with the party intending to import the goods. The bank, [acting as a middle man], approaches the importer with the documentation. If there is acceptance of such documentation, the importer will ask the bank to open the L/C for them. The bank will then see the whole process through until the importer takes delivery of the goods and the exporter receives the price thereof.

(9) Apparently, it is permissible to open L/C with the banks in all the above departments. It s also permissible for the banks to carry out such services.

(10) The bank shall receive from the L/C holder two kinds of charges:

1. The first is for its services stemming from the undertaking given by it to the exporter, and for the paperwork and the like.
This sort of charge is in order on the understanding that it constitutes part of the contract [between the bank and the customer]. That is, the L/C holder agrees to pay the bank such a charge in return for carrying out such services on behalf of the customer. It could, however, be included in the ijarah agreement, provided it fulfils the conditions mentioned therein.
2. The second type of charge takes the form of interest on the sum of money the bank paid to the exporter from its own money, i.e. not from the L/C holder's own account. This proportional interest is charged on the advance made to the L/C holder for a specified period.
Charging such interest may be justified on the premise that the bank is not embarking on a lending process that involves the L/C holder. Neither the price of the goods forms a part of its property according to the loan agreement. Thus, it is not considered usury.
Indeed, the bank pays the debt of the L/C holder at his request. However, from a standpoint of the law of waste, the security of the L/C holder would be a sort of penalty, and not a loan surety for the payment of interest to be haraam.
However, evidently the L/C holder cannot secure for the bank the repayment of the debt per se. Charging interest, therefore, for the delay in repaying the debt is usury that is haraam.
Of course, if the L/C holder undertakes to pay back to the bank the original amount of debt plus the prescribed amount of interest as credit for, say, two months, this should fall under the terms of ijarah agreement. Its being in order is one strand of opinion.
There is, however, another way to avoid usury involved in charging such interest. That is, it could be stipulated in the terms of sale, in that the bank settles the price of the goods in foreign currency. The bank could, then, sell an amount of foreign currency, that is lent to the importer, equivalent to the currency of his country plus the interest. Since the price and the goods are two different things, there is no harm in it.
The rulings discussed above concern national banks. As for banks solely owned by the state and those of joint ownership, where the bank settles the debt of L/C holder from the money of majhoulil malik, the customer is not legally [from the viewpoint of Islamic law] considered a debtor to the bank. The undertaking, therefore, to pay the interest to the bank does not amount to an undertaking of paying usury that is haraam.