Current Legal Issues
BANKING AND FINANCIAL SERVICE
(2) Letter of Credit (L/C)
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.
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
(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:
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.
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
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
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
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.