An Islamic documentary letter of credit is a bank's undertaking to pay the exporter against compliant documents, structured as a paid agency, a Murabaha sale or a Musharaka partnership so that the bank earns no interest on any amount it advances for the importer.
How an Islamic bank opens a documentary credit
The importer submits an application stating the goods, the amount, the documents required and the latest shipment date. The bank then issues its undertaking to the exporter's bank, usually under the uniform ICC rules, and pays once the presented documents comply with the terms.
Paid agency: the bank acting on the importer's behalf
When the importer already holds the funds, the bank acts as agent, or wakil: it checks the documents, pays the supplier with the customer's own money and charges a fixed commission. No credit is extended, so no question of riba arises in this structure.
Which commissions are allowed: a fee for work, never for time
The bank may charge for issuance, amendments, document examination and correspondent costs. The commission must, however, reflect work actually performed and must not be priced as a charge for time elapsed or for the bare guarantee given to the supplier.
What happens to the margin deposited by the applicant?
The cover placed with the bank at opening can stay as a simple safekeeping deposit, or the bank can invest it on a Mudaraba profit-sharing basis. It is later applied to the supplier payment and can never earn the customer a fixed interest return.
Financing the import through a Murabaha linked to the credit
If the importer cannot pay cash, the bank buys the goods from the supplier itself, opens the letter of credit in its own name and then resells the goods to the customer at a margin disclosed in advance, payable later on an agreed schedule.
Bill of lading to the bank's order as proof of ownership
For the resale to be valid, the bank must own the goods before selling them on. Transport documents are therefore issued or endorsed to its order, which gives it legal possession and puts the risk of the cargo on the bank during the voyage.
Resale to the importer once the documents arrive
The Murabaha contract itself is signed only after the bank has become owner, often when the documents reach it. Before that, the customer has merely given a promise to purchase. The price agreed at signing can no longer rise, even if payment runs late.
Import Musharaka: co-financing a single shipment
Another route is for the importer and the bank each to contribute part of the price and become co-owners of the cargo. When the goods are resold locally, profit is split at an agreed ratio, while any loss follows each partner's capital contribution.
Where conventional trade practice clashes with Sharia rules
Several standard trade finance habits rest on interest: refinancing of acceptances, late-payment penalties and conventional cargo insurance. An Islamic bank has to replace them, for example with Takaful cover or a customer undertaking to donate to charity when payment is late.
Discounting a deferred-payment credit: why it is disputed
In the conventional model the exporter sells its deferred receivable to a bank for less than face value. Selling a debt below its nominal amount is treated as riba, so Islamic institutions look for other structures, which their Sharia board must approve beforehand.
Discrepant documents: who bears the risk?
If the bank finds discrepancies, the importer may accept or reject the documents. Under a Murabaha the bank, as owner, bears the loss of goods damaged before resale; shifting that risk to the customer any earlier would make the structure non-compliant.
Questions to ask your bank before the credit is opened
Ask which contract will be used, at what point the bank becomes owner, how the commissions are calculated, what happens if payment is delayed and whether the structure carries the written approval of the institution's own Sharia supervisory board.
Specialist external source
The AAOIFI Shariah standard on documentary credit sets out permitted commissions, the treatment of the cash margin and the accepted Wakala, Murabaha and Musharaka structures.