LC Financing. Comparison between an Islamic and a conventional bank in Essay

LC Financing. Comparison between an Islamic and a conventional bank in Qatar - Essay Example It is a financial agreement – a secure mode of payment - between an importer and exporter for goods shipped (Finance). In Wall Street Words, David L. Scott defines a letter of credit as â€Å"a promise of payment in the event that certain requirements are met. A letter of credit essentially substitutes the credit of a third party (usually a large bank) for that of a borrower. In the case of municipal bonds, an LOC generally permits a trustee to draw six months' interest and sufficient funds to retire outstanding bonds at par in the event of default† (qtd. in Letter of Credit). Since L/Cs carry a risk for the issuing bank in case the client defaults, the bank assesses the client’s creditworthiness and financial position to evaluate his ability to pay in the future. In some cases, the bank may ask for a security to minimize chances of loss. There are various departments within the bank which cater to such analysis and evaluation in order to judge whether the custom er is worthy of providing credit or not. If the customer simply is asking for a letter of credit then the bank assumes responsibility for the traded goods coming into the country. In that case, checks and balances are even stricter and require that the customer is of extremely good credit worthiness based on which financing and LC facilities are then provided. Corporate and commercial banking departments are formulated where teams sit and evaluate companies for their creditworthiness as well as their capacity to pay back the loans that they have taken. Other departments that may be involved in this case may include Risk Management department, Credit management department, Commercial Banking and Audit as well as a committee that is formulated especially to evaluate credit packages that are developed through the corporate or commercial banking departments. (Islam). Uniform Customs and Practice for Documentary Credits (UCP 600), issued by the International Chamber of Commerce, includes the latest rules which govern letter of credit transactions in international trade finance worldwide. What are  L/C finance contracts? There are various financial solutions offered by banks for trade financing. L/C finance contracts are one of them, with modern banks offering a wide range of L/C financing products to meet complex needs of traders. One of these is export contracts through which the exporter's bank extends a loan to him. Trade loans are regarded as an important trade finance technique. They are especially suitable for wholesalers and manufacturers as they can be utilized for both one-off and regular purchases of raw materials, goods, etc. The bank can extend finance until payment from the on-sale of goods is provided by the client (Barclays). L/C finance contracts in Islamic bank Muslim jurists believe that reward for capital needs to be linked to the outcome of any project if financing is being extended by the bank. They are of the view that gains should be made v ia trade involving sale and purchase (Hanif 3). Islamic banks have thus come up with alternate, Shariah-complaint financial solutions for customers as compared to conventional banks. Murabaha is one of the most commonly used principles in Islamic trade finance. It refers to: â€Å"†¦a contract of sale and purchase at a profit margin between the supplier and the purchaser of the good. The