Return on the Letter of Guarantee: Issues and New Proposals in Structuring the Product
The paper aims at discussing the issues surrounding earning of return on Letters of Guarantee (LG) issued under kafālah by Islamic banks and to propose alternative ways of structuring it by sharī‘ah compliant Islamic banks. The paper proposes structuring LG as a service contract under wakālah or as a reputation-based partnership. Letter of guarantee can be issued as a service contract and the Islamic Bank can charge service fees commensurate with the direct and indirect costs of issuing the cover. The paper further proposed that an Islamic Bank and a client (prospective guaranteed) can set up a reputation-based partnership for an underlining project where the Islamic Bank contributes through the issuance of the LG with profit sharing agreed upon and losses borne proportionate to capital contribution. The paper contributes to Islamic bank practice in the financial intermediation role by providing an instrument for such banks to meet unique needs of their clients with financial solutions fulfilling the dual needs of financial intermediation and sharī‘ah compliance.
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