Islamic finance has grown significantly in Iraq since the enactment of Islamic Banking Law No. 43 of 2015, which provided the legal foundation for Sharia-compliant banking. In the trade finance context, Islamic structures offer alternatives to conventional letters of credit and documentary collections that are compliant with the prohibition on riba (interest) a requirement that is of fundamental importance to a significant portion of Iraq’s business community and banking sector. This article examines the legal structures used in Islamic trade finance in Iraq, the regulatory framework under Islamic Banking Law No. 43, and how AAOIFI standards shape Islamic trade finance practice.

The Legal Foundation — Islamic Banking Law No. 43 of 2015

Islamic Banking Law No. 43 of 2015 established the comprehensive legal framework for Islamic banking in Iraq. The law: defines Islamic banking as banking activity conducted in accordance with Islamic Sharia principles that prohibit riba, gharar (excessive uncertainty), and maysir (speculation); authorises the CBI to license banks to conduct Islamic banking either as dedicated Islamic banks or through Islamic banking windows within conventional banks; requires Islamic banks to establish a Sharia Supervisory Board composed of qualified Islamic scholars to oversee Sharia compliance; and empowers the CBI to issue instructions governing Islamic banking operations. The CBI has issued implementing instructions under Islamic Banking Law No. 43 covering licensing, capital adequacy, liquidity management, and product governance for Islamic banks.

Key Islamic Trade Finance Structures

The primary Islamic trade finance structures used by Iraqi banks include: Murabaha, a cost-plus sale arrangement where the bank purchases goods from the supplier and resells them to the customer at a marked-up price, with deferred payment. The bank’s profit is the mark-up rather than interest. Murabaha is the most widely used Islamic trade finance structure globally and in Iraq. Wakala, an agency arrangement where the bank acts as agent for the customer in purchasing goods, receiving a fixed agency fee rather than interest. Murabaha bi-l-wakala, a hybrid structure where the bank appoints the customer as its agent to purchase goods on its behalf, then sells the goods to the customer on a murabaha basis. This hybrid is widely used in trade finance due to its operational flexibility. Salam, a forward sale contract where the bank pays the full price in advance for goods to be delivered at a future date; used in agricultural finance.

Islamic Letters of Credit

Islamic banks in Iraq issue letters of credit that are structured to comply with Sharia principles. An Islamic letter of credit operates similarly to a conventional LC in its trade finance function providing payment assurance to the exporter but the underlying financing arrangement between the bank and the importer is structured as a murabaha rather than a conventional loan with interest. The bank opens the LC using its own funds, pays the exporter upon compliant document presentation, and then sells the goods to the importer on deferred murabaha terms recovering its cost plus a profit margin over the agreed payment period. AAOIFI Sharia Standard No. 14 provides guidance on the Sharia requirements for letters of credit.

AAOIFI Standards in Iraqi Islamic Banking

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) publishes Sharia standards that are widely adopted by Islamic financial institutions globally. In Iraq, Islamic banks are expected to align with AAOIFI standards as part of their Sharia compliance obligations under Islamic Banking Law No. 43 and CBI instructions. Key AAOIFI standards relevant to Islamic trade finance include: Standard No. 1 (Trading in Currencies) governing foreign exchange transactions; Standard No. 8 (Murabaha) governing murabaha transactions; Standard No. 10 (Salam and Parallel Salam); Standard No. 14 (Documentary Credits) governing Islamic letters of credit; and Standard No. 27 (Investment Agencies/Wakala).

The Sharia Supervisory Board

Every Islamic bank in Iraq is required by Islamic Banking Law No. 43 to maintain a Sharia Supervisory Board composed of qualified Islamic scholars. The Sharia Supervisory Board’s role in the trade finance context includes: reviewing and approving new Islamic trade finance products before launch; issuing fatwa (Sharia opinions) on the permissibility of specific transactions or structures; reviewing bank operations periodically to ensure ongoing Sharia compliance; and issuing annual Sharia compliance reports. For trade finance transactions, the Sharia Supervisory Board’s approval of the relevant product structure (e.g. murabaha LC) is essential for the transaction to be considered Sharia-compliant.

Practical Differences from Conventional Trade Finance

Islamic trade finance in Iraq differs from conventional trade finance in several practical respects: documentation is more complex Islamic trade finance transactions require Sharia-specific documents including offer and acceptance forms, murabaha agreements, and Sharia board approvals; the bank must actually purchase the goods in a Murabaha, the bank’s ownership of the goods, even briefly, is a Sharia requirement that must be documented; the profit rate is fixed at inception unlike conventional interest rates that may be floating, murabaha profit is fixed and cannot be increased if the customer is late in payment; and late payment charges require Sharia approval conventional late payment interest is not Sharia-compliant; AAOIFI standards permit charitable late payment arrangements as an alternative.

How Etihad Law Firm Assists

Etihad advises Islamic banks and corporate clients on Islamic trade finance structuring and documentation compliant with Islamic Banking Law No. 43, CBI instructions, and AAOIFI standards. We assist in drafting murabaha agreements, wakala arrangements, and Islamic LC documentation, and advise on Sharia compliance issues arising in complex trade transactions.