Shari'a Compliant Methods For The Financing Of Ships

Article by Peter Measures and Martin Brown

Following the virtual economic meltdown in 2007/8, the banking system teetered on the brink of collapse and the period of prolonged economic growth ended with a bang. Trade slumped and, as a consequence, freight rates fell to alarmingly low levels, as did ship values.

The immediate legacy of the banking crisis was a severe credit squeeze. Whilst levels of new lending dropped dramatically, the cost of borrowing (if you could source it) went up and covenants were tightened. Most banks looked to restructure debt and "repair" their capital base. Many simply closed to new business.

In early 2011, whilst there are signs that new loan facilities are becoming more readily available, the ship finance banks remain circumspect about who they will lend to, indicating that we are still a long way from the heady days of 2003-2007.

In short, the liquidity crisis is far from over, especially for those owners falling into the lower end of the SME bracket.

In such a situation owners (who may have existing commitments to a shipyard or who otherwise see this as an opportunity to expand their fleet) will inevitably look for alternative sources of funding. One such source is Shari'a-compliant finance1 . Although certainly not immune from the effects of the worldwide downturn, Islamic banks expanded their assets in 2009 by 28.6 percent. Shari'a-compliant assets are now said to total about US$1 trillion, making this a significant source of liquidity. Muslims and non-Muslims alike have shown that they are willing to tap this particular source of funding.

If they do, what can they expect to be offered? In this article we examine some of the most common forms of Shari'a-compliant financing structures with which we have been involved.

Some Typical Islamic Financing Structures

1. Murabaha

   The murabaha is often referred to as "cost plus" financing. It is the most commonly encountered instrument in Islamic finance and is used (amongst other things) in financing trade, the acquisition of assets and for the provision of working capital. The murabaha arrangement broadly involves:

   (a) the bank's customer (A) identifying and inspecting the asset it wishes to acquire (e.g. a second-hand ship) and requesting finance from its bank (B).

   (b) A and B enter into a Murabaha Agreement in which A promises to (i) buy the asset from B immediately B acquires ownership, see (d) below, and (ii) pay for the asset on a specified date or dates in the future at a specified price (the deferred price, being the cost price, plus a declared profit margin).

   (c) B appoints A as its agent to purchase the asset from the seller (C) on B's behalf.

   (d) B purchases the asset under a purchase contract with C and pays the price (the cost price) under that contract and title to the asset vests in B.

   (e) B then sells the asset to A for immediate delivery (with title passing to A) for the deferred price on terms that it is payable by specified instalments throughout the murabaha period or in one lump sum on the last day of that period.

   The profit element is intended to reflect B's risk (e.g. credit and title risk). It is usually benchmarked against LIBOR plus a margin. Whilst it has been suggested this is akin in many respects to...