Reclaiming Purpose in Islamic Finance: Rethinking the Use of Tawarruq When Cash Isn’t the Core Need

Islamic finance is a financing activity which complies with Shari’a principles  At its core, it prohibits interest (riba), uncertainty (gharar), and speculation (maisir). , Instead Islamic finance promotes risk-sharing, ethical investment, and mainly asset-backed financing. Transactions are structured to reflect genuine trade or partnership, ensuring that financial activity is closely tied to the real economy.

Among the various tools used in Islamic finance, ‘Tawarruq’ has become one of the most commonly used technique. Tawarruq is used for liquidity management and constitutes an exception to the Shari’a compliant approach where the financing should always be dedicated to a tangible and identified asset allowing the financier to ensure that the financing is used in accordance with Shari’a principles.

Very briefly, Tawarruq  involves the purchase by the financier of  a Shari’a compliant commodity on behalf of the client, on a deferred payment basis followed by an immediate sale of the same commodity on behalf of the client to a third party on spot basis. This allows the client to receive cash without entering into an interest-bearing loan.

Although Tawarruq serves a valid purpose in facilitating cash-based needs, its widespread use—particularly in situations involving tangible asset financing—has sparked debate within the industry. Is it always the right mechanism? More importantly, does its overuse risk diluting the ethical and structural integrity of Islamic finance?

This whitepaper explores the case for a more deliberate approach to financing decisions. It examines why Tawarruq may not always be the most appropriate choice—especially when the transaction involves assets rather than cash—and proposes how the industry can uphold both Sharia authenticity and commercial robustness.

Tawarruq: Utility or Overreach?

Over the past decade, Tawarruq has emerged as a flexible and efficient tool for liquidity generation. It is often used for personal financing, corporate working capital, and even structured investment products. Its simplicity of execution and standardisation of processes have made it a go-to solution across banking and financial institutions.

However, this tendency to apply Tawarruq even where the client’s core need is not liquidity should be reframed to avoid a trivialisation of a financing method which should only be used when no other Shari’a compliant financing technique can achieve the anticipated purposes.

Purpose-Driven Structuring: A Sharia Principle

A key tenet of Islamic finance is intentionality—transactions should reflect the actual economic need and facilitate legitimate activity. Financing should not be a legal workaround but a principled tool that supports meaningful outcomes. This is particularly relevant in scenarios involving physical assets like property, infrastructure, equipment, or development projects.

Islamic finance provides a variety of tools that align more naturally with asset-based needs:

Ijara (Lease Financing): A contract where the financier retains ownership and leases the asset to the client for agreed rental payments. Ownership is normally transferred to the client at the end of the term of the lease agreement.

Istisna’ (Project Financing): A manufacturing or construction-based contract in which a developer or manufacturer delivers an asset in stages, often used for real estate or infrastructure development.

These instruments not only more closely mirror the purpose of the financing but also protect the financier’s interest by embedding the asset within the contractual relationship. Furthermore, a combination of several Shari’a compliant financing methods is often considered in complex financing structures. This however requires the input of specialists whose cost often directs the financier towards the most cost-effective solution, Tawarruq, thus ignoring additional considerable benefits a wel- thought-out structure may offer.

The Risk of Form over Substance

Over-reliance on Tawarruq for non-cash needs raises concerns around the spirit of compliance. While the contract form may pass a Sharia review, its substance might not reflect genuine trade or asset-based financing. This has implications beyond individual transactions:

• It blurs the line between Islamic and conventional finance, potentially reducing differentiation in the eyes of clients.

• It weakens Islamic finance's ethical and philosophical foundations, which were designed to promote fairness, transparency, and shared responsibility.

• It discourages innovation, as institutions default to a standardised product instead of crafting solutions that meet clients' needs.

This is particularly problematic in jurisdictions where regulators push for greater Sharia authenticity and clients—especially corporates and family offices—are becoming more discerning in their expectations.

A Better Risk Profile for Banks and financial institutions

From a commercial standpoint, asset-based contracts like Ijara or Istisna may offer better protection to banks and financial institutions. In lease and project-based contracts, the financier typically retains ownership or control of the asset during the financing period. This not only enhances the security of the transaction but also gives the financier more levers to manage risk and recover value in case of default.

In contrast, Tawarruq transactions often involve commodities irrelevant to the client’s actual operations—typically metals or palm oil traded through brokers—making the contracts more abstract and potentially less enforceable in complex recovery scenarios.

The Strategic Role of Regulators and Sharia Boards

Oversight bodies are key in helping the Islamic finance industry mature sustainably. Regulators, central banks, and Sharia boards must move beyond approval checklists and consider the intent behind financial structuring. Rather than focusing solely on technical compliance, issuing guidance on the contextual appropriateness of each Sharia tool will encourage better outcomes.

Furthermore, promoting innovation in underused but powerful structures like Musharakah (joint ventures) or diminishing Musharakah (diminishing equity participation ) could diversify the sector’s toolkit and elevate its authenticity.

Choosing with Intent, Structuring with Integrity

Tawarruq remains a valuable and legitimate part of Islamic finance. But like any tool, its effectiveness depends on how, where, and why it is used. When cash is not the primary financing requirement, structuring a transaction through Tawarruq may not just be suboptimal—it may erode the foundations upon which Islamic finance is built.

The future of Islamic finance depends on a return to its principles: ensuring that structures serve real economic purposes, reflect asset-based logic, and uphold the ethics of Sharia. For financial institutions, this is both a reputational and strategic imperative. For clients, it is a reassurance that their financing is aligned with their values.

As the market evolves, so must our approach—choosing financing tools not for convenience but relevance, integrity, and long-term value.

Feel free to reach out via LinkedIn or to michele.elkhoury@supportlegal.com to share your thoughts and questions.

Michèle El Khoury is a Banking and Finance Principal in Support Legal's Dubai office.  ____________________________

This material is provided for general information only. It should not be relied upon for the provision of or as a substitute for legal or other professional advice.