RETURN ON THE LETTER OF GUARANTEE: ISSUES AND NEW PROPOSALS IN STRUCTURINGTHE PRODUCT

The paper aims at discussing the issues surrounding earning of return onLetters of Guarantee (LG) issued under kafālah by Islamic banks and topropose alternative ways of structuring it by sharī‘ah compliant Islamicbanks. The paper proposes structuring LG as a service contract underwakālah or as a reputation-based partnership. Letter of guarantee can beissued as a service contract and the Islamic Bank can charge service feescommensurate with the direct and indirect costs of issuing the cover. Thepaper further proposed that an Islamic Bank and a client (prospectiveguaranteed) can set up a reputation-based partnership for an underliningproject where the Islamic Bank contributes through the issuance of the LGwith profit sharing agreed upon and losses borne proportionate to capitalcontribution. The paper contributes to Islamic bank practice in the financialintermediation role by providing an instrument for such banks to meet uniqueneeds of their clients with financial solutions fulfilling the dual needs offinancial intermediation and sharī‘ah compliance. JEL Classification: G21, Z12, E44