- This forms the fourth chapter of the guide titled ‘A guide for Islamic trade finance’.
- The definitive guide has been produced by Trade Finance Global (TFG), in collaboration with FCI and the International Islamic Trade Finance Corporation (ITFC), a member of the Islamic Development Bank (IsDB) Group.
- Factoring, as defined by FCI, is the assignment of receivables for collection, administration, and credit protection rather than financing, and when conducted without discounting or interest it is fully Shariah-compliant.
Although the history of factoring dates back to Babylonian times, over four thousand years ago, two-factor international factoring transactions as we know them today started with the 17th-century colonisation. Then, factors functioned as middlemen in trade: they bought and sold products in order to facilitate trade between colonies and colonists.
In modern factoring, factors no longer trade in physical products, but in receivables. Due to its different forms and applications, factoring has many different definitions all around the world.
The FCI rules
FCI, the global representative body for factoring and financing of open account receivables, defines a factoring contract as follows:
“A factoring contract means a contract pursuant to which a supplier may or will assign accounts receivable […] to a factor, whether or not for the purpose of finance, for at least one of the following functions:
- Receivables ledgering
- Collection of receivables
- Protection against bad debts”
In accordance with this definition, factoring can include one or more of the three core functions: collection, bookkeeping, and protection against bad debts of the assigned receivables, regardless of whether there is financing.
FCI’s general rules do not refer to financing. According to FCI’s definition, an export factor assigns a receivable to an import factor, transferring the full ownership.
The import factor, for its part, undertakes to pay the full amount of the receivable whenever it collects or, failing that, 90 days after the due date if the debtor fails to pay. Factors earn a commission for this.
A discount is never a subject between factors in the international two-factor system unless they have a separate agreement.
Since the export and import factors are responsible for 100% percent of the receivable assigned to them under the terms of assignment (called hawalah in Islamic factoring) and pay 100% of the proceeds, factoring alone is fully compliant with Islamic Shariah.
The AAOIFI rules
Discounting is a secondary function of, and not the entirety of, factoring
Riba (interest) is forbidden in accordance with Verse 2/275 of the Quran. Although an occasional discount or rebate for early payments is permissible in Shariah, a pre-agreed continuous discounting is considered as riba in certain Islamic jurisdictions, and thus not allowed.
On the other hand, maturity factoring, which involves a settlement of 100% of the purchase price of the receivable on a pre-agreed date without financing, is permissible according to Shariah.
However, there is occasional confusion with this. A standard issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the leading international not-for-profit organisation that develops global Islamic finance standards, issued a standard saying that:
“As per Shariah, it is not permitted to deal in a contract of purchasing the invoices on a discount (factoring), unless their purchase was for a commodity, or a usufruct or a service wherein the subject-delivery is ascertained.”
This forbids the purchase of invoices (receivables) at a discount against a monetary amount.
In the AAOIFI’s standard, the parentheses linking discounting and factoring lead the reader to understand that the two are one and the same, and as such, both are forbidden.
However, factoring itself is permissible on a standalone basis as long as it doesn’t include financing or discounting, which are secondary and optional, not inherent functions.
Where are contractually pre-agreed early settlements allowed?
Author: Mahika Ravi Shankar, Trade Finance Global (TFG)
Breaking this down introduces the principle of ibra’, or rebate. Late payment surcharges are riba, which are clearly prohibited under Islamic finance. Early payment discounts are slightly more confusing, but if pre-agreed and automatic, they still constitute a time-based adjustment to a debt. So both would technically constitute riba.
Having said this, early payment discounts reduce the debtor’s burden, are optional, and don’t penalise late payments. In the Quran, riba is fundamentally about extraction and exploitation; as such, early payment discounts or ibra’ waivers are not held as riba in certain jurisdictions.
Specifically in the Gulf Cooperation Council (GCC) and other jurisdictions, early payment is allowed – so long as it’s not pre-agreed or contractual. An obligor can approach their bank and request to pay early, and whether or not the bank accepts this request is to their discretion.
Malaysia
Bank Negara Malaysia, the country’s central bank, has issued specific guidelines on ibra’ for sale-based Islamic financing that explicitly allow rebate on early settlement. This is evidenced in practice through standard financing terms from RHB Islamic Bank, which show ibra’ contractually granted on early settlement.
Here, ibra’ is calculated as:
Ibra’ = Remaining Unearned Profit (unrealised profit at the time of full settlement) – Early Settlement Charges as determined and notified by the Bank.
Indonesia
In Indonesia, ibra’ is recognised and applied in Islamic banking, particularly in murabaha contracts, as part of customary contractual practice.
However, a 2025 study identifies inconsistencies in how ibra’ is implemented in Indonesian Islamic banks. Unlike the mandates stipulated by the Bank Negara Malaysia, the lack of standardised policy means Islamic banks that don’t implement ibra’ face competitive disadvantages.
In summary, in Indonesia, ibra’ is applied on a contractual and discretionary basis at bank practice level.
Türkiye
In general, Turkish Islamic banking operates under a participation banking model where conventional interest is replaced with profit-sharing contracts. Though there are no explicit regulatory documents from Turkish authorities, Islamic finance manuals from the region treat ibra’ as part of the contractual pricing adjustment within murabaha contracts.
Saudi Arabia
The Saudi Central Bank (SAMA) requires Islamic banks to apply a form of ibra’ by eliminating the ‘cost of time’ – that is, profit stemming from interest. So, if a loan is scheduled for three years, and the customer decides to settle the debt after one year, the two additional years of interest would be waived.
Additional protection of Islamic rules
Islamic finance requires real trade transactions and imposes standards for verification, adding a layer of security compared to traditional factoring.
In factoring, there are two main risks taken by the export factors: disputes and indirect payment.
Disputes are any kind of objection used by debtors to avoid or delay payment, as well as any counterclaims and claims for set-off. A related problem in factoring is fraud, which can involve fictitious sales to non-existent or unrelated buyers with fake documents.
Under Islamic factoring, factors are part of the transaction, so they have more opportunity to investigate the details of the sales contracts they are participating in since the product has to be verified for compliance with Islamic rules to ensure the transaction doesn’t involve haram goods or services (like pork, drugs, weapons, gambling, pornography, or entertainment).
The factor’s extensive knowledge about its client and the related product or service protects it against disputes and fraud.
Furthermore, the fact that the factor is the final owner of the receivable, and that this is known to the debtor, obliges the debtor to pay to the factor, not to the supplier. This diminishes the risk of indirect payment, again protecting the financial institution.
Case study: International factoring deal between Kuveyt Türk and ABN Amro
Authors: Mahika Ravi Shankar, TFG; Betül Kurtuluș, FCI
In 2022, a buyer based in France sought to buy from a plastic supplier of stretch film based in Türkiye. The transaction, involving export factor Kuveyt Türk Katılım Bankası A.S. and import factor ABN AMRO Asset Based Finance N.V., was awarded Best Deal of the Year 2022 by FCI.
Why? The deal was the first international transaction completed under the scope of the FCI’s Supplemental Agreement for Islamic International Factoring.
The transaction adhered to Shariah principles through order-based approval, where Kuveyt Türk examined the underlying trade at inception, verifying that the seller’s business activities, products, and sales conditions was Shariah compliant before acceptance.
This ensured the receivable stemmed from a bona fide sale of halal (permissable) goods, maintaining good faith throughout the genuine commercial transaction.
Unlike conventional factoring, Islamic factors participate early in the trade cycle, ensuring transactions involve halal products and legitimate commerce rather than merely financing receivables post-sale.
This landmark deal emphasised that conducting a deal under Islamic factoring principles requires extensive groundwork: Kuveyt Türk assembled a dedicated cross-functional team, negotiated with numerous international factors, and pioneered the product’s introduction to FCI’s network.
In nature, the process was a relatively standard two-factor approach: whereby the export factor, Kuveyt Türk, used the services of the correspondent import factor, ABN AMRO, in the buyer’s country, Türkiye.
This transaction represented the first implementation of the Islamic international factoring product adopted by FCI in 2018, unique since it was structured between an Islamic financial institution and a conventional financial institution.
For the first time in practice, Islamic and conventional financial institutions successfully collaborated within a single international factoring structure under a Shariah-compliant framework.
By applying this model, both institutions jointly paved the way for a broader understanding that open account trade finance and international factoring can be executed through a correspondent network, regardless of whether that network is Islamic or conventional in nature.
This transaction showed that the use of a correspondent factoring network is not a barrier to Shariah-compliant open account trade finance, but rather a viable and scalable solution.
In doing so, the two institutions acted as flag bearers of the product, being the first to operationalise a structure that had previously been considered difficult to implement in practice.
Their successful execution clearly demonstrated the practicality, acceptability, and commercial relevance of Islamic international factoring, contributing to its wider recognition and adoption within the FCI network, where many Islamic financial institutions are now active participants.
