A lack of liquidity management tools is seen as one of the key challenges to the Islamic finance industry. However, the sector still lacks a management scheme that is truly global and fully Shari'ah-compliant. At the International Islamic Finance Forum (IIFF) 2010, Isla MacFarlane sat in front of a panel which discussed the alternative options for liquidity management in Islamic capital markets.
Commodity Murabahah is currently the one Islamic money market tool that can help provide liquidity in the Islamic banking system. Commodity Murabahah is based on the concept of Tawarruq, that is, receiving cash for a debt of a higher amount. The structure attracted considerable attention when, in 2003, the OIC Islamic Fiqh Academy likened commodity Murabahah to "organised" Tawarruq which it deemed a synthetic and fictitious transaction and therefore impermissible under Shari'ah. And so, if commodity Murabahah was to be subtracted, what other options do Islamic financial institutions have?
According to Ismail Dadabhoy, the Executive Director of Islamic Finance for UBS, there is no doubt that the market will have to look towards Islamic repurchase agreements, or repos, which would help Islamic banks to create and manage liquidity in Sukuk. However, a section of Shari'ah scholars view repos as inherently un-Islamic and say the repo rate - the price difference between the transactions - contravenes the ban on borrowing and lending on interest.
Dadabhoy said, "As far as repo is concerned, I have been working with the IIFM for a number of years to try and come up with a structure that is acceptable to Shari'ah, and at the same time is acceptable to the market. Unfortunately the biggest stumbling block has been Shari'ah, in trying to find a solution that is acceptable to market participants and scholars. We have come to the conclusion that the way to move ahead with repo is to collateralise Murabahah. There are other solutions, but unfortunately many will only work in a domestic market.
"For me, having worked in conventional banking and having traded repo, I know that repo is a very important tool and it will certainly help to develop the market both in terms of cash management, and in terms of developing the Sukuk market. As far as cash management is concerned it is fairly straight forward - whatever liquidity you have, you take out and get collateral in the form of Sukuk or any other instrument. It also allows you the ability to borrow more than you would do otherwise. I think it is a very effective tool. Most central banks use repo to manage the liquidity in the system. This will allow Islamic banks to do repo with the central banks. Many Islamic financial institutions don't have a tool to go to their central bank, and repo could be that tool.
"We have looked at many structures to solve the issues with Shari'ah. The first structure we looked at was a sell-buy-back. Straight forward - sell and buy back. Okay, it's not acceptable. The element that we are trying to change around, with different maturities and different pricing, was also unacceptable. We went through various stages with Shari'ah, and we are now going to leave it to the market to try and come up with a solution.
"As far as swap balances are concerned - it's a good idea, which has also been practised in the market place. However, you need to have two institutions that are prepared to take each other's credit, if you don't have that, there is an issue."
Abdul Rauf Sivany, Managing Director of Islamic Finance Treasury and Capital Markets for Global Commodity Finance explained that developing electronic platforms could help the industry. He said, "I actually joined this institution which was created for the purpose of creating money market and capital market products. The DIFC was very supportive to such initiative. The basic purpose of the institution was to develop an electronic platform as we know that Islamic institutions implement Wakala and Murabahah transactions for money market activities and you need to have Shari'ah compliance such as offer, acceptance, spot price and so forth. So all these requirements are put into the platform so that any bank that would like to place funds with another bank just clicks a button and everything is executed automatically.
"In addition to this, we have developed the model for transacting the Wakala facilities onto the platform. The biggest objective that we have achieved is giving and taking free money. The platform provides this support whereby the giving and taking of money is calculated on the basis of coins, and the coins are calculated on the basis of Murabahah rate.
"The system is very complex but simple for the user: a borrower puts his order into the system, and the members of this platform, which happens to be Islamic institutions because of Shari'ah reservations that conventional banks cannot take free money from Islam. Nevertheless we have also given a small option that if you're Shari'ah approved, you can go onto the platform. So the platform is basically a market place for the Islamic industry.
"What is in the market is someone putting a placement for one day or 10 days or 20 days, but the name is not disclosed. The moment the bank would like to exhibit the transaction, only at that stage would you see the name of the counterparty and the confirmations are immediately communicated by the system and the points are calculated by the system.
"We have been working on the development of Sukuk repo automated - working on exactly the same basis. We are also working on the concept of synchronising Sukuk for money market activities."
As an alternative, the United Arab Emirates' Central Bank plans to become the first central bank in the region to issue Islamic certificates of deposit (CD) with maturities of one week up to one year. The move will make liquidity management more effective for the UAE's Islamic banks, as using conventional CD auctions is not in line with Shari'ah.
The UAE Central Bank's monetary policy is limited by its dirham peg to the US dollar. It uses CDs auctions and repurchase facilities among other tools to regulate liquidity in the banking system.
The new Islamic CDs will be Shari'ah-compliant, based on a commodity Murabahah concept and will be offered in daily auctions. After the issuance of Islamic CDs the Central Bank will offer repo facilities for these CDs to support their liquidity.
In Bahrain, the Central Bank expanded in November 2008 acceptable collateral for overnight funds to include Ijarah Sukuk as part of measures to stabilise money markets. The instrument, which functions in a similar way to an overnight repurchase facility, allows Islamic banks to borrow funds against Sukuk issued by Bahrain's government as collateral.
For now, commodity Murabahah remains the one Islamic money market tool that can help provide liquidity in the Islamic banking system. There is no other instrument that is as widely used as commodity Murabahah, especially in the short term money markets. And with an estimated annual turnover of over $1 trillion, commodity Murabahah isn't likely to be replaced anytime soon.
Dadabhoy concluded, "There are still a number of things we need to think about to come to an acceptable solution for liquidity and risk management."
We have looked at many structures to solve the issues with Shari'ah. The first structure we looked at was a sell-buy-back. Straight forward - sell and buy back. Okay, it's not acceptable. The element that we are trying to change around, with different maturities and different pricing, was also unacceptable. We went through various stages with Shari'ah, and we are now going to leave it to the market to try and come up with a solution.
© Islamic Business and Finance 2010
