Islamic Liquidity Management Issues

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Islamic Liquidity Management Issues

• ISLAMIC BANKING AND FINANCE
• Lebanese American University, School of Business,
  Irwin Hall, Beirut, Lebanon
• February 2324, 2006
• Warren Edwardes, ceo, Delphi Risk Management
  Limited
• e we_at_dc3.co.uk
• w dc3.co.uk

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Delphis website contains

• articles on Islamic banking ondc3.co.uk/ibnews
• The full speech will be on
• dc3.co.uk/IslamicLiquidity060218.pdf
• with PowerPoint on
• dc3.co.uk/IslamicLiquidity060218.ppt

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thoughts on liquidity

• More than listing
• Is there a buyer when you are a seller?
• More than negotiable
• At what price?

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thoughts on liquidity

• British Gas
• Falklands War
• Dumping of Aaa A1-P1CP
• Dont hold paper in the news

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thoughts on liquidity

• Midland Bank
• Crocker bank led to dumping of Midland CDs
• Dont hold paper in the news

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thoughts on liquidity

• Continental Illinois
• Plenty of liquid assets
• No diversification of liabilities
• mainly wholesale and few retail customers

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thoughts on liquidity

• Access to determinate amount of cash
• When you need it
• Preservation of capital on demand
• Free from price risk
• Undoubted quality low credit risk and be seen to
  be so
• Need a quality Triple-A overnight instrument with
  stable capital values

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Background to Islamic liquidity

• Islamic banking is having a growth spurt. .
• shortage of inter-bank liquidity,
• signs that tentative moves are being made to
  address these shortcomings.
• Middle East Economic Digest
• December 19, 1997 over 8 years ago!

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Background to Islamic liquidity

• Asset/liability gap management
• Shortage of instruments
• LMC /IIFM initiatives
• Numerous Sukuks including Malaysia, Bahrain IDB
  Sukuks
• Liquidity and price transparency is required for
  an active secondary market
• Issues oversubscribed but minimal trading
• This lack of liquidity paradoxically increases
  the demand for liquidity

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liquidity management

• Investments long dated deposits are short
• massive gap
• Massive liquidity problem
• Need flexibility with Shariah compliance
• Sukuks held to maturity
• Short selling?
• Stock borrowing?

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liquidity management

• LME Murabaha is main destination
• Bilateral transactions
• Counterparty limits
• Some funds exist
• But not capable of market size transactions
• Segmentation inevitable
• Co-operation needed with a market level solution

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No Inter-bank market

• Balance sheet management problem
• Cannot easily finance when there are withdrawals
• So more liquidity than needed by a conventional
  bank
• Bilateral Murabaha with break clauses is
  widespread
• liquidity vehicles cannot withstand a 100million
  injection or withdrawal

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Risk Pyramid

• Sound ALM requires a quality / liquidity pyramid.
• Most liquid is USD bill or note
• Nil earnings but price stability vs USD
• Then a range of bonds from super nationals to
  governments and funds
• Most with price risk
• Some with earnings volatility but fixed price
• No such highly rated Islamic instruments

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Risk Pyramid

• Governments reserves are in gold and government
  Triple-A paper
• Fiduciary or trust money should be both liquid
  and safe and price risk free
• Basle II is approaching
• Even before that sound risk management principles
  apply

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Risk Pyramid

• Pyramid of risk
• Blended portfolio from Triple-A down to Single-B
• Can interpolate risk between Triple A and
  Single-A
• Cannot extrapolate risk from lesser risks to
  triple-A

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Risk Pyramid

• Risk / return trade-off in conventional markets
• Add to this the Halal / Haram trade-off
• Need Triple-A Halal instruments

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Conclusion summary

• Sukuks bought to hold
• minimal secondary market for on sale
• Mark to market and price determination is
  difficult
• Shortage of paper
• Is debt trading really Halal?
• Novation agreements
• Cancellation of original purchase and replacement
  with new owner in contract note

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Conclusion summary

• Asset / Liability problem
• Long term asset fixed and short term variable
  deposits
• No derivatives yet!
• Gharrar?
• Financial Takaful?

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Conclusion Summary

• Lack of short term instruments
• Sukuks are medium plus term
• Not price stable or really liquid
• Shortage of credit lines
• Wanted an overnight Triple-A, market-sized,
  liquid, inter-bank market solution where
  institutions can park their reserves