Islamic Treasury Products: An Update

1. Islamic Treasury Products: An Update Prof Dato’ Dr. Mohd Azmi Omar azmiomar@iiu.edu.my Seminar on Islamic Banking & Capital Market: Products & Instruments, 23-24 May 2007, Kuala Lumpur, CERT

2. Contents • Issues facing Islamic Financial Institutions (IFI) with respect to Liquidity • Efforts taken by IFIs to resolve Liquidity and Low Return issue • Current Islamic Treasury Products and Instruments offered by IFI • Update on global Islamic Treasury products • Conclusion International Islamic University Malaysia

3. Issues facing Islamic Financial Institutions (IFI) with respect to Liquidity • Too liquid • Financing deposit ratio (loan deposit ratio) of IFIs tend to be higher than conventional FIs. As at end of June 2005 it stood at 61.5% • Low returns • Returns from short term investments tend to be low as compared to conventional • Maturity mismatch • Liabilities are short term and assets are long term International Islamic University Malaysia

4. Limited investment opportunities • Short term investment products are very limited especially at the global level • Liquidity shortage • At the global level, IFIs have problems of attracting short-term funds to meet cash flow requirements • The absence of lender of last resort – e.g.,Ihlas Finance in Turkey International Islamic University Malaysia

5. Efforts taken by IFIs to resolve Liquidity and Low Return issue • Development of New Shariah Compliant Treasury products • Enhancement of Liquidity Management Centre activities (Bahrain) via • Coordinated cross-border regulation • Homogenisation of products • Increased depth and breadth of market through greater collobration with Islamic financial centres International Islamic University Malaysia

6. List of Islamic Treasury Products and Instruments in Malaysia • General Investment Account-i (GIA-i) • Mudharabah • Special Investment Account-i (SIA-i) • Mudharabah • Negotiable Debt Certificate-i (NDC-i) • BBA and Bai al-Dayn • Negotiable Instrument of Deposit-i (NID-i) Mudharabah • Government Investment Issue-i (GII-i) • Qardul Hasan, Bai Al-Inah, BBA, Bai Al-Dayn International Islamic University Malaysia

7. Bank Negara Negotiable Notes-i (BNNN-i) Bai Al-Inah, Bai Al-Dayn • Private Debt Securities-i (PDS-i) • Bai Al- Inah, BBA, Murabahah, Ijarah Istisna, Salam, Bai Al-Dayn • Sell and Buy Back Agreement-i (SBBA-i) • BBA and Bai al-Dayn • Accepted Bills-I • Murabahah and Bai Al-Dayn International Islamic University Malaysia

8. Outstanding Amount of Financial Instruments As At 22 May 2007 International Islamic University Malaysia

9. Outstanding Amount of Financial Instruments As At 22 May 2007 International Islamic University Malaysia

10. ISLAMIC INTERBANK MONEY MARKET MONTHLY VOLUME BY TENOR BETWEENJANUARY-2001 TO MAY-2007(RM mil) International Islamic University Malaysia

11. NEGOTIABLE ISLAMIC DEBT INSTRUMENTS MONTHLY VOLUME TRANSACTED THROUGH MONEY BROKERS BETWEEN JANUARY-2003 TO MAY-2007 International Islamic University Malaysia

12. ISLAMIC ACCEPTED BILLS (IAB) MONTHLY VOLUME TRANSACTED THROUGH MONEY BROKERS BETWEENJANUARY-2001 TO MAY-2007 International Islamic University Malaysia

13. Other Treasury Instruments in Malaysia • Commodity Murabahah Programme (CMP-i) • Islamic Profit Rate Swap (IPRS) • Islamic Cross Currency Swap (ICCS) & Islamic Forward Rate Agreement (IFRA) International Islamic University Malaysia

14. Commodity Murabahah Programme (CMP-i) • A trade transaction designed for investment purposes as well as to mobilize depositors’ fund. • It is introduced as an alternative innovation to liquidity management instruments in the broad Islamic Money Market spectrum • Carried out based on spot purchase (immediate delivery) and forward sale on deferred payment term (cost plus mark–up basis) of Shariah–approved commodities • Shariah Principle • The Shariah principle applied to this transaction is Murabahah (deferred cost–plus sale) where commodities are sold at a price comprising its cost plus a known profit margin, and the settlement is based on a lump–sum payment at an agreed future date International Islamic University Malaysia

15. Minimum Amount • The minimum amount deposited/ invested for Commodity Murabahah transaction is RM500,000 while no maximum amount is imposed • Tenor • Minimum of 1 day to 5 years • Rate of Return • Fixed and benchmarked against interbank money market rates International Islamic University Malaysia

16. Features of Commodity Murabaha International Islamic University Malaysia

17. Commodity Murabahah Programme (CMP-i) Corporate Client 2 Deferred $ ABC, acting as agent Client then sells the commodity to ABC via deferred payment. The Sale Price represents the return from deposit for the Client. Commodity 1 $ Commodity ABC, as principal Corporate Client appoints ABC as its agent to buy commodity from Commodity Exchange. ABC buys the commodity by cash via Trader 1. Trader 1 Commodity $ 3 Trader 2 ABC sells the commodity at Commodity Exchange via Trader 2 for cash.. 17

18. Islamic Profit Rate Swap (IPRS) • An agreement to exchange profit/return/coupon rates between two counterparties (normally consist of a Fixed Rate Party with a Floating Rate Party or a Floating Rate Party with another Floating Rate Party or any other variant); • Implementation is by the execution of a series of underlying Murabahah contracts on certain Shariah–compliant assets or commodities International Islamic University Malaysia

19. Motivations for IPRS are: • Hedging/matching profit rate exposure (existing and potential exposure) • Immunizing balance sheet asset & liability exposure • Restructuring capital market and debt profiles (profit rate on relevant currency) • Indirectly enhancing credit risk management through reduction of credit risk exposure • IPRS is transacted based on underlying spot purchase and sale (immediate delivery) of Shariah–compliant commodities or assets and with deferred profit payment term. International Islamic University Malaysia

20. Shariah Principle • Murabahah principle. The contract involves underlying sale and purchase transactions of Syariah–approved assets or commodities consisting of its cost price plus a determined profit margin mark–up to be settled in at an agreed date. • Minimum Amount • Transaction is based on notional amount with no physical exchange of principal cashflow except in case of cross currency IPRS or in other case as requested. Minimum amount of MYR5,000,000 shall be imposed on corporate (non–interbank) transaction. International Islamic University Malaysia

21. Tenor • Minimum 6 months. No maximum tenor • Profit Margin • Profit margin or spread premium can be applied to IPRS rates depending upon specific market requirement or credit standing of counterparties. Normally these margins are quoted above the floating indices or as a premium built into the quoted IPRS prices. International Islamic University Malaysia

22. Features of IPRS International Islamic University Malaysia

23. Islamic Profit Rate Swap 2. Client views interest rate is likely to rise. It then enters into IPRS deal to pay fixed rate and to receive floating rate on quarterly basis over 3 years. Eg. Client pays 4.5% fixed profit payment and receives 3-month KLIBOR. 3-Month KLIBOR CLIENT SCBMB 4.5% Fixed 1. Client has fixed rate financing portfolio assuming at 6.0%p.a. 6.0% Fixed FINANCING PORTFOLIO (RM) 23

24. Islamic Profit Rate Swap -Combination of Commodity Murabahah Sale & Purchase TRADER 2 TRADER 1 4 3 1 6 Commodity B $ $ Commodity A Commodity A Commodity B $ $ ABC as Agent 2 Commodity A Sale Price equivalent to 4.5% fixed CLIENT ABC 5 Purchase Price equivalent to 3-Month KLIBOR Commodity B 24

25. Islamic Cross Currency Swap • An arrangement between 2 parties to exchange a series of profit (interest) and/or principal payments denominated in one currency for another series of profit (interest) and/or payments denominated in another currency, based on a notional principal amount, over agreed period International Islamic University Malaysia

26. Islamic Forward Rate Agreement • An agreement between 2 parties to exchange one payment of profit (interest) denominated in a single currency for another payment of profit (interest) denominated in the same currency, based on a notional principal amount, at a single specified period. International Islamic University Malaysia

27. List of Islamic Treasury Products and Instruments in Other Countries • Salam Sukuk (BMA) • Not tradeable in secondary market • Short Term Ijarah Sukuk (BMA & Liquidity Management Centre) ) • Can be traded in secondary market • Maturity 6 months • More maturities needed • Carve out/re-parcel existing long term Ijarah sukuk • Commodity Murabaha & Reverse Commodity Murabaha • Not tradeable in secondary market International Islamic University Malaysia

28. THANK YOU & WASSALAM