ISLAMIC MONEY MARKET PART 2 At the end of this chapter, you should be able to: • Know the examples of Islamic money market instruments used in the industry.
Role of Islamic Money Market Islamic Money Market Instruments Characteristics of Money Market Instruments Development of Islamic Money Market in Malaysia 01 03 02 04 Page 02
Islamic Money Market Instruments The money market has two key components: An interbank money market and a platform for trading money market instruments. Banks are so dependent on the money market that it is often referred to as the interbank money market. The shariah contracts typically used in the Islamic interbank market are commodity murabahah (tawarruq), mudarabah, bay' al-dayn, bay' al-'inah, wadi'ah and wakalah. ISLAMIC FINANCIAL SYSTEM Page 07
Page 08 In this arrangement, a bank with surplus funds invests its excess funds as a rabb al-mal (fund provider) for a limited period in a bank with deficit funds, which is the mudarib (fund manager) at a pre-agreed PSR. In line with the mudarabah principles, profit from the investment will be shared according to the pre-agreed PSR and losses, if any, will be borne by the fund provider. Below is the illustration of the Mudarabah Interbank Investment. 100% Loss Bearing Profit Sharing Ratio = X:Y Y X Flow of Funds Flow of Funds
Page 09 Commodity murabahah is a popular term used in the market to imply a tawarruq arrangement. It is a sale contract whereby a buyer buys an asset from a seller with deferred payment, and subsequently sells the asset to a third party on cash with a price less than the deferred price to obtain cash. Commodity murabahah is the instrument most commonly used by IFIs to provide short-term interbank liquidity. The basic structure is as follows: Undertaking & Appoint Agent B A Purchase Commodity Sell Commodity (deferred) Sell Commodity (spot) Receive Cash Pay Principal + Profit C
Page 10 Interbank liquidity between Islamic banks can also be managed using a wakalah agency contract. The investing bank (surplus bank), or the muwakkil appoints the investee bank (deficit bank) as its wakil to invest in general or specific Shariah-compliant transactions on behalf of the muwakkil. The wakil will notify the investing bank of the profits expected to be generated upon placement of funds. Any profits exceeding the quoted expected profits will be retained as an incentive by the investee bank. 100% Loss Profit minus Fee Profit fee
Appoint Agent Page 11 Government Investment Issue (GII) is an example of the Islamic money market instruments introduced in Malaysia which are issued to finance the development expenditure of the Malaysian government. Until 2013, GII was introduced based on the contract of bay' al-'inah. Since then, commodity murabahah has been used as the underlying structure for the issuance of GII. The figure below illustrates the structure of GII based on commodiy murabahah: Appoint Agent B A Purchase Commodity Commodity (Transfer of ownership via e-certificate issued by BMIS) Sell Commodity (deferred) Sell Commodity (spot) C Proceeds Proceeds GII Issuance Payment (redemption)
Page 12 In the conventional sense, treasury bills (T-bills) are short-term government securities which are traded on a yield basis. The maturity of T-bills ranges from three, six and twelve months. Since T-bills are issued at a discount from their par value, investors derive their yield from the increase in the value between the time of purchase and the time of maturity. Islamic treasury bills (ITB) are of similar characteristics, but uses Shariah-compliant contracts in structuring the instrument. ITBs in Malaysia are issued to finance the government's operating expenditure. The MITBs are structured based on the bay' al-'Inah principle where BNM, on behalf of the Malaysian government, will sell an identified government asset on a competitive tender basis, to form the underlying transaction of the deal. The allotment is based on the highest price tendered (or the lowest yield). The price is determined after the profit element is imputed (discounting factor). The successful bidders will then pay cash to the government. The bidders will subsequently sell back the assets to the government at par based on credit terms. The government will issue MITBs to bidders to represent the debt created. MITBs are usually issued periodically with original maturities of one year and price on discounted basis. Both conventional and Islamic institutions can buy and trade on MITBs. Price = FV ______ 36,500 1 - r x t The formula to calculate the price of an MITB: FV = Face value r = Discounting rate t = Number of days remaining to maturity
In Sudan, the Central Bank Musharakah Certificates (CMCs) and the Government Musharakah Certificates (GMCs) provide investment financing option to banks on a musharakah basis. The CMCs and GMCs contributed in bringing down the amount of large access reserves that the Sudanese banks used to hold. Below figure illustrates the operational structure of CMCs Page 13 Clearing and settlement of trades Sudanese Financial Services Co. is an SPV that: • Holds and manages the equity fund • Maintains the registry of certificates • Manages sales and redemptions of certificates Lists and trades certificates Musharakah contracts Sukuk Issued Cash Fund Transfer of equity claims into a 'fund' managed by SPV
Page 14 The Islamic Negotiable Instruments (INIs) are Shariah-compliant equivalent of the conventional Certificate of Deposits (CDs). A certificate of deposit refers to a bank-issued short-term security that documents a deposit and specifies the interest rate and maturity date. The CDs, also referred to as bearer instruments, imply that whoever posseses the instrument upon maturity, will receive the principal and interest. Consequently, since charging and giving interest is not allowed from the Shariah viewpoint, an alternative structure is created to serve the same purpose. An INI may be issued based on BBA or mudarabah. In Malaysia, the instrument based on the BBA is called the Negotiable Islamic Debt Certificate (NIDC) whilst the one based on the mudarabah is called the Islamic Negotiable Instrument of Deposit (INID). Negotiable Islamic Debt Certificates (NIDC) • Issued by IFI to evidence that a sum of money has been deposited with the issuer for a specified period. • Issued based on BBA principle (bay' al-'Inah). • Can be resold at a discount prior to maturity. • Quoted in terms of price per MYR100 nominal value.
Page 15 Islamic Negotiable Instrument of Deposit (INID) • Shariah-compliant version of the conventional Negotiable Instrument of Deposit (NID). • The purpose is to enable tradability of deposits in the secondary market. • Offer higher yields than treasury bills. • Issued based on mudarabah (profit-sharing principle). • Quoted in terms of price per MYR100 nominal value.
Page 16 Islamic accepted bill (IAB) is the Shariah-compliant equivalent to the conventional Banker's Acceptance (BA). In conventional space, BA is an order to pay a specified amount of money to the bearer on a given date. They have been in use since the twelfth century. They are used for the sole purpose of financing goods which are yet to be transferred from the seller to the buyer. BAs are shortterm zero coupon debt papers issued by companies. Since the BAs are payable to the bearer, they can be bought and sold until they mature. The are sold at a discounted price, similar to the treasury bills. The IAB is a bill of exchange drawn on or drawn by a bank, payable at a specified date in the future, to evidence the debt that arises out of a trade transaction. These bills may be used as part of the trade finance facilities by importers to finance their imports / purchases, or by exporters to finance their exports / sales. Among the conditions set by BNM for the issuance of IABs are the following: The financing facility must be for genuine trade, the goods involved must be tangible and Shariahcompliant, it must not involve the selling or purchasing of services, and the parties involved must not be a single entity. Under the current BNM rules, the minimum denomination for an IAB is MYR50,000 and they are issued in multiples of MYR1,000.
Page 17 In import IABs, the Islamic bank will first appoint the customer as its agent to purchase the required asset from the exporter or seller on behalf of the bank. The asset is consequently resold to the customer on a murabahah basis at a markup price with the agreement to repay based on deferred payment which can be up to 365 days. Upon maturity, the customer pays the bank the cost of the goods and the bank's profit margin. The sale of goods by the bank to its customer on a deferred basis represents debt securitized in the form of a bill of exchange that is drawn by the bank and accepted by the customer. The full amount of the selling price will be paid upon maturity. The Islamic bank as the drawer of the IAB can hold the IAB until maturity where it will receive the full selling price or alternatively, sell the IAB prior to its maturity at a discount to any investor using the principle of bay' aldayn. Import and Local Purchases
Page 18 After an exporter has obtained the approval of his bank for export trade finance facilities and fulfilled the export documentation required under the export or sale contract, the documents are sent to the importer's bank. The exporter later draws on his bank, new bills of exchange as a substitution bill that represents the IAB. The acceptance by the bank indicates a promise that it will pay the full value of the bill to the bearer upon maturity. Then, the bank purchases the IAB from the exporter at a discount, based on the Islamic principle of bay' al-dayn. The bank can hold the IAB until maturity and receive the full selling price or it can sell the bill before maturity to a third party at a discount. Export / Local Trade
Page 19 This is similar to conventional REPO but structured in a Shariah-compliant way. REPO in conventional banking is an agreement under which a seller of securities sells the securities to a buyer at an agreed price and repurchases the securities from a buyer at a specified price on a future date. The difference between the repurchase price and the original sale price is the interest earned by the buyer who is also a lender. Under the Sell and Buy Back Agreement (SBBA), the transacting parties enter into two separate agreements. The first agreement is between the seller (owner) of securities and the buyer (investor) who buys the securities at a specified price agreed by both parties in a standard sale agreement (bay'). The second agreement is an undertaking whereby the buyer (investor) promises to sell back the securities to the original owner, and the latter promises to buy back at a specified price on a specified future date. The first contract is an outright sale, thus, the securities will cease to be part of seller's investment portfolio. BNM requires that, at least one of the parties to an SBBA transaction must be an Islamic banking institution whilst the tenure for the SBBA transaction must not exceed 1 ear and the minimum value must be al least MYR50,000.
Page 20 Collateralized murabahah is a low credit-risk financial instrument that adds diversity to the existing liquidity management tools and further promotes greater liquidity in the Islamic financial market. This Shariah-compliant equivalent of the conventional REPO facilitates daily Islamic money market operations in the interbank market. This is essentially a Shariah-compliant financing that is secured by assets in which the financier has the right to sell the asset should the client fail to repay the financing. The key features of this agreement is that the fund placing institution will have the comfort of having the collateral in case of any eventuality, with segregated safe-keeping and a margin maintenance mechanism to support risk management. The collateral is taken through a pledge mechanism, and will be held by a third-party custodian to facilitate access to the collateral in case of default or severe impairment of the collateral giving institution's credit worthiness.
Page 21 These are Shariah-compliant securities that are primarily issued as Sukuk. These instruments can be structured based on a number of Islamic finance contracts such as BBA, murabahah, salam, istisna' ujarah, mudarabah, musharakah, and wakalah. These sukuk can be issued either at discount or at premium, or on a rental basis. Some examples of these securities are as follows: Cagamas Sukuk Cagamas Berhad, the Malaysian National Mortgage Corporation, was established as an SPV to mobilise low-cost funds to support the national home ownership policy and spearhead the development of the private debt securities market in Malaysia. To that end, Cagamas issued a number of Islamic fixed income securities that are traded in the money market. The securities are Sanadat Mudharabah Cagamas (SMC) and Sanadat Cagamas. Sanadat Mudharabah Cagamas Sanadat Cagamas - Based on Mudharabah - to finance purchase of housing and hire purchase debts - coupon paid semi-annually - tenure up to 10 years - Based on Bai' Bithaman Ajil (BBA) - to finance purchase of housing and hire purchase debts - coupon paid semi-annually - tenure up to 10 years
Page 22 Source: ISRA (2016), Islamic Financial System
May Allah guide us and increase our knowledge. Readings: Chapter 9 of: Muhammad, M., & Ahmed, M. U. (Eds.). (2016). Islamic Financial System: Principles and Operations (Second Edi). International Shari’ah Research Academy for Islamic Finance (ISRA). Page 25