The 3rd Islamic Financial Services Forum : The European Challenge will be held at The Westin Paris on 4th March 2009 and is jointly organized with the Financial Stability Institute and hosted by Banque de Paris.
The itinerary showed that it will focus on liquidity management - I guess this is due to the financial crisis that is happening all over the world right now.
Liquidity is about having access to a determinate amount of cash - and when you need it. This can be either through the asset side or the liability side of the bank or financial institution. On the asset side, it is about the preservation of capital on demand. That means that the asset must have undoubted quality with minimal credit risk. And it must be seen to have that quality behind it. That also means it must be free from price risk.
The Liquidity Management Centre and the International Islamic Financial Market in Bahrain and others have done some excellent work and new Islamic liquid instruments such as the Sukuks issued by Malaysia, Bahrain, the IDB and more recently by several corporates are coming on stream on a regular basis. Malaysia of course has had such instruments in its domestic market for some time. There have been great strides made but much more work needs to be done. Without an efficient capital market to operate within, Islamic banking finance will not continue to grow meaningfully. The market requires liquidity and price transparency to enhance a secondary market. It is all very well having entire issues oversubscribed – but there has to be an exit route to demonstrate liquidity. And this lack of truly liquid assets has paradoxically increased the demand for liquid instruments.
Islamic banks investing in long-term assets are still faced with a problem in that most of their deposit liabilities are very short-term leading to a massive liquidity problem. Liquidity management tools that are both flexible and undeniably Shari'h compliant are lacking. Although Sukuks can be traded most are held to maturity. This lack of market liquidity is often seen as the major constraint to the development of an integrated Islamic financial system. Malaysia is an exception where they even have overdrafts.I
It is inevitable that competition between various conventional banks and Islamic ones has led to segmentation and prevented a really substantial market being developed leading to an upwardly spiralling virtuous vortex of liquidity. For things to change there will need to be more co-operation amongst Islamic banks and between them and their Conventional counterparties.
The LMC and IIFM are providing just such a lead. In addition to the lack of long-term assets to invest in and get out of, Islamic banks face another serious problem in balance sheet management: the lack of an Islamic inter-bank market on the scale of similar sized Conventional markets. Because Islamic banks unlike Conventional banks cannot borrow at interest to meet unexpected withdrawals from their depositors, it is difficult for them to run mismatched asset and liability portfolios. And this is aside from the interest rate risk they run when they invest long at fixed rate and have their liabilities re-price frequently.The way banks have most commonly solved this problem is to have more liquid assets than would be in the case of Conventional banks and these are placed with commodity Murabahas on the understanding that they can get liquidity when required through early cancellations at an explicit or hidden cost. These are done through agency agreements or break clauses. But a facility for early cancellation does not come without cost explicit or otherwise.
There are a few Islamic liquidity vehicles but these are fairly small and could not withstand a several hundred dollar injection or withdrawal. There needs to be a market-wide central solution that allows institutions to park funds in between medium to long term investment sales and purchase. We need a solution that involves high quality, standardisation, gets away from bilateral Murabaha investments by the investor with all the problems of break clauses, listing and price transparency and be able to transact in substantial size.
The itinerary showed that it will focus on liquidity management - I guess this is due to the financial crisis that is happening all over the world right now.
Liquidity is about having access to a determinate amount of cash - and when you need it. This can be either through the asset side or the liability side of the bank or financial institution. On the asset side, it is about the preservation of capital on demand. That means that the asset must have undoubted quality with minimal credit risk. And it must be seen to have that quality behind it. That also means it must be free from price risk.
The Liquidity Management Centre and the International Islamic Financial Market in Bahrain and others have done some excellent work and new Islamic liquid instruments such as the Sukuks issued by Malaysia, Bahrain, the IDB and more recently by several corporates are coming on stream on a regular basis. Malaysia of course has had such instruments in its domestic market for some time. There have been great strides made but much more work needs to be done. Without an efficient capital market to operate within, Islamic banking finance will not continue to grow meaningfully. The market requires liquidity and price transparency to enhance a secondary market. It is all very well having entire issues oversubscribed – but there has to be an exit route to demonstrate liquidity. And this lack of truly liquid assets has paradoxically increased the demand for liquid instruments.
Islamic banks investing in long-term assets are still faced with a problem in that most of their deposit liabilities are very short-term leading to a massive liquidity problem. Liquidity management tools that are both flexible and undeniably Shari'h compliant are lacking. Although Sukuks can be traded most are held to maturity. This lack of market liquidity is often seen as the major constraint to the development of an integrated Islamic financial system. Malaysia is an exception where they even have overdrafts.I
It is inevitable that competition between various conventional banks and Islamic ones has led to segmentation and prevented a really substantial market being developed leading to an upwardly spiralling virtuous vortex of liquidity. For things to change there will need to be more co-operation amongst Islamic banks and between them and their Conventional counterparties.
The LMC and IIFM are providing just such a lead. In addition to the lack of long-term assets to invest in and get out of, Islamic banks face another serious problem in balance sheet management: the lack of an Islamic inter-bank market on the scale of similar sized Conventional markets. Because Islamic banks unlike Conventional banks cannot borrow at interest to meet unexpected withdrawals from their depositors, it is difficult for them to run mismatched asset and liability portfolios. And this is aside from the interest rate risk they run when they invest long at fixed rate and have their liabilities re-price frequently.The way banks have most commonly solved this problem is to have more liquid assets than would be in the case of Conventional banks and these are placed with commodity Murabahas on the understanding that they can get liquidity when required through early cancellations at an explicit or hidden cost. These are done through agency agreements or break clauses. But a facility for early cancellation does not come without cost explicit or otherwise.
There are a few Islamic liquidity vehicles but these are fairly small and could not withstand a several hundred dollar injection or withdrawal. There needs to be a market-wide central solution that allows institutions to park funds in between medium to long term investment sales and purchase. We need a solution that involves high quality, standardisation, gets away from bilateral Murabaha investments by the investor with all the problems of break clauses, listing and price transparency and be able to transact in substantial size.
