12.09.2015 Views

issue no. 163 - january–march 2007 / muharram–rabi al awwal 1428

issue no. 163 - january–march 2007 / muharram–rabi al awwal 1428

issue no. 163 - january–march 2007 / muharram–rabi al awwal 1428

SHOW MORE
SHOW LESS
  • No tags were found...

You also want an ePaper? Increase the reach of your titles

YUMPU automatically turns print PDFs into web optimized ePapers that Google loves.

ANALYSIS: SUKUK<br />

NEWHORIZON January–March <strong>2007</strong><br />

The role of the sukuk in<br />

managing liquidity <strong>issue</strong>s<br />

Managing liquidity is essenti<strong>al</strong> if banks are to maximise their<br />

earnings and control their risks. Convention<strong>al</strong> banks have the<br />

inter-bank market to help manage short- and medium-term<br />

liquidity, but what options are available to Islamic banks? Don<br />

Brownlow t<strong>al</strong>ks to Stella Cox, managing director at DDGI Ltd.<br />

Stella Cox,<br />

DDGI Ltd<br />

Liquidity management is the art of matching<br />

an organisation’s incoming and outgoing<br />

cash-flows so that it can usefully invest any<br />

excess funds. Such investment needs to be<br />

made in a way that provides a return while<br />

still <strong>al</strong>lowing the organisation quickly and<br />

easily to convert the investment back to<br />

cash. Convention<strong>al</strong> banks use the inter-bank<br />

market to buy and sell interest-bearing<br />

instruments amongst themselves to meet<br />

liquidity requirements.<br />

This inter-bank market is termed a<br />

secondary market because the instruments<br />

that are traded are <strong>no</strong>t bought directly from<br />

the <strong>issue</strong>rs, as they are in primary markets,<br />

but are traded among participating banks.<br />

In this way Bank A, which has excess<br />

liquidity, may buy a ‘Treasury 8%, maturity<br />

2009 Gilt’ from Bank B, which wishes to<br />

raise cash to meet outgoings. The Treasury<br />

Gilt was origin<strong>al</strong>ly <strong>issue</strong>d by the UK<br />

Government and bought by an investor<br />

bank in what is k<strong>no</strong>wn as the primary<br />

market. That <strong>no</strong>te is then traded –<br />

starting with the investor bank – and<br />

moves backwards and forwards between<br />

others as part of the secondary market.<br />

Islamic banks wishing to remain Shari’ah<br />

compliant can<strong>no</strong>t utilise these interestbearing<br />

inter-bank products. So Islamic<br />

banks have developed <strong>al</strong>ternative Shari’ahcompliant<br />

instruments and products. The<br />

most popular have been those based around<br />

murabaha, where the financi<strong>al</strong> contracts are<br />

supported by physic<strong>al</strong> assets. The contracts<br />

can be structured to achieve a risk/yield<br />

profile comparable to an inter-bank deposit.<br />

However, murabaha products have a<br />

significant disadvantage in that many are<br />

<strong>no</strong>t particularly liquid and are therefore<br />

more difficult to trade; others, because<br />

of Shari’ah stipulation, can <strong>no</strong>t be traded<br />

at <strong>al</strong>l.<br />

Historic<strong>al</strong> estimates indicate that up to 80<br />

per cent of Islamic banking assets are held<br />

in murabaha and other similar products.<br />

The net effect is that Islamic banks can<br />

suffer from asset concentration and from<br />

large holdings of short-term, but illiquid,<br />

investments. As a result, Islamic banks need<br />

to maintain much higher levels of cash to<br />

meet their liquidity requirements than their<br />

convention<strong>al</strong> banking counterparts. This<br />

reduces their profitability. Of more concern<br />

is the future compliance of Islamic banks to<br />

the Basel II accord, which requires a bank<br />

to provide capit<strong>al</strong> according to the risk<br />

weighting of its assets.<br />

Most market participants believe that<br />

the sukuk is the long-term way forward to<br />

enable Islamic banks to manage liquidity<br />

through a range of maturity profiles while<br />

still remaining Shari’ah compliant. This<br />

versatile instrument first appeared in<br />

M<strong>al</strong>aysia around 2000. Despite some initi<strong>al</strong><br />

scepticism in the Middle East, many of the<br />

structures supporting sukuk <strong>issue</strong>s have <strong>no</strong>w<br />

been accepted in this region. Although some<br />

observers estimate that the tot<strong>al</strong> sukuk<br />

market is <strong>no</strong>w worth around $54 billion,<br />

internation<strong>al</strong> users only account for around<br />

$25 billion. In both M<strong>al</strong>aysia and the<br />

Middle East, sovereign nations, banks and<br />

commerci<strong>al</strong> businesses have brought to<br />

market sukuk <strong>issue</strong>s. At sovereign level,<br />

the Government of Bahrain has led the<br />

way with its regular, consistent <strong>issue</strong>s<br />

of sukuk into the market.<br />

However, there needs to be a secondary<br />

market before the sukuk can become<br />

an instrument suitable for liquidity<br />

management. Such a secondary sukuk<br />

market will <strong>al</strong>low banks to buy and then<br />

readily sell sukuk for cash, depending on<br />

their liquidity needs. Once this market<br />

exists, Islamic banks will have a true<br />

liquidity management tool that they can<br />

38 IIBI www.islamic-banking.com

Hooray! Your file is uploaded and ready to be published.

Saved successfully!

Ooh no, something went wrong!