Transcript policy

CENTRAL BANK and MONETARY POLICY
CENTRAL BANKING AND MONETARY POLICY
Basic central operations / Appropriate Islamic financial contracts
Type of facility
Purpose of
facility
Appropriate
contract
Overdraft window
Support the
payment system
General purpose
mudarabah
Lender-of-last
resort
Support the
soundness of the
banking system
General purpose
mudarabah
General financing
Provide general
purpose financing
to the economy
General purpose
mudarabah
Open market
operations
Quick intervention
to influence
money and foreign
exchange markets
Outright
sale/purchase of
securities;
underlying assets
Continue
Islamic economy is a money economy
In order to avoid gharar and exploitation,
Prophet (SAW) is reported to have discouraged
barter exchange of goods and encouraged the
use of money to buy and sell necessities of life.
 Injunctions against Riba al Fadl were directed at
eliminating the possibilities of injustice in barter.
 Prohibition of riba al nasiah was directed at
freeing money economy from injustice and
exploitation in loan transactions and making
them rational.
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Primary function of central bank in Islamic
state
 Stability of value of money as differed payment
 As a store of value
Monetary authorities have the power to
regulate banking and financial operations to
both allocate resources and to direct them to
specific goals.
 Loss of interest would make the economy
more market oriented.
 This will justly distribute the fruit to the right
parties.

An important instrument is legal reserve
ratio.
 Enables central bank to regulate the volume
of credit by raising and deposit-reserve ratio.
 May be used as indirect method of credit
control.
 Another instrument is statuary reserves
enables the central-bank to regulate money
supply.
 Central bank can vary the weightage to the
funds provided to a banking institution in
sharing profits. This change can be choose
to favor certain sectors in the economy.

State bank can lay down the minimum rate of
return that should be charged by banks
providing funds for trade related modes like
murabaha, salam or leasing.
 Central bank can also acquire shares of
commercial banks and financial institutions
to further enhance its control over banking
system.
 The ‘moral suasion’ may also supplement the
above package of monetary policy tool.

The device of ‘profit sharing ratios’ can be
used to replace the bank rate. The Council of
Islamic Ideology in its Report of 1980
describes the functioning of the mechanism
in the following words.
 “there is a general consensus--------------------------------national policy objectives”.
 To view the full text please refer the book.

The changing of profit sharing ratio would
depend on actual circumstances and
ultimate ends.
 Also the changes would be applicable to the
new projects not to the already financed
projects.
 Central bank may use some other ratios,

 Refinance ratio would influence the quantum of
credit extended by the commercial bank.
 Qard-e-hasan Ratio or Lending ratio may be used
when commercial banks are obliged to lend out
certain percentage of their demand deposits on
interest free or service charged based loans.
The central bank may also resort to open
market operations by sale and purchase of
securities created on the basis of islamic
modes.
 For effective monetary management central
bank should discretionary control over the
growth of reserve money.
 General financing to banks, overdraft (OD)
and lender of the last resort (LLR) facilities
can be provided to the banks on the basis of
Mudarabah.
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The state bank may like to provide
refinancing to banks on Musharakah and
restricted Mudarabah basis while the banks
may use any of shariah compliant modes.
For a general financing facility, a Mudarabah
auction format can be developed.
1. profit oriented productive projects can be
financed on the basis of Musharakah,
Istisna’a and Leasing. Gov commodity
needs/operations can also be based on
Murabaha-Muajjal, Salam and Istisna’a.
 2. Socio-economic expenditure can be
financed through:
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Trade operation
Leasing operations
Income participatory operations
Creation of money by central bank
All instruments used for private sector
finacing are available for gov finance.
How to use these Modes
1. for smooth use appropriate institutions will
have to be developed.
 2. establish trust that would run trading /
leasing operations on behalf of government.
 3. it will be possible for the trust to issue
fixed income and quasi-fixed income
securities.
 4. Gov can issue salam certificates also on
raw material s and immediate goods
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Other sources for the Governement
1. Printing money
 2. Taking over part of credit creation by
banking system
 3. central bank can issue deposit certificates.
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Eliminating interest from Government
financing and in particular form the NSSs
operation is also a big challenge in the
process of transformation of the financial
system, fraught with ceratain risks.
 45% have been raised through NSSs prize Bonds
scheme out of total domestic debt.
The Government may create a mutual
fund out of its share in public sector
corporations.
 Leasing based securities may also be
helpful in replacing the interest based
savings instruments with shariah
compliant securities.

It would be very difficult to convert all the
existing stock of debt into new instruments
on any given date as this may disrupt and
endanger the financial system.
 The system will have to be adopted for new
issues or by changing the basis of
investment, upon maturity of instruments
issued before the cut-off date.

Stable Income Securities and
Certificates of Deposits
1- securitize or sell a pool of assets or offer
CDs against a fund composed of pooled
Ijarah and some Murabaha, Installments
sale and Istisna’s contracts.
 2- the instrument of CD will offer the
depositors a defined stream of cash flow
constituting the return on the pooled
assets.
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3- such securities would accommodate
risk averse investors, enhance liquidity
and generate new resources for
additional intermediation and income
flow to the bank.
Growth Oriented Securities
(Shirkah Based)
1. Securitize a pool of Musharakah and
Mudarabah contracts like central bank
Musharakah certificates (CMCs) or
Government Musharakah Certificates
(GMCs).
 2. Such securities will offer an investors
a stream of variable income with
potential for growth, based on the
strength of the underlying projects.
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3. these would accommodate risk taking
investors with commensurate growth
oriented income.
Mixed (Growth/Stable income)
Securities
1. Securitize a pool of Musharakah, Ijarah
and some Murabaha, Installment sale,
Istisna’a and Joa’alah contracts.
 2. The risk/return on the security will
depend on the chosen mix of contracts.
 3. such securities would accommodate
various degrees of risk preferences of the
investors with the commensurate income,
and liberate capital or generate new
resources for additional intermediation or
liquidity

NATIONAL INVESTMENT FUNDS
Eliminating interest from gov borrowings is the
most difficult area in the process of
transformation of financial system.
 The best way to transform is to restructure
public sector financing by establishing a number
of National Investment Funds and securitization
of bank contracts and gov assets.
 These funds will raise resources for joint pools
by issuing units, certificates or shares on the
basis of Mudarabah and invest the same in
public sector finacing operation on the basis of
equity sharing, Murabaha, Salam, Ijarah,
Istisna’a etc.

Certificate / unit holders of these funds would
get pro-rata return based on the financial
results of concerned funds.
 Mgt of these funds can be carried out by the
organization acting as mudarib or agent.
 The management of the fund would be given
a pre agreed fee for its services. The fee can
be lump sum or periodic or any percentage
of net asset value of fund.
 Depending on the nature of business, these
funds can be called equity fund, Ijarah or
leasing fund, Murabaha / trade fund or the
mixed fund.

Equity funds would invest their resources in
shares of joint stock companies and earn capital
gains or dividends.
 Shares of all companies whose functioning
conform to shariah can be unanimously bought
and sold.
 Problem is that most of the companies even
dong halal business are involved in interest
transactions.
 Many contemporary scholars are of the opinion
that it is permissible to deal in the shares of
companies whose leverage based on their
market capitalization does not exceed 33 % and
whose income from prohibited/doubtful sources
is not in excess of 5% of its total income.
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Also it is condition that all income from
prohibited sources must go to the charity.
 Scholars in general say that if majority of
assets (more than 51%) of a company are in
liquid form, i.e. in the form of money or
receivables, they cannot be purchased or
sold except at pr value because such shares
represent money which cannot be traded
except at par.
 Ijarah or leasing based funds would use the
pooled amount for purchasing the real assets
for leasing to the ultimate users.
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Each subscriber of these ijarah funds will be the pro
rata owner of the leased funds and the certificates
will be negotiable and traded in the secondary
market.
A trading fund would use the pooled sums for
purchase of goods and their sale on margin of
profit.
the fund must possess the ownership of the
purchased goods before selling them to the gov
(client).
Transfer of constructive possession is also
acceptable whereby risk of commodity must pass to
the owner.
Certificates/units of such funds can only be traded
provided that the portfolio owns the inventories all
the times.
If the goods are sold on deferred payment
basis immediately after purchase from
supplies, the funds will not possess any
tangible assets and will have only the cash
or receivables on the balance sheets, and
the certificates or units will not be
negotiable/tradable except at face value.
 If the pooled amounts in a fund are
employed in different types of investments
like equities, leasing or trade, the fund may
be called a mixed investment fund. If the
tangible assets of such a fund are more than
50%, its certificates can be traded at any
price.

Monetary and Credit policy in
IRAN
1. In Iran, whatever existed in the old law as
objectives and functions of the central bank
has been retained as valid and applicable for
usury free banking.
 2. The words ‘Interest rate’ have been
phased out of the banking system.
 3. The amount or value of prizes and
bonuses for Qard-e-Hasnah depositors and
commission of banks in respect of
investment deposits can be used by
monetary authorities as a monetary tool.
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4. Return of the principal amount of all the
deposits has been guaranteed by the law.
 5. Irrespective of the nature of the mode of
refinancing, the banks have been advised to
remain as the “intermediary of funds” and not
to engage in commercial activities as traders.
 6. On assets side, the contract documents in
respect of all modes of financing contain a
guarantee for the principal amount.
 7. Presently, in respect of statutory reserves,
an average of 4% is paid to the banks on
their treasury bonds holdings and 1% on
cash reserves.
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8. The profit rate, the anticipated rate of
return (ARR) and the profit ratio (the bank’s
share of profit) can be employed by the
monetary authorities as lever.
 The lower the ARR, the higher will be the demand
for credit facilities.
 Profit rate is not being practically used as
monetary tool.

9. Payment or receipt of any amount on
deposits, loans and credits, in any manner or
under any title granted by the Central bank to
the gov, gov organizations, and wholly stateowned companies are by no means Riba
and are recognized as permissible.

10. The tool of discounting and rediscounting
is applicable on a wide level as in the case of
traditional banking. The buying of any bill
originating from commercial transactions or
any discount relating to a factual
indebtedness by the banking system is
permissible. The commercial bills and drafts
discounted by banks can be rediscounted by
the Central bank. Similarly, certificates of
indebtedness denoting the real claim of the
banks on their customers can be discounted
by Central Bank.
Monetary Policy in SUDAN
Monetary policy is being conducted in Sudan
through all the conventional instruments of
monetary control, which are interest free and
are perceived to be consistent with Islamic
Shariah.
 These include;

 Cash Reserve Requirement (reserves are not
remunerated)
 Change in %age in participation of a client in finance.
 Adjustment in the minimum %age of profit margin
under Murabaha mode.

The central bank has two instruments called
as
 1. Central bank Musharakah Certificates (CMCs)
 2. Gov Musharakah Certificates (GMCs)

Banks are also required to maintain a
variable liquidity ratio which is watched on
weekly basis. When banks foresee shortage
of liquidity, they apply central bank to provide
money for specific period and in specific
amount. The central bank enters into
Musharakah with the commercial bank for
that specific period which may be renewed
for another period but not beyond that.
In case, a commercial bank’s current
account is overdrawn, the bank will not allow
the commercial bank to operate in the
clearing house for that day so the
commercial bank will have to arrange
resources either by selling CMCs or encash
them or borrow from another commercial
bank but this requires securities and other
documentation.
 Commercial banks can borrow from the
central bank to meet temporary shortages,
expected shortages, short term borrowing for
investment and for agriculture and exports.

Temporary shortage for 15 days is met
without any problem (returned on
Musharakah basis)
 For expected shortage the banking
supervision department is contacted which
recommends or not.
 This is on the basis of Musharakah in which
central bank’s share is 70% and commercial
banks share is 30%.

CMCs as developed in SUDAN
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In Sudan, large assets of ministry of finance
and the bank of Sudan, bank of khartoum,
Nilain bank and other public entities are
identified for the purpose of securitization.
Value of these assets keeps changing.
30 April 1999, value stood 39.4 billion SD.
It is calculated monthly and the Bank of Sudan
advices the new values.
Shares are handled by a subsidiary of Bank of
Sudan called “Sudan Financial services
company”
All the shares are transferred to this
company.
 Musharakah certificates are auctioned; a cutoff date is decided and generally about 50
certificates are auctioned.

Example of quotations
Quotations
10.00
10.250
10.00
10.200
10.00
10.150
10.00
10.140
10.00
10.130
10.00
10.100
10.00
10.000
10.00
9.990
Cut –off
point
(Illustrative)
Value in SDs
Holders of certificates have legal claims to
assets of bank of Sudan and ministry of
finance etc.
 These certificates have no maturity date and
are open dated.
 The private sector can hold these shares like
pension funds, insurance co. and indviduals.

Main features of CMCs
1. the CMCs is based on Musharakah
Principle.
 2. A close ended fund is established
consisting of gov and central bank ownership
in commercial banks and other financial
institutions.
 3. The face value of the fund is established
on the date of issue.
 4. the fund is divided into finite number of
equal value units.

5. The fair value (equal to book value +
retained profits) of fund units is published on
monthly basis.
 6. The CMCs are issued without maturity
term.
 7. Dividends transferred to fund are not
distributed to CMC holders but re-capitalized
in the fund.
 8. The CMC are sold (or bought) by the
central bank through auctions.
 9. The CMC can be traded in the secondary
inter-bank market.

10. The central bank stands ready to buy the
CMCs on demand for a daily posted price
that reflects the last auction price (or
published fair value, whichever is available)
minus a fixed brokerage amount.
 11. CMC holders get profit (or loss) from
realized capital gains (or losses).

THE END