Transcript Seminar on Islamic Finance Monetary Policy and

ISLAMIC DEVELOPMENT BANK
Seminar on Islamic Finance
BANCA D’ITALIA
(Rome ,11 November 2009)
Second session 12.00 a.m
Monetary Policy and Liquidity Management
Objectives of monetary policy in an
Islamic economy
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Economic well-being with full employment and
optimum rate of economic growth;
Socio-economic justice and equitable distribution
of income and wealth; and
Stability in the value of money to enable the
medium of exchange to be a reliable unit of
account, a just standard of deferred payments
and a stable store of value.
Instruments of monetary policy in an
Islamic economy
• All conventional tools normally available in a modern
economy are at the disposal of the monetary authorities
the exception are the tools that involve the use of interest
rate such as :
• The discount rate
• Open Market Operations that can be done on the basis of
Shari’ah approved instruments
Current structure of the Islamic money market
The short-term instruments dominated by(but not
restricted to)
• Interbank mutual financing facilities within the profitsharing framework among Institutions offering only
Islamic Financial Services (IIFS).
• Interbank transactions between conventional and
Islamic counterparties based on Commodity
Murabahah contract, or Special arrangements for
holding compensating non-interest-bearing deposits
between Islamic banks.
Long-term instruments
• Islamic money market and public financing instruments
based on Islamic asset securitisation of various
underlying Shari`ah-compliant contracts, have led to
operations based on Sukuk suitable for interbank money
market transactions, and monetary management.
• Example Government Investment Certificates (GICs)
Monetary Policy Operations
• Market-based monetary operations are not well developed.
Only some of money and capital market instruments are negotiable
in secondary markets. Their volumes is relatively small and they are
not yet suitable for flexible asset–liability management by IIFS and
monetary operations by central banks.
• Central banks apply the same treatment to IIFS and conventional
banks. Most features of the reserve requirement system (such as the
length of the base period, the reserve maintenance arrangement, etc.)
are the same .
• Most central banks do not give return on the required or excess
reserves of IIFS. All central banks impose penalties on reserve
shortfalls, but the method of charging the penalties differs in some
jurisdictions. This led to different demand for central bank balances
between conventional and Islamic banks .
• Foreign exchange swaps are not approved by certain Shari’ah
Boards. This limits the use of foreign exchange operations as tools
to influence domestic monetary conditions.
Summary of issues and challenges
• Under-development or non-existence of a formal or
organised Islamic money market in one form or another.
• Limited options for central banks to consider for effective
open-market type operations using Shari`ah-compliant
tools.
• Low liquidity in the Islamic money market due to the
limited number of market participants and the small size of
their transactions.
• Shortage of Shari`ah-compliant money market instruments
requires IIFS to hold a substantial portion of their assets in
the form of cash (with minimum or no return) which could
affect their profitability and competitiveness .
continued
• IIFS tend to hold Islamic money market papers until maturity
instead of trading. Negatively impact on general market
depth/liquidity, mark-to-market pricing practices and liquidity of
IIFS assets.
• Inadequacy of existing Shari`ah-compliant money market
instruments, dominated by Mu_arabah-type or with linkages
to commodity markets for active secondary market.
•
Absence of lender of last resort privileges with central banks
such as discount window and Lombard facilities for day-to-day
liquidity management of IIFS .
• Reliance on conventional interest-based indices due to the
limited availability of benchmark rates of return that reflect
better the domestic monetary and financial conditions of the
IFSI.
continued
• The interbank money market is segmented between
Islamic and conventional banks. IIFS rely on interbank
arrangements with other IIFS, and on special arrangements
between IIFS and conventional banks.
• Islamic money markets are not well integrated into the
overall money markets in most jurisdictions.
• Different interpretations of Shari`ah rulings, on financial
matters has led to differing methods of structuring
financial instruments, and to non- recognition of some
contracts .
• The cost of issuance, for instruments that are designed
through asset securitisation, exceed that for conventional
issues.
Way Forward
• Design simple Islamic money market and Islamic Government
financing instruments with relatively low risk, regularly issued,
can be held by both Islamic and conventional banks, as well as
non-banks, to avoid segmentation of money markets, and
supported by a robust payment and settlement system.
• Incorporate Islamic Government finance instruments as an
integral part of the overall public debt and financing
programme, and foster the development of an Islamic
Government securities market.
• Actively use Islamic Government finance instruments in
market-based monetary operations of the central bank to
manage liquidity in the Islamic money market.
Continued
• Develop efficient trading arrangements and the associated
market microstructure for Islamic money and Government
finance instruments, and develop in parallel the foreign
exchange markets.
• Provide supervisory guidance and incentives for effective
liquidity risk and asset liability management by IIFS, and in
parallel foster privately issued Islamic money market
securities.
THE END
THANK YOU
• Commodity Murabahah
Interbank funds are used to execute a Murabahah
transaction in a commodity, with the proceeds (net of
commissions) passed on to the bank providing the fund.
Another variation, a bank with surplus funds to buy metals
(other than gold and silver) on international commodity
market) and then sell them the same day to a counterparty
for a deferred payment at a price equal to the purchase
price plus mark-up
• Compensating mutual balances
Exchange of interest-free deposits with arrangements to
ensure that net balances average to zero in a defined
period.
(GICs)Government Investment Certificates
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An asset-based security issued against a number of contracts,
including Ijarah, Salam, Mu_arabah and Istisna’. The
relationship between the holder of a GIC and the issuer is
based on a restricted Mu_arabah contract. The instrument’s
profile ranges from two to six years. The expected return is
determined by the fixed rental income on Ijarah plus the
income from the sale of Murabahah, Salam and Istisna’
contracts. Profit is distributed every three or six months. Sales
of primary issues are made through an auction system. The
GIC is listed on the stock exchange(Sudan)