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Sunday, 30 November 2014

Islamic Finance Set To Tackle Long-Standing Repo Challenge

Separate but converging efforts are underway in Islamic finance to help develop globally accepted alternatives to conventional repurchase agreements, as the industry tries to crack one of its greatest structural limitations.

In the last several years Islamic banks have grown faster than conventional ones, partly because of economic booms in the core regions for Islamic finance, the Gulf and southeast Asia.
But the banks have largely lacked the collateralised money market tools which many bankers believe are essential for the industry’s long-term health and viability.

Developing sharia-compliant substitutes for repos would help Islamic banks manage their liquidity more cheaply and flexibly, allowing them to cope better during times of market stress.
Islamic banks are now considered systemically important in countries including Kuwait, Saudi Arabia, Qatar, Malaysia and the United Arab Emirates, according to the Kuala Lumpur-based Islamic Financial Services Board (IFSB).

Until now, progress in developing “Islamic repos” has been slow because of a lack of consensus among bankers, regulators and scholars on what structures would be both religiously permissible and financially effective.

But this is now changing. Pressure on regulators to agree on Islamic repo structures has increased; Basel III banking standards, now being phased in around the world, make banks’ need to manage short-term funding more acute, the IFSB said last month as it released draft guidance on liquidity risk management.

Early this month another Islamic standard-setting body, the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), said it was developing a sharia standard for repurchase agreements.

And on Sunday, the Bahrain-based International Islamic Financial Market (IIFM) released a contract template for collateralised murabaha transactions, a cost-plus-profit structure which might serve as an alternative to conventional repos.

So far, Bahrain and Malaysia have been at the forefront of creating such tools but more efforts are needed, Jeddah-based Mohamed Ali Elgari, an industry expert who sits on over 80 sharia boards around the world, told Reuters.

“Any successful structure has to satisfy the requirements of sharia, and the requirements of regulators, and the requirements of risk managers. To combine all these three factors, it’s very difficult.”


Conventional repos allow institutions to lend out assets for short periods to generate liquidity. This is problematic in Islamic finance because it entails charging interest.
“Repurchase is not permitted in a purchase contract. This is combining two types of contracts,” Elgari said.
Also, Islamic finance specifies that actual ownership of collateral be transferred, a requirement which has limited the international approval of some solutions.

For example, Malaysia’s approach uses a sale and buy-back contract known as inah, but the practice has been shunned by Gulf-based Islamic banks which argue that transfer of ownership of assets is not clearly executed.

The IIFM’s collateralised murabaha format tries to avoid controversy by having the financier buy the asset at market value and immediately sell the asset to the customer for a mark-up on a deferred payment basis.

But in practice, such transactions need more clarity to gain wider acceptance, said IIFM chief executive Ijlal Ahmed Alvi.

“There is still a lot of work and deliberation needed such as fixing of forward leg between two counterparties, the legal entity which can act as the third party and take risk, etc.”

For its own standard on repurchase agreements, AAOIFI will conduct extensive consultations with scholars on all aspects of the transactions, said secretary general Hamed Hassan Merah on the sidelines of AAOIFI’s annual conference in Manama last week. Merah did not specify when the standard might be ready.

Meanwhile, some regulators see short-term, U.S. dollar-denominated Islamic bonds (sukuk) issued by the Malaysia-based International Islamic Liquidity Management Corp (IILM) as collateral that might be used for sharia-compliant repos.

Nigeria’s central bank has issued guidelines for asset-backed securities that can employ IILM sukuk as collateral, while regulators in Indonesia are discussing ways to allow IILM sukuk to be used as guarantees in money market transactions.

“We are studying whether we can accept IILM to be traded as short-term sukuk securities within Indonesia’s Islamic money market,” said Halim Alamsyah, deputy governor of Bank Indonesia.
Islamic banks are largely buy-and-hold investors of sukuk; collateralised transactions could energise sukuk secondary markets by encouraging banks to make better use of those assets.
“Institutions of all sizes will be equally comfortable to transact and better utilise their Islamic securities portfolios, particularly sukuk,” said Khalid Hamad, executive director of banking supervision at Bahrain’s central bank and IIFM chairman.

(Gulf Business / 29 November 2014)
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Small-ticket Islamic banking may become possible with payment banks

mild form of Islamic banking - where the key tenet is that interest will neither be paid nor received - may become possible if one reads the fine print of the Reserve Bank of India's (RBI's) new guidelines for the setting up payment banks.
A key guideline for payment banks is that they can only invest in government securities upto a year's maturity - which means treasury bills. T-bills upto 364 days' maturity carry no interest; they are essentially discounted instruments where the face value is paid on maturity. For example, a 91-day T-bill of Rs 100 face value may be bid for (or offered) at Rs 98. No interest is payable, but one can deduce an in-built yield rate from the discount (Rs 2, in this case) and the holding period (91 days).
This means any Muslim non-bank financial institution can strictly follow the Koranic injunction on non-receipt of interest (called riba, which also means usury) - at least at the investment end of banking.
That leaves us with the question: what about deposit rates? Is that not riba, and thus sin in some Muslims' eyes?
True, but payment banks can get around this by offering interest-free deposit accounts - where the gains are given in the form of transaction discounts. A payment bank account, in any case, is not a big-ticket savings bank account; it is intended largely for settling transactions - paying bills, making purchases, making small payments to third parties, etc.
Two possibilities exist: one way is to offer those who hold zero-interest accounts to be compensated through discounts. For example, if the normal interest rate is, say, 5 percent on a deposit account, discounts equal to the value of 5 percent can be offered by the bank on bills payable to, say, a mobile company, a power company, or on a Flipkart/Amazon purchase, etc.
The other way is to allow depositors to also become shareholders or profit sharers. This would need the RBI's indulgence and permission, but if a proportion of the profits of the payments bank can be earmarked as dividends for depositors, this issue can be sorted out. A simple tweak of the guidelines, where the bank will be allowed to pay dividends annually on zero-interest accounts would do the trick.
Beyond Islamic banking, which is actually nothing but interest-free or profit-and-loss share banking that has been given a sectarian title, it is possible for e-commerce or mobile companies to offer customers discounts on bills in addition to their normal interest earnings on savings deposits.
The RBI has not been too keen on Islamic banking for the simple reason that you can't run two separate regulatory regimes in one integrated banking system. However, payment banks are an option that NBFCs who want to tap the sharia-conscious customer can look at closely.
(First.Biz / 28 October 2014)
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