Islamic Liquidity Alternatives

8/9/2019 Islamic Liquidity Alternatives

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By: Jawaid IqbalRabi-ul-awwal 30, 1430 A.H. Saturday, March 28, 2009

Al- Sadiq (A.S) Institute of Islamic Banking, Finance & Takaful

Al- Sadiq (A.S) Institute of Islamic Banking, Finance & Takaful


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` L iquidity Management a Challenge for Islamicbank

` Options for L iquidity Management

Inter-bank Musharakah & MudarabahInvestment in SukuksIslamic Placement AccountsCommodity Murabaha (FCY & PKR)Forward Cover / Currency HedgingEquity / Islamic Funds

` W ay Forward


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L iquidity Management specially in short term has been acontinuous challenge worldwide for Islamic banks andespecially in Pakistan. Due to the following limitations:

Absence of an Islamic inter-bank marketL

ack of Shariah compliant alternatives both at inter-bank and central bank level. Absence of Islamic discount window at SBP level for IFIs.

Absence of enough Islamic Sukuks both in short & longterm


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Islamic L iquidity Management has two sides:

Placement of excess fundsMatching the short falls & short term liquidity needs

The challenge becomes even greater for IFIs becauseunlike conventional banks the same alternative modemay not work for both situations


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L iquidity Management alternatives for Islamic banksinvolves following alternatives:

Inter-bank Musharakah/Mudarabah based poolsIslamic Placement accountsCommodity Murabaha transactionsIslamic Sukuks (Ijarah, Musharakah, Salam etc.)Trading & Hedging for currenciesEquity Market / Islamic Mutual Funds


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The need for acquiring funds from the Inter-BankCall Market arises usually due to the following reasons:

` W ithdrawals by existing Depositors` New Disbursement/Financing Requirement` General L iquidity Requirements

The above requirements can be met by an Islamic Bankthrough acceptance of funds based on the mode of Musharakah / Mudarabah


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Basic Mode: Specific Investment Pools (FI Pools) are created for acceptance of funds.

Funds from Financial Institutions (FIs) are acceptedunder Musharakah or Mudarabah structure in thesepools.

Proper Profit Sharing Ratio is assigned to each partner.


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Specific F.I. PoolThe F.I. Pools are specific investment pools comprisingof financing assets like Murabaha, Ijarah etc (ideallytangible assets) created to meet the short-term liquidityrequirements of the bank.

At maturity, normally these F.I. Pools are dissolved andassets are transferred back to other investment pools.


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Musharakah based F.I. PoolsIn Musharakah based F.I. Pools, the FI participates in aspecial F.I. Pool as a sleeping partner with IFI asworking partner. The risk and reward of the pool areshared as per the rules of Musharakah.

Mudarabah based F.I. PoolsIn Mudarabah based F.I. Pools, the FI participates asRabb-ul-Maal or Investor with IFI as Mudarib. The riskand reward of the pool are shared as per the rules of Mudarabah.


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In the creation of specific FI Pools following parameters are taken carebased on the nature of mode & tenure of the fund acceptance.

Parameters:The FI pool will comprise of financing asset(s) transferred from theOther asset Pool of the bank or new assets will be booked for thePool.The pool must comprise of significant portion (min10%) of

fixed/tangible assets (like Ijarah or fixed asset Musharakah etc) tomake redemption possible.The tenure of this FI pool must be less than or equal to the tenure of the financing assets in the Pool.


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Islamic Bonds commonly known as Sukuk can be veryeffective in managing liquidity in Islamic Banks and meetingS L R requirements.Sukuk can be developed through Securitization of assetswhich represent the proportionate ownership of the holder

in illiquid or tradable assets.Trade of such securities is permissible as this will betantamount to the sale/ purchase of holders proportionateshare in the assets, which is allowed in Shariah.Examples: GoP Ijarah Sukuk, W apda Sukuk, Qatar Global Sukuk, DubaiGlobal Sukuk


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Islamic Banks can offer placement accounts to other IFIsin the market, tailored exclusively for their needs tomanage excess liquidity in an immediate and profitablemanner.

These account can be used for acceptance of funds inthe General deposit pools from SBP as an alternativeto conventional discount window.


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Meezan Islamic Institution Deposit Account (MIIDA)Key Features:

A Checking Account only available for IFIs. Deposits invested under a Mudarabah arrangementMinimum investment amount- PKR 10,000,000/- or multiplesthereof Maximum investment amount PKR 1 billionW ithdrawals of funds :- 24 hrs. notice for PKR 50 - 200M deposit- 48 hrs. notice for 200M+ deposit

Profit disbursed on a monthly basisProfit calculated on daily product basis


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Commodity Murabaha is commonly used for placingexcess liquidity/funds. Available in maturities of overnight to 1 year.The Islamic Bank purchases a commodity (such as basemetals) listed on the major commodity exchanges (suchas L ondon Metal Exchange)The purchases are made on spot basis from commoditybroker against cash consideration.

After taking delivery the Islamic Bank through its agentwill sell the commodity on deferred payment basis.


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Recently L ocal commodity Murabaha transactions havetaken place in Pakistan.

The process was developed by in consultation withShariah Advisor/SSB members, local commodity tradersand other Islamic & conventional FIs.

Extra care has been taken to ensure the transactionstrictly confirms to the requirement of Shariah & usedonly for managing the liquidity situation.


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1. Sells the commodity to EGIB L

3. EGIB L sells commodity to ABC

5. ABC sells commodity to Buyer D

Seller A

EGIB L

ABC Bank

Buyer D

C (Agent of ABC Bank)

2. Identify commodity and takespossession from EGIB L

B (Agent of EGIB L )

4. Identify commodity and takespossession from ABC

K ey Points:Agent A & C can not be same

Agent C & Buyer D can not be same


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Forward Cover plays a very important role infacilitating imports and exports.

Islamic bank cannot enter into a forwardsale/purchase agreement, however, they canenter into a promise to sell/purchase agreement inorder to sell/purchase foreign currencies in future.


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Definitions as per Shariah` Spot (Ready) Transaction:

If the Deal (transaction) Date & Maturity Date is same then thetransaction will be considered Spot (hand-to-hand) as per the rulesof currency trading in Shariah. In this case the bank is allowed to doa normal sale/purchase transaction of currency.

` Forward Transaction:If the Deal Date & Maturity Dates are different then the transactionwill be considered as forward as per the rules of Shariah (eventhough the market convention defines Spot transaction in range of 1-3 days under T+2 system). In this case IB can enter into a

promise to Sell or Buy with the counter party.


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Hence, all FX transactions that are not ready, can onlybe done on the basis of Unilateral Promise to Sell/Buy.This means that those spot transactions which are notsettled on the same day will also be done through apromise to buy/sell.


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Equity Market & Islamic Funds also providesalternative channel for managing liquidity for Islamicbanks.However in trading of share the Islamic banks needsto follow the approved screening criteria for shares aswell as avoid gharar & speculation.

Available Screening criteria: KMI Islamic Index criteria,Dow Jones Islamic Market Index (DJIM), KualaL umpur Shariah Index (KSI L ).


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Key Screening factors (Meezan Islamic Index Criteria)

Nature of Business Halal / permissibleRatios

Interest based Debt to Asset ratio < 45%Illiquid to total assets - at least 20%Non-Shariah compliant investment < 33%Non-Shariah compliant Income < 5%

Net liquid asset per share < share price


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Other avenues for liquidity Management in Equity MarketsIslamic Alternative for Ready Future based on twoseparate sale transactions.

Another possible options could be Islamic alternative for

Margin & CFSHowever, the concept needs more research and alsosupport from KSE, SECP as few changes may berequired to make Shariah compliant alternative viable.


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Islamic Liquidity Alternatives

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