ISLAMIC BANKING AND FINANCE

Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Islamic Liquidity Management Issues

ISLAMIC BANKING AND

FINANCE
Lebanese American University,
School of Business, Irwin Hall,
Beirut, Lebanon
February 2324, 2006
Warren Edwardes, ceo, Delphi
Risk Management Limited
e: we@dc3.co.uk
w: dc3.co.uk

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Delphis website contains:

articles on Islamic banking on:

dc3.co.uk/ibnews
The full speech will be on:
dc3.co.uk/IslamicLiquidity060218.pdf
with PowerPoint on
dc3.co.uk/IslamicLiquidity060218.ppt

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

thoughts on liquidity
More than listing
Is there a buyer when
you are a seller?
More than negotiable
At what price?

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

thoughts on liquidity
British Gas
Falklands War
Dumping of Aaa A1-P1+CP
Dont hold paper in the news

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

thoughts on liquidity
Midland Bank
Crocker bank led to
dumping of Midland
CDs
Dont hold paper in the
news

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

thoughts on liquidity

Continental Illinois
Plenty of liquid assets
No diversification of
liabilities
mainly wholesale and few
retail customers

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

thoughts on liquidity

Access to determinate amount of cash

When you need it
Preservation of capital on demand
Free from price risk
Undoubted quality low credit risk and
be seen to be so
Need a quality Triple-A overnight
instrument with stable capital values

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Background to Islamic liquidity

Islamic banking is having a growth spurt. .
shortage of inter-bank liquidity,
signs that tentative moves are being made to
address these shortcomings.
Middle East Economic Digest
December 19, 1997 over 8 years ago!

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Background to Islamic liquidity

Asset/liability gap management
Shortage of instruments
LMC /IIFM initiatives
Numerous Sukuks including Malaysia, Bahrain &
IDB Sukuks
Liquidity and price transparency is required
for an active secondary market
Issues oversubscribed but minimal trading
This lack of liquidity paradoxically increases
the demand for liquidity

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

liquidity management
Investments long dated deposits are short
massive gap
Massive liquidity problem
Need flexibility with Shariah compliance
Sukuks held to maturity
Short selling?
Stock borrowing?

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

liquidity management
LME Murabaha is main destination
Bilateral transactions
Counterparty limits
Some funds exist
But not capable of market size
transactions
Segmentation inevitable
Co-operation needed with a market
level solution

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

No Inter-bank market
Balance sheet management problem
Cannot easily finance when there are
withdrawals
So more liquidity than needed by a
conventional bank
Bilateral Murabaha with break clauses is
widespread
liquidity vehicles cannot withstand a
$100million injection or withdrawal

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Risk Pyramid
Sound ALM requires a quality / liquidity
pyramid.
Most liquid is USD bill or note
Nil earnings but price stability vs USD
Then a range of bonds from super nationals
to governments and funds
Most with price risk
Some with earnings volatility but fixed price
No such highly rated Islamic instruments

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Risk Pyramid
Governments reserves are in gold
and government Triple-A paper
Fiduciary or trust money should
be both liquid and safe and price
risk free
Basle II is approaching
Even before that sound risk
management principles apply

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Risk Pyramid
Pyramid of risk
Blended portfolio from
Triple-A down to Single-B
Can interpolate risk
between Triple A and
Single-A
Cannot extrapolate risk
from lesser risks to triple-A

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Risk Pyramid
Risk / return trade-off in
conventional markets
Add to this the Halal / Haram trade-
off
Need Triple-A Halal instruments

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Conclusion & summary

Sukuks bought to hold
minimal secondary market for on sale
Mark to market and price determination is difficult
Shortage of paper
Is debt trading really Halal?
Novation agreements
Cancellation of original purchase and replacement
with new owner in contract note

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Conclusion & summary

Asset / Liability problem
Long term asset fixed and short term
variable deposits
No derivatives yet!
Gharrar?
Financial Takaful?

Warren
ISLAMIC BANKING AND FINANCE
Lebanese American University, School of Business, Irwin Hall, Beirut, Islamic Liquidity Management Issues
Lebanon February 2324, 2006

Conclusion & Summary

Lack of short term instruments
Sukuks are medium plus term
Not price stable or really liquid
Shortage of credit lines
Wanted an overnight Triple-A, market-
sized, liquid, inter-bank market
solution where institutions can park
their reserves

Warren