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Islamic Liquidity Management Issues

Islamic Liquidity Management Issues. ISLAMIC BANKING AND FINANCE Lebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006 Warren Edwardes, ceo , Delphi Risk Management Limited e : we@dc3.co.uk w : dc3.co.uk. Delphi’s website contains :.

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Islamic Liquidity Management Issues

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  1. Islamic Liquidity Management Issues • ISLAMIC BANKING AND FINANCE • Lebanese American University, School of Business, Irwin Hall, Beirut, Lebanon • February 23–24, 2006 • Warren Edwardes, ceo, Delphi Risk Management Limited • e: we@dc3.co.uk • w: dc3.co.uk Warren Edwardes

  2. Delphi’s 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 Edwardes

  3. thoughts on liquidity • More than listing • Is there a buyer when you are a seller? • More than negotiable • At what price? Warren Edwardes

  4. thoughts on liquidity • British Gas • Falklands War • Dumping of Aaa A1-P1+CP • Don’t hold paper in the news Warren Edwardes

  5. thoughts on liquidity • Midland Bank • Crocker bank led to dumping of Midland CDs • Don’t hold paper in the news Warren Edwardes

  6. thoughts on liquidity • Continental Illinois • Plenty of “liquid” assets • No diversification of liabilities • mainly wholesale and few retail customers Warren Edwardes

  7. 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 Edwardes

  8. 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 Edwardes

  9. 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 Edwardes

  10. 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 Edwardes

  11. 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 Edwardes

  12. 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 Edwardes

  13. 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 Edwardes

  14. 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 Edwardes

  15. 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 Edwardes

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

  17. 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 Edwardes

  18. Conclusion & summary • Asset / Liability problem • Long term asset fixed and short term variable deposits • No derivatives – yet! • Gharrar? • Financial Takaful? Warren Edwardes

  19. 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 Edwardes

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