DEVELOPMENT OF THE ISLAMIC MONEY MARKET
NASIRUDDIN AHMED
In a traditional interest-based system, the money market becomes a means by which financial institutions can adjust their balance sheets and financial position in these markets. Short-run cash positions, which exist as a result of imperfect synchronization in the payment period, become the essential raw material for the presence of money markets. A money market, in this case, becomes a source of temporary financing and an abode of excess liquidity in which transactions are mainly portfolio adjustments.
In an Islamic system, the liabilities that an economic unit emits are, by necessity, closely geared to the characteristics of its investments. On the other hand, the liabilities that financial intermediaries emit are expected to have nearly the same distribution of possible values as the assets they acquire. Hence, given that debt instruments cannot exist. Islamic money market activities will have characteristics different from their counterparts in the traditional system.
The existence of a poor money market combined with a poor structure of financial intermediation leads to a situation where money becomes mor e important as a repository of wealth than it is in a situation with more active financial intermediation. Th e existence of broad, deep and resilient markets in which financial intermediary assets or liabilities can be negotiated is a necessary ingredient.
Additionally, to the extent that money markets help lower the income elasticity of demand for cash and help investment projects to be financed, their importance in the Islamic financial system cannot be overlooked. Even in this system, money markets will enable financial units to be safely illiquid, provided they have assets which are eligible for this market. In this system, too, the basic raw material for the money market is the existence of pools of excess liquidity.
One principal activity of money markets in this system is expected to be arrangements by which the surplus funds of one financial institution can be channelled into the profit-sharing projects of another. It is conceivable that some banks may, at times, have excess funds available but no assets, or at least no assets attractive enough in terms of their riskreturn characteristics, on which they can take a position.
On the other hand, there may be banks with insufficient financial resources to allow them to fund all available opportunities or with investment opportunities requiring commitments of what the banks may consider excessive funds in order for them to take a position, for which they may prefer risk-sharing with surplus banks. In this case, the development of an inter-bank fund is a distinct possibility. It may be possible for some banks to refinance a certain position that they have taken by agreeing to share prospective profits in these positions with other banks in the inter-bank funds market.
Finally, since much of the investment portfolios of banks will be in equity position of various terms and maturities, it is also possible that a subset of their asset portfolios composed of equity shares can be offered in the money market in exchange for liquidity.
Here, too, effective and viable money markets in the Islamic system will require active support and participation by the Central Bank, particularly in times when investment opportunities and/or the risk-return composition of projects and shortages of liquidity in the banking system may require a lender of last resort. Such money markets must be flexible enough to handle cash shortage periods for individual banks based on some form of profit-sharing arrangement.
The challenge for money markets, as well as for secondary markets, in an Islamic financial system is the development of instruments that satisfy the liquidity, security and profitability needs of the markets while at the same time assuring compliance with the rules of the Sharia, i.e., the provision of uncertain and variable rates of return on instruments with corresponding real asset banking.
Islamic banks as financial intermediaries have emerged over a period of fifteen years. The banking operations conducted over this period have amply proven the viability of the interest-free banking system. Nevertheless, it has to be admitted that there is a long way yet to go to achieve a strong foot-hold for Islamic banking operations in the financial markets.
In Bangladesh, the second largest Muslim country in the world, banking operations avoiding Riba commenced with the establishment of the Islami Bank Bangladesh Limited in 1983. The second bank, that came into existence in mid-1987 to conduct business on the basis of Islamic tenets, was the Al Baraka Bank Bangladesh Limited.
Recently, two more Islamic banks, namely, Al Arafah Islami Bank Limited and the Social Investment Bank Limited, have started functioning and one insurance company has been allowed to be set up to operate on the basis of the tenets of the Sharia.
The banking operations of the existing Islamic banks are restricted to a close orbit owing to limitations in financial transactions with the interest-based banking network now existing in the country. One such limitation is the inability of the operating Islamic banks to have recourse to the country’s financial market owing to its interest-based character.
The financial market consists of two wings, namely: the money market and the capital market. The basic function of both these wings is to mobilise financial resources from savers and transfer the same to the borrowers. The money market in Bangladesh is confined to inter-bank transactions on a limited scale and that, too, mostly in the capital city of Dhaka.
The scheduled banks, including the specialised financial institutions, having surplus funds, lend out to others who are in need of short-term financial resources. The inter-bank lending-borrowing operations generally take place in Dhaka, where the head offices of all the banks are located. The bank branches from all over the world remit their surplus funds to their respective head offices in Dhaka for investment, while they draw on their head offices at times of financial need. But the Islamic banks cannot approach this money market for short-term financial accommodation, or investments of excess liquidity, since they operate on the traditional interest-based system.
To overcome this situation, the Islamic banks in the country can organise a domestic Islamic money market to ensure inter-bank fund flow for its efficient utilisation. If this is done, the banks having excess funds but no attractive assets in terms of risk-return characteristics will have the chance to channel their surplus funds to some other banks, which have attractive investment opportunities but do not have sufficient financial resources to invest.
Needless to say, such inter-bank fund flows will have to be made on the basis of the risksharing principles of the Sharia; and appropriate instruments will have to be developed for the purpose. There is, however, no denying the fact that even in building up the Islamic money market as a counterpart of the traditional interest-based money market, the active support of the Central Bank as the lender of last resort will be necessary at times to meet inter-bank fund shortages.
Similar limitations are also being faced by the Islamic banks in mobilising long-term financial assistance of a longer maturity period for projects belonging to the industrial, agricultural, construction and other sectors of the economy that are assessed on an ex-ante basis to be profitable – both socially and financially.
Generally, the commercial banks cannot go for such long-term project financing from their mobilised deposits without endangering the desirable liquidity level. Hence, in longterm project financing, they look forward to credit lines from international financial institutions or commercial banks. But the Islamic banks cannot run after such credit lines, as in almost all cases, these are interest-bearing.
The establishment of the Islamic money market and thereby funds utilising the same, must be made in accordance with the Islamic Sharia. Accordingly, the principle focus should be on the following major issues:
1. Avoiding trading in money or debt, which is forbidden from a religious point of view.
2. Utilising funds operating on the profit-and-loss-sharing concept.
3. Utilising the accumulated funds directly in productive areas which are consistent with Sharia principles.
4. Not dealing in interest – either taking or giving it.
Developing Islamic financial and monetary instruments is aimed at the development of Islamic banking; and consequently, the development of Islamic financial markets is to be considered on the basis of the following two aspects:
1. Instruments to mobilise funds
2. Instruments to utilise funds.
In order to meet the essential needs of inter-Islamic bank transactions, it has become imperative to develop Islamic financial instruments, since inter-bank transactions between conventional banks and Islamic banks cannot take place. This is because such transactions include interest, thus contradicting the Sharia principles.
It may, however, be possible for Islamic banks now operating to transact among themselves on a very short-term basis, to meet their liquidity needs in the case of an emergency, beside long-term inter-bank transactions.
In the present context, the Islamic banks may help each other in support of their liquidity crises by placing their surplus funds with others who are in need of funds for maintaining liquidity and to undertake short-term trading business by placing funds in (i) Mudaraba deposit accounts (Savings Accounts), (ii) in Mudaraba Short-Term deposit accounts and (iii) Mudaraba term deposit accounts.
Since two Islamic banks – the Islamic Bank Bangladesh Limited and Al-Baraka Bank Bangladesh Limited – have already gained strength, and their activities have increased and diversified manifold; and two more Islamic banks, namely Al Arafah Islami Bank Limited and the Social Investment Bank Ltd, have recently started functioning, the development of new Islamic financial instruments has become a priority in order to meet the requirement of creating the domestic inter-bank Islamic market and thus to ensure the overall development of Islamic banking.
It should be kept in mind that Islamic banks are, by their very nature, multifarious banking operations and they serve productive activities. Most of their activities have so far been directed to short- and medium-term operations. Consequently, the proposed financial instruments for creating the Islamic money market have been of a medium- and long-term nature in order to provide stability to the banks’ resources and to cope with the financial needs for economic development activities.
With a view to extending long-term project finance within the permissible limit, avoiding Riba, the Islamic banks and insurance houses can develop a common fund by contributing specified amounts, as may be agreed upon, for channelling financial resources to viable projects at their disposal under syndication loans.
With a view to extending long-term project finance within the permissible limit, avoiding Riba, the Islamic banks and insurance houses can develop a common fund by contributing specified amounts, as may be agreed upon, for channelling financial resources to viable projects at their disposal under syndication loans.
1. Islamic certificates of deposit.
2. Islamic certificates of investment to provide finance for specific projects.
3. Islamic certificates of investment to provide finance for a certain field of activity.
4. Long-term certificates.
5. Floating of Mudaraba, Musharaka and bonds for investment in specific trade investment and long-term project finance.
6. Sharing income bonds.
7. Overnight Islamic commodity finance, etc.
Before introducing the above instruments for mobilizing funds and utilizing the same for short-and-long-term financing, a high-powered committee, consisting of senior bankers, Islamic economists and eminent Islamic scholars (jurists having a thorough knowledge of Sharia principles), must be formed to evaluate and determine their structure, modus operandi, applications, functions and utilization in terms of the Sharia point of view.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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