According to the IFSB, governors and representatives of a
number of central banks and multilateral organizations that are members of the
IFSB participated in the signing ceremony of the Memorandum of Participation.
Yet the market will have to wait for another two weeks to
find out the structure, the details of the founding participants, the capital
resources, and the underlying transactions for the liquidity management scheme.
The powers that have decided to have the official launch of the IILM on Oct. 25
in Kuala Lumpur during the Global Islamic Finance Forum (GIFF), arguably the
major Islamic finance industry event in the world which is organized by Bank
Negara Malaysia, the central bank, and which is by invitation only.
Some Islamic financial institutions would have preferred
IILM to be launched in Washington during the World Bank Group meetings because
they believe that the corporation would have had a much greater global media exposure
which could have had a knock-on effect in terms of demystifying and
articulating Islamic finance and liquidity management to the wider world. In
contrast, a launch in Kuala Lumpur would merely serve to preach to the
converted.
According to an IFSB statement “the primary objective of the
IILM is to issue Shariah-compliant financial instruments in order to facilitate
more efficient and effective liquidity management solutions for institutions
offering Islamic financial services (IIFS), as well as to facilitate greater
investment flows of Shariah-compliant instruments across borders.”
In 2008 the IDB and the IFSB established two task forces —
the task force on "Islamic Finance and global financial stability"
with the brief to recommend ways of further strengthening the Islamic financial
infrastructure to boost its resilience and ability to meet future challenges;
and a liquidity management task force whose mandate is to enhance the
efficiency of Islamic financial institutions in managing liquidity at both
national and across borders.
The Islamic Finance: Global financial stability report was
unveiled in Khartoum, Sudan, in April this year, and the key suggestions
included eight building blocks in three key areas to promote financial
stability in the global Islamic financial industry; the establishment of an
Islamic Financial Stability Forum (IFSF) which would essentially "be a
broad-based and constructive strategic platform for IFSB members to achieve the
primary objective of building cross-border dialogue in efforts to promote
financial stability within the Islamic financial system;" and the
promotion of "collaboration and cooperation in remedial policies to
prevent, contain and manage emerging issues in Islamic finance."
The task force mandated the IFSB to prepare a report on the
establishment of IILM, which says that the IFSB is also in line with its
mandates as stated in its articles of agreement to enhance and coordinate
initiatives to develop instruments and procedures for efficient operations and
risk management; and to encourage cooperation amongst member countries in
developing the Islamic financial services industry. As such, IILM’s
establishment says the IFSB “is a major breakthrough in the Islamic financial
industry development as it will provide liquid short-term Shariah-compliant
instruments that would promote further the competitiveness and resilience of
IIFS globally.”
In the politics of global Islamic finance, it is perhaps
noteworthy that IILM would be headquartered in Kuala Lumpur. This is a significant
development in terms of the future success of IILM in delivering its
objectives. Basing IILM in Malaysia means that it would have the systemic
framework and support of the Malaysian state — the enabling legislation; proper
internal controls including budget; easy immigration regime for expatriate
employees under the SEP (special employment passes) regime; probably diplomatic
status for the secretary general or CEO of IILM; and a range of other
incentives, which the corporation would definitely not have enjoyed in any
other location anywhere in the world. Malaysia also has an active,
well-developed and relatively substantial local currency-based Islamic money
market which has been in operation for over two decades.
The report for IILM took almost three years to complete. One
of the major challenges especially would be to identify suitable assets that
can be the basis for the underlying transactions and that are tradable on a
cross-border basis with full recourse to the law of the land. Hitherto, the
main liquidity management mechanisms have been commodity Murabaha trades
through LME (London Metals Exchange) warrants and more recently through trades
based on palm oil futures contracts on the Bursa Suq Al-Sila’ platform.
Sami Al-Suweilam, deputy director of IRTI, the research and
training entity of the IDB Group, has over the last two years been suggesting a
liquidity management scheme based on the Salam (forward sale) contract.
The urgency of a liquidity management mechanism cannot be
overstated. Markets all over including the established ones of Malaysia,
Bahrain and the UAE are screaming for a well-established short term hard
currency international liquidity management scheme to meet their various
overnight, daily, monthly and even yearly requirements. There is a huge lack of
this type of facility, especially one not managed by a commercial entity.
The lack of a global Islamic interbank market and a
liquidity management scheme according to several Islamic bankers has hampered
the systemic development of the Islamic finance industry. But in the aftermath
of the global financial crisis and the credit crunch, a renewed effort has been
initiated to come up a mechanism that is truly global, effective, efficient and
Shariah-compliant. The need and urgency for establishing a global Islamic
liquidity management scheme is further underlined by the fact that the global
commodity Murabaha market is estimated at a staggering $1.2 trillion.
Regulators, industry organizations and market players have
time and again stressed the urgent need for a global Islamic interbank market
and a liquidity management scheme. Speaking in London at a conference on the
"Emerging Financial Stability Framework" organized by the
IFSB/IDB/IRTI in 2009, Professor Rifaat Abdel Karim, secretary general of IFSB,
reiterated that “we need to expedite the development of a systemic liquidity
infrastructure for the Islamic financial services industry, as this constitutes
one of the key prerequisites for sustaining financial stability. We need to
step up our efforts to foster the development of liquid sovereign sukuk
markets, Islamic interbank money markets and more efficient tradable
Shariah-compliant financial instruments.”
Sami Al-Suwaillam presenting his alternative Bai Salam-based
model stressed that the objectives for an alternative liquidity management
scheme must be “optimal fund management; minimum transaction costs; and
flexible short-to-medium-to- longer-term funds and borrowing.”
He suggests that using the Bai Salam contract to lend money
and to collect assets and commodities may be a more efficient and
cost-effective liquidity management system, although he acknowledges that a
problem could be the price risk for future delivery of the commodity or asset.
But this could be mitigated by a fund to protect value through a dynamic asset
allocation strategy. “The Bai salam could be traded on the basis of a parallel
Bai Salam, where the buyer has recourse to the Islamic banks and the new owner
has recourse to the counterparty if the party does not deliver the commodity or
asset. The bank would be issuing a new Bai Salam contract with identical terms
to the original Bai Salam. The bank effectively takes the credit risk,” he explained.
Market players such as Badlisyah Abdul Ghani, CEO of CIMB
Islamic Bank, however, stresses that it may be better for each market to
develop its own Islamic liquidity management scheme, before the industry
contemplates establishing a global Islamic interbank system.
Liquidity structure, especially in the light of new
liquidity requirements announced recently by the Financial Services Authority
(FSA), is a main challenge for Islamic banks in the UK. According to Giles
Adams, a partner at KPMG, there are no liquid assets Islamic banks in the UK
can hold because there is no basis for the placement of short-term assets with
the Bank of England on a Shariah-compliant basis. Similarly, there are no
government or corporate sukuk originations out of the UK. As such Islamic banks
in the UK are further hampered because they cannot even place their reserve
requirements with the regulator on a Shariah-compliant basis. This issue is not
confined to the UK or non-Muslim jurisdictions. It is a feature of the global Islamic
finance industry because in most Muslim countries there are no Islamic
interbank markets or any Shariah-compliant liquidity management scheme.
Professor Volker Nienhaus, principal of Marburg University
in Germany and a seasoned researcher in Islamic finance, stressed that much of
the financing provided by Islamic banks is short-term. “Proponents of an
Islamic system propagate profit-and-loss-sharing modes of financing as the
‘true’ Islamic alternative. Such modes, however, are difficult to apply in short-term
financing and applied to medium to longer term financing, they usually imply a
considerable maturity mismatch,” explained Nienhaus.
He suggested that without an efficient interbank market and
without support from central banks, “market forces have driven Islamic banks
toward an increasingly sophisticated replication of conventional banking
techniques. There is obviously a trade-off between efficiency and
distinctiveness of Islamic finance. Given the conceptual preference for profit
and loss or risk sharing, much more fresh thinking and radical innovations are
needed in order to engineer efficient instruments for participatory financing.”
The lack of an Islamic interbank or global liquidity system
is impacting on the operations of Islamic financial institutions in both Muslim
and non-Muslim countries. Islamic banks have hardly any liquid assets they can
hold on to in many markets because of a lack of high quality sukuk assets; and
there is no basis for placement of short-term assets with central banks for
reserve and other requirements because there are very often no
Shariah-compliant papers or instruments to invest in.
