Al-Jasser had earlier delivered a “tour de force” lecture titled “Macroeconomic Management in an Oil Economy: the Case of Saudi Arabia” in the historic Examinations Hall at Oxford University in the presence of Adrian Wood, professor of International Development at Queen Elizabeth House, Oxford University; Farhan Nizami, director of the Oxford Centre for Islamic Studies (OCIS), and Nazir Tun Abdul Razak, chairman and CEO of Malaysia’s CIMB Bank Group and younger brother of Malaysian Prime Minister Najib Tun Abdul Razak.
The fact that Al-Jasser included Islamic finance as one of four main challenges of managing the Saudi economy going forward is a welcome departure from previous governors of SAMA who dare not speak the name of Islamic banking. The challenges identified by Al-Jasser included those posed by the unpredictability of oil revenues; that of employment and economic diversification; the implications of the global financial crisis of 2008-09 for the Saudi financial system and what part Islamic finance can play in the future; and that of food price inflation.
The governor openly lauded the Islamic system of financial management, which he said has a role to play in economic growth and financial stability and looked forward to the further growth of the Islamic finance industry.
Al-Jasser reminded that the basic concept of Islamic economics is fairness and shared responsibility in risk-taking. “Islamic financial institutions have been growing rapidly around the world and Shariah-compliant banking products and services account for about 38 percent of the banking sector assets in Saudi Arabia. The challenge for SAMA is how to expand the role of Islamic financial institutions in the interbank money markets and to design tools that will be Shariah-compliant but at the same time allow SAMA to manage liquidity in the money market, especially repo agreements,” he said.
Liquidity risk management is as crucial as credit risk management, and this has been well proven during the recent global credit crisis. One of the objectives of asset-liability management (ALM) is liquidity risk management. Conventional banks, added Al-Jasser, have the traditional asset-liability mismatch (i.e. they borrow short and lend long) but they have the required platform to manage their maturity gap and cash flow in a relatively efficient manner (they trade instruments between themselves and they have back-up of the central bank as lender of last resort).
In contrast, he lamented, banks operating on Shariah principles are faced with operational issues in managing their liquidity effectively. This is because they also have the traditional asset-liability mismatch but their liquidity management tools are not as flexible.
Although sukuk can be traded, they are mostly held to maturity. “It is all very well having entire sukuk issues oversubscribed, but there has to be an exit route to demonstrate liquidity. And this lack of truly liquid assets has paradoxically increased the demand for liquid instruments,” he explained.
Indeed, the absence of an interbank market in Islamic instruments is one of the major constraints to the development of an integrated Islamic financial system. Central banks can expand the range of instruments they will accept in their role of lender of last resort to accommodate Islamic instruments, but what is needed is an interbank market.
In this respect, SAMA considers the establishment in October 2010 of the International Islamic Liquidity Management Corporation (IILM), whose equity subscribers are confined to central banks, monetary authorities and multilateral agencies, as “an encouraging development.” The IILM, which is headquartered in Kuala Lumpur, has an authorized capital of $1 billion of which $80 million is paid in. SAMA and Bank Negara Malaysia, the central bank, are the two largest subscribers to the equity of $10 million each, followed by a $5 million subscription each by the central banks of Luxembourg, Mauritius, Kuwait, Qatar, Indonesia, Turkey, Sudan, the UAE, Nigeria and Iran and the Islamic Development Bank (IDB) and its private sector funding arm, the Islamic corporation for the Development of the Private Sector (ICD).
The IILM has one main objective to facilitate liquidity management across borders for Islamic finance and will issue papers periodically in tranches in different currencies. The first two tranches will be in the US dollar and the euro. The corporation will also by business-driven with top class management. In fact, the inaugural CEO of the IILM, Mahmoud AbuShamma, started work on Feb. 1 with the process of establishing the management and operations of the corporation.
Besides the IILM, Al-Jasser believes that banks (both conventional with Islamic banking units or windows and those operating solely on Shariah principles) can play a crucial role through an interbank arrangement in addition to pricing sukuk in the secondary market.
In the area of monetary and banking policies, SAMA follows a monetary policy aimed at achieving stability in the financial sector and providing the necessary liquidity to meet domestic demand for credit, by taking a package of proactive measures to enhance the liquidity position and reduce the cost of lending to ensure that banks continue their financing role in the development process in the Kingdom.
The most prominent measures used are: Reducing the statutory reserve requirements ratio, the Repo and the Reverse Repo rates several times, enhancing the liquidity position in the banking system by placing long term deposits in local currency and US dollar with local banks on behalf of government institutions and organizations, reducing the pricing of treasury bills, facilitating foreign exchange swaps to provide the necessary liquidity in US dollar for the local banking system.
However, SAMA has failed to act as a market maker for domestic Islamic liquidity management instruments and as such an Islamic interbank. This is because the Saudi central bank has not issued any Shariah-compliant commercial papers — local currency issuances or international ones — to date. In contrast, Malaysia regularly issues government Islamic notes, Islamic private debt securities, MTNs, sukuk either by the Ministry of Finance through Bank Negara Malaysia or by Cagamas, the state-owned Malaysian Housing Finance Corporation, one of the largest issuers of sukuk and arrangers of Islamic securitization in the country if not the world. At the same time, the central bank of Bahrain has pioneered the zero coupon Sukuk Al-Salam in addition to domestic and international sovereign Sukuk Al-Ijara.
Saudi Islamic banks at best hold investments at amortized cost in the form of Murabaha with SAMA. At end of June 2010, the Al-Rajhi Bank Group’s Murabaha investment with SAMA, for instance, alone stood at SR27.5 billion, much larger than the three other Islamic banks in the Kingdom — Alinma Bank, Bank Albilad and Bank AlJazira. Alinma Bank's investment held at amortized cost in the form of Murabaha with SAMA totaled SR2.5 billion at the end of September 2010. Cash and balances with SAMA totaled SR578.061 million and the bank’s statutory deposit with the agency stood at SR254.152 million at the same period. Its Murabaha receipts due from other banks totaled SR5.2 billion. Bank Albilad had interim 2010 cash balances totaling SR1.6 billion and a statutory deposit totaling SR73.024 million with SAMA. Commodity Murabaha held with SAMA at amortized cost totaled SR1.2 billion. Bank AlJazira cash balances with SAMA at the end of 2009 stood at SR1.4 billion; its statutory reserve was SR1.39 billion; and it held SR2.3 billion in Commodity Murabaha with SAMA at amortized cost. The bank’s total money market placements, which are funds placed on a Murabaha basis, totaled SR6.9 billion.
In Saudi Arabia and Kuwait, IFIs also use interbank compensating mutual financing facilities within a profit-sharing framework. This involves the exchange of interest-free deposits with arrangements to ensure that net balances average to zero in a defined period.
The commodity Murabaha is preferred by SAMA to manage liquidity of Islamic banks in their markets. Here a bank with surplus funds buys metals (other than gold and silver) on the London Metals Exchange (LME) or some other international commodity market, and then sells them the same day to a counterparty for a deferred payment at a price equal to the purchase price plus a mark-up. In another variation, interbank funds are used to executive a Murabaha transaction in a commodity with the proceeds (net of commission) passed on to the bank providing the fund.
The disadvantage of the commodity Murabaha is that it is not tradable under Shariah principles and may carry some market, commodity price, counterparty, credit and even Shariah risk. Some observers stress that it is also not flexible enough to be used for monetary policy operations.
The hope for SAMA must be that the Bahrain-based International Islamic Financial Market (IIFM) is successful in developing an Islamic alternative to Repos and collateralization based on Murabaha.
Bankers stress that Repos are important tools in cash and liquidity management; in creating liquidity in the underlying instrument; in financing and leveraging the investment; in credit enhancement and greater volume; in playing a role in other structured products (derivatives, swaps etc); and in oiling the wheel of the bond market. The objectives of the IIFM’s I’aadat Al Shira’a (repurchase) project, include the funding the positions of sukuk and other instruments; better asset, liquidity and cash management; assisting in sukuk credit and yield pickup and increasing secondary market liquidity in sukuk; a useful tool which can be used by central banks to control money supply and to better fulfill reserve requirements.
