Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

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

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

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

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

thoughts on liquidity

• More than listing• Is there a buyer when

you are a seller?• More than negotiable• At what price?

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

thoughts on liquidity

• British Gas• Falklands War• Dumping of Aaa A1-P1+CP• Don’t hold paper in the news

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

thoughts on liquidity

• Midland Bank• Crocker bank led to

dumping of Midland CDs

• Don’t hold paper in the news

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

thoughts on liquidity

• Continental Illinois• Plenty of “liquid” assets• No diversification of

liabilities• mainly wholesale and few

retail customers

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 DigestDecember 19, 1997 – over 8 years ago!

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

Risk Pyramid

• Risk / return trade-off in conventional markets

• Add to this the Halal / Haram trade-off

• Need Triple-A Halal instruments

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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 Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 2006

Conclusion & summary

• Asset / Liability problem– Long term asset fixed and short term

variable deposits

• No derivatives – yet!– Gharrar?– Financial Takaful?

Warren Edwardes

Islamic Liquidity Management Issues ISLAMIC BANKING AND FINANCELebanese American University, School of Business, Irwin Hall, Beirut, Lebanon February 23–24, 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