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ANALYSIS

Islamic banks pressed to diversify money market deals

Dubai, March 28, 2013

Regulators, scholars and simple economics are pressing Islamic banks in the Gulf to diversify their money market transactions, a trend which could spur growth of the region's financial markets.

Islamic money market assets have expanded rapidly in the last few years along with the rise of sharia-compliant banking.

In the United Arab Emirates, for instance, Islamic certificates of deposit issued by the central bank and held by commercial banks have more than tripled in the past two years, to 15.1 billion dirhams ($4.1 billion) last December from 4.6 billion in 2010, central bank data shows.

The main tool which Gulf banks use to manage such short-term liquidity is commodity murabaha, a common cost-plus-profit arrangement in Islamic finance. Under the arrangement, a bank agrees to purchase merchandise for another bank, which promises to buy it at an agreed mark-up.

Traditionally, the merchandise has been commodities traded through the London Metal Exchange (LME). But an increasing number of banks are looking at alternatives to this.

"There is still an over-reliance on commodity murabaha, but this can only be addressed when you get alternatives in the market," said Ijlal Ahmed Alvi, chief executive of Bahrain-based International Islamic Financial Market (IIFM), an industry body which develops specifications for financial contracts.

OPPOSITION TO MURABAHA

Although commodity murabaha is widely used, it faces opposition from some Islamic scholars on the boards which oversee banks' activities. The practice is criticised as not sufficiently based on real economic activity, a key principle in Islamic finance.

"Sharia boards are driving this - in the UAE, most banks are shying away from commodity murabaha," said Husam Saif, head of treasury and capital markets at Manama-based Khaleeji Commercial Bank.

Opposition to commodity murabaha crystallised when Oman issued regulations last December covering its fledgling Islamic finance industry. It essentially banned commodity murabaha, also known as organised tawarruq.

One possible solution for banks is to improve the way they conduct commodity murabaha to make it "stronger" or more closely aligned with sharia principles. This month, the Dubai Multi Commodities Centre (DMCC) offered a way to do this by launching an Islamic trading platform.

The DMCC argues that its platform permits stronger murabaha by tracking the ownership of commodities in a way which gives assurance that an actual exchange of commodities is occurring, rather than just a paper transaction.

Another potential advantage for Gulf banks is that the DMCC is close to home; this allows same-day settlement and means legal recourse to assets can be secured, said Kazim Ali, head of corporate banking at Dubai-based Noor Islamic Bank.

"It's a very positive development - from an interbank perspective it allows banks to make regional transactions, which makes it more efficient."

Ali said his bank planned to extend its use of the DMCC platform from interbank deals to include transactions with individual clients.

"What we plan to do is customer murabahas in this platform. Besides interbank and direct customer transactions, the bank will also consider commodity financing. This has great value for the industry."

ALTERNATIVES

At the same time, some banks are exploring alternatives to commodity murabaha. Islamic contracts such as wakala (agency) agreements are gaining popularity, and appear to be garnering a larger share of interbank markets, although official data are not available.

Saif at Khaleeji estimates commodity murabaha volumes in the Gulf vary daily between $8 billion and $11 billion, while wakala contracts could be edging close to a third of that volume.

Wakala, where one party acts as an agent for another to manage a pool of assets, will soon have a standardised agreement being developed by the IIFM, Alvi said.

"Our unrestricted wakala documentation standard is under finalisation, and it will be most likely published before Ramadan (July), if not earlier."

The IIFM has also developed standards for Islamic hedging, and it is developing a collateralisation standard for the use of tradeable sukuk (Islamic bonds) in liquidity management, Alvi added.

Qatar took a step towards facilitating the use of sukuk for banks' liquidity management this month when it launched a regular programme of quarterly sukuk issuance.

Next in line could be Oman, which having banned commodity murabaha is now considering other ways for its banks to park their funds.

"Most probably it will be some type of tradeable sukuk, either ijara- or equity-based" said Jamil Jaroudi, chief executive of Bank Nizwa, Oman's first Islamic bank. Ijara is an Islamic leasing structure.

Bank Nizwa ultimately plans to use a mix of wakala and tradeable sukuk to manage its funds, Jaroudi said, as well as murabaha deals with regional Islamic banks conducted outside Oman.

Oman's first sukuk may take some time to become available, however; central bank chief Hamood Sangour al-Zadjali said this month that rial-denominated sukuk were likely to be issued towards the end of 2013 or at the start of next year. – Reuters




Tags: Dubai | Gulf | Sharia | Financial market |

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