Transcript Folie 1 - Banca d'Italia

Second Session:
Monetary Policy and Liquidity Management
Andreas (Andy) Jobst
Monetary and Capital Markets Dept.
International Monetary Fund (IMF)
Seminar on Islamic Finance
Banca d’Italia
November 11, 2009
Rome, Italy
700 19th Street, NW, Washington, DC 20431, USA
E-mail: [email protected]
© A. Jobst, 2009
Disclaimer: This presentation should not be reported as representing the views of the IMF. The views
expressed in this presentation are those of the author and do not necessarily represent those of the IMF or
IMF policy.
Window of opportunity for Islamic banking …
Soul-searching in conventional finance:
– reduction of complexity  simpler financial products
– no asymmetric incentive systems
– stable growth only if there are redundancies without
leverage  otherwise gyrations and no room for error
– fundamental reform: no makeshift repairs, structural change
 marginalization of leveraged financing
See also
• Nassim Taleb, “Ten Principles for a Black Swan-proof World” (FT, April 2009)
• Viral Acharya, Thomas Philippon, Matthew Richardson, and Nouriel Roubini, “The
Financial Crisis of 2007–2009: Causes and Remedies” (Geneva Papers, February 2009)
© A. Jobst, 2009
… given the basic precepts of Islamic finance (1) …
• asset-linkage
– payments can only be made in association with the temporary
or permanent use of assets and not from the time value of
money  asset-backing is essential
– align investments in real assets and associated financial claims
– prohibition of short-selling and marginalization of the
possibility of leverage (underfunding)
• shared business risk from (entrepreneurial) investment
– payoffs from state- or time-contingent profit/loss sharing
arrangements without guarantees, based on direct
participation in asset performance
– contractual certainty via clear and transparent investor rights
and obligations
© A. Jobst, 2009
… given the basic precepts of Islamic finance (2) …
• identifiable object characteristics (“quantity and quality”) of a
bona fide trade and/or certainty about delivery results
– sales must be immediate and absolute without uncertainty
(gharar)
– delayed delivery and payment permissible if their commercial
value (“diversity of trade”) overrides term contingencies 
salaf (forward trade)
– any contingency risk limited to pre-defined timing mismatch of
delivery or payment
• no trading of the same object between buyer and seller for profit
with time delay (bay’ al inah), incl. exchange of money for debt
without an underlying asset transfer
• no betting and gambling (maisir), no unilateral (or zero-sum) gains
© A. Jobst, 2009
Overview
• The Balance Sheet and ALM of Islamic Banks
• Trade-off between Profitability and Liquidity
• Consequences for Liquidity Issues: Solutions
for More Efficient Liquidity Management
• Economic, Regulatory and Legal Challenges
• Conclusion
© A. Jobst, 2009
Islamic banking is on the rise …
• Islamic banking and AUM to exceed US$1 trillion by end-2010
• surplus liquidity to aggressively boost deposit volumes while
maintaining focus on retail and corporate sectors, also due to
safe haven flows from retail entrenchment
• fragmented and emergent market system as well as excessive
liquidity base has sheltered them from credit crisis, but have
not escaped unscathed
• retail-funded, commercial banks with low leverage and
abundant liquidity  wholesale-funded investment banks
with concentrated deposit base and highly cyclical exposure
© A. Jobst, 2009
… but liquidity management is a challenge …
Concept of liquidity lies at the heart of ALM
• ability to capture and retain funding to maintain
intermediation margins/ growth, and withstand
chance of insolvency (deposit runs)
• capacity to secure alternative funding via selling
assets and/or superior financial flexibility
• ALM: balance sheet optimization from cash
perspective
© A. Jobst, 2009
… especially if interest rates increase
• fixed interest rate on asset side, but floating short-term
liabilities
– re-pricing risk on assets (DGAP) and higher funding costs
(DCR) than in conventional banks
– potential losses from higher interest rates
Conventional Banks
Assets
Liabilities
Assets
Liabilities
Floating
income assets
Fixed income
liabilities
Fixed
income assets
Profit-sharing
liabilities (not
fixed)
Risk from lower interest rates
© A. Jobst, 2009
Islamic Banks
Risk from higher interest rates
Balance Sheet of IFIs – Funding Structure
• Focus on ample short-term liquidity
– suboptimal term structure transformation due to religious constraints
• Assets: high transaction costs
– ample short-term (fixed) assets, such as murabaha, less profitable
with high duration-sensitivity (DGAP>0)
– long-term assets entail disproportionate credit risk (which can erode
investment deposits), such as musharaka
– natural limits to diversified asset side: underdeveloped inter-bank
money market and dependence on commodities as generic collateral
• Liabilities: uncertain funding liquidity and term risk
– principal-guaranteed checking account deposits and savings/term
deposits
– “pass-through” mechanism (displaced commercial risk, DCR):
investment deposits and profit-sharing investment accounts (PSIAs)
contingent on capital appreciation  cash reserve  endogenizes
mutual cost of deposit protection (self-insurance)
© A. Jobst, 2009
Stylized Balance Sheet
ASSETS
thin interbank market due
to prohibitions on debt
investment , derivatives
Shari’ah Compliance
• cash
• short-term interbank murabaha
• sukuk
• other investments
(musharaka, murabaha)
• credit portfolio
• others
LIABILITIES
• checking accounts (qardh hasan)
• short-term murabaha and wakala
(interbank/customers)
• long-term syndicated murabaha
• sukuk
• unrestricted PSIAs
• profit equalization reserves
(PERs)
• equity
Low credit leverage (liquid credit exposures in asset allocation) and
low financial leverage (debt-like liabilities in total funding)
© A. Jobst, 2009
Islamic Inter-Bank Market
• GCC: no Islamic money market and debt securities account for
less than 5% of capital market
–
–
–
–
high oil revenues
reliance on bank finance
easy access to equity finance
poor governance standards and infrastructure
• Malaysia: Islamic Inter-bank Money Market (IIMM)
– introduced by Bank Negara Malaysia in 1994
– wholesale transactions (Islamic banks and Islamic windows)
– but still 2/3 conventional
© A. Jobst, 2009
Trade-off between Profitability and Liquidity
excessive liquidity syndrome: blessing and curse
Assets
under-utilized surplus liquidity generating suboptimal revenue and concentrated
nature of asset side
Liabilities
vulnerable funding pattern of long-term assets via short-term PLS and non-PLS
deposits and payment of long-term liabilities from deposits and short-term assets
Maturity Mismatch Dilemma
high concentration of liquid (but expensive) short-term assets and illiquid
(but profitable) long-term assets without access to long-term funding and
hedging instruments but high credit risk from asset-linkage
Risk of Liquidity Shortfall
 recent tendency to lengthen average tenor of credit exposure
© A. Jobst, 2009
Causes of Liquidity Shortage
Higher CDR and Funding
Volatility:
changes in micro- and
macroeconomic
conditions
Asset Linkage:
susceptibility to asset
price fluctuations and
defective asset quality
Reliance on balance
sheet assets for liquidity
management
© A. Jobst, 2009
Nascent Short-term
Money Market:
no liquid/diverse asset
side
Causes of
Liquidity
Shortage
Maturity Mismatch:
scarce longer term
funding sources
Religious prohibition of
“debt sale” and low
interbank liquidity
Consequences of Liquidity Issues
• conduct of monetary policy
– different approaches and challenges faced in
applying monetary policy tools
• OMOs
• solutions for more efficient liquidity
management via securities markets
– commodity murabaha, repos, sukuk and
derivatives
© A. Jobst, 2009
Greater Scale of OMO for Short-term
Balance Sheet: Duration and Convexity
Price ($)
Greater convexity implies that the price (yield) will …
➀ fall (rise) slower (faster) than the yield (price) rises (falls),
➁ rise (fall) faster (slower) than the yield (price) falls (rises).
Duration:
slope of line
➁
Gains from convexity
Short-term profile of
interest-sensitive
assets and liabilities
10,155.24
+$155.24
Dollar gain from convexity
10,000
-$152.28
9,847.72
QE during crisis
➀
8.8
© A. Jobst, 2009
9.4
10
Annual interest rate %
Solutions for More Efficient Liquidity
Management (1)
• regulatory dynamics to allow for more efficient
investment of excess cash and lower credit risk
concentration
• assets – credit leverage
– more liquid (and diverse) assets over different
tenors to avoid short-term asset/deposits funding
long-term liabilities
• liabilities – financial leverage
– more long-term funding sources to balance longterm exposures to real estate, etc.
© A. Jobst, 2009
Solutions for More Efficient Liquidity
Management (2)
use of innovative asset classes to complement variety-starved asset
section and alleviate ALM concerns
Commodity
murabaha
Short-term ijara
sukuk
Repurchase
Agreements
Other sukuk
Derivatives
© A. Jobst, 2009
Solutions for More Efficient Liquidity
Management (3)
• tawarruq and commodity murabaha most used
Commodity
murabaha
Tawarruq
• sale of certain commodity on cost-plus basis
• most used liquidity management instrument
• reverse form of commodity murabaha as
cost-plus sale of commodity to customer on
installment basis
• customer sells commodity and receives cash
© A. Jobst, 2009
Solutions for More Efficient Liquidity
Management (4)
Short-term
ijarah sukuk
Other sukuk
• securitization of
receivables under
murabaha contract(s)
• alternative to
auction-based t-bills
• buyback and
issuance of sukuk
• same underlying
asset
© A. Jobst, 2009
Repurchase
agreements
Derivatives
• repo of tradable
Islamic securities
• but rejected by most
scholars
• instead, combination
of receivables and fixed
assets
• sale and separate
unilateral promise to
buy back
• alternative: deposit
against acquisition of
asset and liquidation
upon maturity
• medium-/long-term
sukuk only a small
portion of the balance
sheet  illiquid,
concentrated,
predominantly local
issuance
• not all can be used as
collateral for interestbased interbank/central bank
repos
• scarce, customized
and contested
• tendency towards
short-term, less
costly solutions, such
as inefficient backto-back hedging
Sukuk: Definition and Market (1)
• transform bilateral risk-reward sharing between borrowers
and lenders into the market-based refinancing of shari’ahcompliant lending or trust-based investment
• investors own the underlying asset(s) via SPV that funds
(un)secured payments to investors from direct investment in
real, religiously-sanctioned economic activity
• sukuk do not pay interest, but generate returns through
commoditization of capital gains
© A. Jobst, 2009
Sukuk: Definition and Market (2)
•
•
sukuk volume dropped
to US$17.2bn (50%
from US$36.3bn.) in
2008, while structured
finance volume dried up
with just US$387bn.
issued (80%) amid
stable EM issuance
(US$310bn.)
issuance 2009Q2
already exceeded total
issuance in 2008
Issuance of Islamic Finance Instruments (In US$ bn.)
20
Other
© A. Jobst, 2009
20
Islamic synd. loans
15
International sukuk
15
Domestic sukuk
10
10
5
5
0
0
20
03
-Q
1
20
03
-Q
3
20
04
-Q
1
20
04
-Q
3
20
05
-Q
1
20
05
-Q
3
20
06
-Q
1
20
06
-Q
3
20
07
-Q
1
20
07
-Q
3
20
08
-Q
1
20
08
-Q
3
20
09
-Q
1
20
09
-Q
3
•
moderate issuance in
2008, but number of
deals brought to market
has steadily increased
(139 in 2008 vs. 161 in
2007 over same time)
Derivatives in Islamic Finance: Classification
Forward2
Option
Swap
Legacy
Derivatives
Explicit
Derivatives
x
(salam, bay mu’ajal,
bay bithaman ajil
(BBA), istisna)
x
(various commodity
hedges and
“wrappers”)
x
(wa’d, arbun, al-shart)
x
(foreign exchange
option contracts)
x
(tawarruq, almuqasah)
x
(wa’d-based swap,
profit rate swap, crosscurrency swap)
Jobst, A. (2009), “Islamic Derivatives,” International Journal of Monetary Economics and Finance, Vol. 2, Nos. 3/4, 254-60.
© A. Jobst, 2009
Most derivatives are customized
and costly …
FIXED LEG
single term murabaha
Profit Rate Swap
(cost price + fixed profit portion (“cost-plus”))
“Interest Rate Risk”
Protection
Fixed Rate
Payer
Islamic
Bank B
2
Floating Rate
Payer
fixed periodic payments
sale of commodity A
sale of commodity B (every 3 months)
Islamic
Bank A
5
periodic floating rate payments 1/
1/ This includes full payment
and physical settlement each
period. This structure was
pioneered by Commerce
International Merchant Bank
(CIMB) of Malaysia in 2005.
FLOATING LEG
4
purchase of
commodity B
Supplier
© A. Jobst, 2009
3
sale of
commodity A
Broker/
trader
1
reverse murabaha
(commodity market price + floating
rate profit portion (over LIBOR))
purchase of
commodity A
Supplier
6
sale of
commodity B
Broker/
trader
Current Challenges – Market Infrastructure
• traditionally weak reliance on capital market financing 
critical legal hindrances that impact on the way financial
innovation can redress ALM constraints
• organization of trading: contamination via (conventional)
market practices
• sukuk
– identify reference assets that meet shari’ah requirements
– illiquidity in the secondary market and regional fragmentation
– origination and servicer risk from narrow asset supply poses
challenges to investor diversification
– fair valuation of sukuk and first defaults without body of case law
© A. Jobst, 2009
Current Challenges – Regulation and Supervision
(1)
• Islamic jurisprudence neither definite nor bound by precedent and no
universal recognition and enforceability of rulings
– no unified principles on which shari’ah scholars decide on compliance
of new products
– no cross-referencing or consolidation of fatwas
– regional diversity of secondary sources supporting religious doctrine:
ijtihad (independent analytical reasoning), ijma (consensus) and qiyas
(deduction by analogy)
• regulatory standards of shari’ah compliance vary considerably
– IFSB Task Force on standard sukuk structures (early in 2008)
– International Islamic Financial Market (IIFM)) with ISDA  master
agreement
– limitations of AAOIFI recommendations
© A. Jobst, 2009
Current Challenges – Regulation and Supervision
(2)
• legal governance of transactions: commercial law vs. Islamic
law (via shari’ah board)
– shari’ah compliance by substance or form ? – risk of legal
re-qualification
– current ISDA/IIFM derivatives master agreement defines
secular law as forum
© A. Jobst, 2009
Thank you.
© A. Jobst, 2009
References
•
•
•
•
•
•
•
•
•
Čihák, Martin and Heiko Hesse, 2008, “Islamic Banks and Financial Stability: An Empirical Analysis,”
IMF Working Paper 08/16 (Washington: International Monetary Fund).
Hesse, Heiko, Jobst, Andreas A., and Juan Solé, 2009, “Market Tension,” Islamic Banking & Finance,
Vol. 7, No. 2 (April-May), 24-6.
______________, 2008, “Trends and Challenges in Islamic Finance,” World Economics (April-June).
Jobst, Andreas A. and Juan Solé (2009), “The Governance of Derivatives in Islamic Finance,” Journal
of International Business Law and Regulation, Vol. 24, No. 11, 556-65.
Jobst, Andreas A., Peter Kunzel, Paul Mills and Amadou Sy, 2008, “Islamic Bond Issuance – What
Sovereign Debt Managers Need to Know,” International Journal of Islamic & Middle East Finance and
Management, Vol. 1, No. 4.
Jobst, Andreas A., 2009, “Risk Management and Islamic Financial Instruments,” Qatar Finance – The
Ultimate Resource (“Qfinance”), Bloomsbury Publishing, London.
______________, 2007, “The Economics of Islamic Finance and Securitization,” Journal of Structured
Finance, Vol. 13, No. 1 (Spring), 1-22.
______________, “A Primer on Structured Finance,” Journal of Derivatives and Hedge Funds, Vol.
13, No. 3, 199-213.
______________, “Derivatives in Islamic Finance,” in: Salman, Ali (ed). Islamic Capital Markets –
Products, Regulation and Development. Islamic Development Bank, Islamic Research and Training
Institute (IRTI), Jeddah.
© A. Jobst, 2009