The recent disruptions caused by the coronavirus and the oil price slump are affecting Islamic banks’ liquidity and highlight the need to develop deeper Shariah compliant repurchase agreements (repo) markets, according to Fitch Ratings report ‘Liquidity Stress Highlights Importance of Effective Sharia-Compliant Repo Market’. The report mentions that, a better-functioning Islamic repo market would be credit positive for Islamic banks’ funding and liquidity profiles by providing banks with an additional source of short-term funding on a secure and low-risk basis, especially in times of liquidity stress.
Fitch’s report says that it can also provide some support to Islamic banks’ earnings-generation capabilities through a lower cost of funding due to the collateral held. However, issues with Shariah compliance, the lack of standardization and regulatory hurdles are hindering the growth of the Islamic repo market and its acceptance among counterparties.
Table 1: Features of the CCM product used in Malaysia |
|
Product |
Collateralized Commodity Murabahah (CCM) |
Shariah structure |
• Structured as a commodity Murabahah via Tawarruq with the obligation created through the commodity sale and purchase. The collateral is transferred to secure the deferred payment of the commodity Murabahah • Collateral arrangement is recognized as Rahn |
Shariah conditions for the use of the collateral |
• The collateral is not to be sold in the secondary market and must be retained until maturity. • If the seller intends to repledge the collateral, the seller is to obtain prior consent from the buyer. |
Source: CIMB |
Review of 2020
The economic downturn caused by the coronavirus pandemic and the sharp fall in oil prices are reducing banks’ liquidity in Islamic finance’s core markets, namely GCC countries and Malaysia says Fitch. While each of these countries is at a different stage of development, Malaysia’s money and repo markets are the deepest and most liquid. The country has well-developed domestic debt capital markets that drive a broad range of collateral eligible for repos under sale and buyback agreements (SBBA) with the central bank ranging from sovereign Sukuk to Islamic private debt securities. Funding options for Islamic banks in Malaysia are broader than in other countries due to the longer repo tenors available says Fitch.
In Indonesia, Bank Indonesia in May 2020 continued to strengthen the policy mix aimed at mitigating the risks from the COVID-19 outbreak, and maintaining financial market and financial system stability. It also strengthened the monetary operation and Islamic financial market deepening by introducing three new Islamic repo products called liquidity facilities, liquidity management and fund management certificates based on Shariah principles.
Meanwhile, in the GCC, the Central Bank of Bahrain is leading the way by introducing Shariah compliant liquidity management tools, such as the Islamic Sukuk Liquidity Instrument and Wakalah, an intraday credit facility available to Islamic banks against their tradable Islamic securities holdings (Sukuk Ijarah) according to Fitch.
Fitch says compared to their conventional peers, Islamic banks face several constraints to raise funding through repo markets, especially for bank-to-bank transactions. These constraints include differences in Shariah interpretation, lack of standardization and regulatory hurdles faced by Islamic banks. Malaysia’s Islamic repo structure, the SBBA, is not viewed as Shariah compliant in GCC countries, where Murabahah, Ijarah and Tawaruq are mainly used. This lack of harmonization hinders growth according to Fitch.
To address the issue of standardization and provide an alternative to conventional repo Fitch said, the Bahrain-based International Islamic Financial Market published the Master Collateralized Murabahah Agreement in 2014. While the creation of the standard is a positive step, its uptake has been low with implementation mostly limited to the UAE. The adoption of AAOIFI standards has been compulsory for Islamic banks since September 2018; its impact on the Islamic repo market is evolving and is still being assessed.
Regulatory hurdles are another challenge. Some countries with less-developed Islamic finance ecosystems, such as Oman, Jordan and Morocco, do not have any Islamic repo facilities with central banks or have very limited offerings. This places Islamic banks at a disadvantage to their conventional peers, which is especially problematic given the current tight liquidity conditions according to Fitch.
Preview of 2021
In Malaysia, Bank Negara Malaysia on the 12th November 2019 had come out with a new Policy Document which sets out the revised requirements and expectations of the central bank on market participants (licensed banks and licensed investment banks) which enter into repo transactions involving ringgit and non-ringgit repo and reverse repo transactions including any outright sale or purchase of repo securities with an intention to repurchase or resell these repo securities at a future date. This encourages Islamic banks to sign the Collateralized Commodity Murabahah (CCM) agreement as part of liquidity instruments. Hopefully, this will lead to the standardization of agreements among Islamic banks globally where Tawarruq is viewed as Shariah compliant in GCC countries.
The liquidity of Islamic banks is still ample and flush with good preemptive action taken by the central banks. However, Islamic banks cannot be complacent with this surplus but need to find other alternative instruments for liquidity management. In my view, CCM or Islamic repo facilities are very important products where the agreements had been executed among Islamic banks and they are an important tool for liquidity management since they create and support opportunities for the low-risk investment of cash, as well as the efficient management of liquidity and collateral by financial and non-financial firms.
Should the economic disruptions caused by the coronavirus pandemic continue and oil prices remain low, I expect central banks across the GCC and other jurisdictions to increase repo facilities and provide additional sources of liquidity to banks. Most GCC countries have already announced that additional liquidity will be made available to support the banks if needed and this includes banks’ access to repo funding at their respective central banks.
Conclusion
The rapid spread of the COVID-19 pandemic and its far-reaching effects on the domestic and global economy are anticipated to dampen credit demand and affect the performance of Islamic banks this year according to Ram Ratings. Most Islamic banks require the right liquidity management tools to fund their assets on a daily basis. Islamic banks should be more proactive in the Islamic repo market instead of just using the normal traditional ways of managing their daily liquidity.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of CIMB.
Mohamad Zabidi Ahmad is the senior managing director and global head of Islamic treasury, treasury and markets of group wholesale banking at CIMB Investment Bank (CIMB). He can be contacted at [email protected].