Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes Islamic Liquidity Institute of Islamic Banking & Insurance, London 18 February 2004 Warren Edwardes, ceo, Delphi Risk Management Limited e: w: dc3.co.uk

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes Basle II is going to make a major impact Powerful computers are needed They have been looking for this A weapon of Maths Instruction

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes Delphi’s website contains: articles on Islamic banking on: dc3.co.uk/islamicbanking The full speech will be on: dc3.co.uk/islamicliquidity pdf with PowerPoint on dc3.co.uk/islamicliquidity ppt

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes thoughts on liquidity More than listing Is there a buyer when you are a seller? More than negotiable At what price?

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes thoughts on liquidity British Gas Falklands War Dumping of Aaa A1-P1+CP Don’t hold paper in the news

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes thoughts on liquidity Midland Bank Crocker bank led to dumping of Midland CDs Don’t hold paper in the news

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes thoughts on liquidity Continental Illinois Plenty of “liquid” assets No diversification of liabilities mainly wholesale and few retail customers

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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 Digest December 19, 1997

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes Background to Islamic liquidity Asset/liability gap management Shortage of instruments LMC /IIFM initiatives –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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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?

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes Risk Pyramid Risk / return trade-off in conventional markets Add to this the Halal / Haram trade- off Need Triple-A Halal instruments

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes Conclusion & summary Asset / Liability problem –Long term asset fixed and short term variable deposits No derivatives – yet! –Gharrar? –Financial Takaful?

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes 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

Islamic Liquidity Management Issues Institute of Islamic Banking & Insurance, London, 18 February 2004 Warren Edwardes They have been looking for this A weapon of Maths Instruction