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Liquidity and Islamic Capital Markets
 

Liquidity and Islamic Capital Markets

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Abridged version of my presentation at the IFSB Seminar held in Istanbul 1st October 2010. Discusses the key bottlenecks constraining liquidity and what can be done to ease the flow of liquidity.

Abridged version of my presentation at the IFSB Seminar held in Istanbul 1st October 2010. Discusses the key bottlenecks constraining liquidity and what can be done to ease the flow of liquidity.

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    Liquidity and Islamic Capital Markets Liquidity and Islamic Capital Markets Presentation Transcript

    • LIQUIDITY & ISLAMIC CAPITAL MARKETS MARKETS SALES AND TRADING TREASURY ISLAMIC FINANCE SAYD FAROOK, GLOBAL HEAD ISLAMIC CAPITAL MARKETS 01 OCTOBER 2010
    • Challenges in Islamic Capital Markets Information search cost very high (Industry : embryonic stage) + Lack of Global Connectivity (community fragmented) + Lack of Structured workflow = Lack of Liquidity
    • CONCLUSION FROM LISTING TO LIQUIDITY GAP: OVER THE COUNTER SOLUTIONS: SCREEN BASED IF ‘GLOBAL SITUATION ROOM’ CONSEQUENCES GLOBAL CONNECTIVITY & DIVERSIFICATION
    • AGENDA • Islamic Treasury & Interbank Markets Focus • Liquidity Status • Unique Characteristics of Islamic Capital Markets • Spurring Liquidity: Key factors and impediments
    • ISLAMIC TREASURY & INTERBANK MARKETS FOCUS WHY TREASURY SHOULD BE THE FOCUS OF ISLAMIC CAPITAL MARKETS DEVELOPMENT
    • FLOW OF FUNDS ISLAMIC CAPITAL MARKETS Islamic finance has attracted investment from institutional investors, but seems to be a retail driven market thus far given the large asset base of commercial banks Suppliers of Capital RETAIL INSTITUTIONAL Financial Intermediary Awqaf/ Takaful (1%) $951B Mass Affluent Endowments 100 Funds (5%) 90 Sukuk (10%) Sovereign Wealth 80 Investment Funds 70 Banks (10%) 60 Pension Funds 50 Commercial 40 Banks 30 (74%) UNHWI/HNWI 20 10 0 Takaful Treasury remains the Source: E&Y, The Banker major sweet spot in terms of liquidity
    • LIQUIDITY POSITION OF ISLAMIC BANKS Consistent liquidity surplus: Islamic banks have continued to demonstrate their excess liquidity before, during and after the global financial crisis, as investors seek a safe haven, while complying with Shari’a principles. INTERBANK RATIO NET FINANCING/DEPOSITOR & SHORT TERM FUNDING Source: Bankscope Source: Bankscope Liquidity excess flows directly into treasury funds pool, particularly after GFC.
    • FLOW OF FUNDS TO CAPITAL MARKETS
    • LIQUIDITY STATUS WHERE ARE WE RELATIVE TO WHERE WE SHOULD BE?
    • WHY IS LIQUIDITY DESIRABLE? WITHOUT LIQUIDITY: • Costs are higher – Issuance & coupons – Higher costs for issuers – Trading – Higher Brokerage Premiums & Wide Pricing • Risks are higher – Perceived Risk of holding instruments – Mark to Market Calculations & VAR more accurate • Market inefficient (even with solid primary markets)
    • VOLUMES & LIQUIDITY IIMM: OVERNIGHT MUDHARABAH VOLUME TRANSACTED THROUGH MONEY MARKET BROKERS 1996-2010 Recovery from Period of Rapid Asian Crisis Economic Growth Monthly Volume (MYR Million) Overnight Mudarabah Total Financial Crisis * USD to MYR: 3.19 (as-on 01/08/10) Source: IIMM, Oanda
    • POST GFC MARKET CONDITIONS COMMERCIAL BANKS INVESTMENT BANKS (ex-Dubai) demonstrating (ex-Qatar) consumed high liquidity deployable liquidity reserves EASING CONDITIONS SPREADS TIGHTENING, PLACEMENTS TO SOLID BANKS TREASURY OLD GUARD INCREASING SUPPORT DEMAND FUNCTION FOR REPLACED PERFORMANCE
    • PRIMARY MARKET ISSUANCES & TIME TO ISSUANCE Total Issued Corporate Quasi-Sovereign Change in Total Assets (Top 75 Islamic Banks) Assets Top 75 Islamic Banks Top 75 Islamic Bank 80 Sovereign issuances, the bread & Assets in 100blns axis 350 butter of treasury placements, is far 70 from sufficient to relieve demand 300 Required 60 level of 250 issuance 50 USD Blns 200 40 150 30 100 20 10 50 0 0 2005 2006 2007 2008 2009 ISSUANCE PROCESS 2-9 MONTHS Due to structural complexities and added layer of heterogeneous Shari’a due diligence, sukuk issuance process can take anywhere between 2 to 9 months
    • MARKET DEPTH Smaller base of willing secondary market investors 10 Contributors 7 Contributors
    • MATURITY PROFILES 20 Traditional Bonds 18 Islamic Sukuk 16 14 Few USD Eurobond issuance beyond 5 12 years Yield 10 8 6 4 2 0 06/07/2009 01/04/2012 27/12/2014 22/09/2017 18/06/2020 15/03/2023 09/12/2025 04/09/2028 01/06/2031 25/02/2034 Maturity
    • UNIQUE CHARACTERISTICS OF ISLAMIC TREASURY & INTERBANK MARKETS
    • LIQUIDITY CHALLENGES The VALUE of an ASSET is derived from the ABILITY to sell it in a MARKET SURPLUS OF LIQUIDITY SHORTAGE OF LIQUIDITY Liquid Inter-Bank Market Islamic Financial Institutions IFI’s have limited ability to tap (IFI’s) are generally more liquid short-term funds to meet cashflow than their conventional peers requirements Low Returns Lender of Last Resort Limited short-term investments Most banking failures are due to (overnight-month), hence IFI’s liquidity shortages. There is a earn low returns on liquid assets need for a “lender of last resort” MATURITY MISMATCH/GAP Long-Term Assets IFI’s main investments are long-term e.g. sukuk, project finance, real estate Short-Term Liabilities IFI’s main funding is from short-term customer deposits
    • INFRASTRUCTURE CONSTRAINTS POOR INFRASTRUCTURE Treasurers complain of the requires that most transactions are difficulties in executed on DISCOVERY, EXECUTION & UNRELIABLE & DIFFICULT TO CONFIRMATION AUDIT TELECOM BASED SERVICES RELATIVELY HIGHER OPERATIONAL RISK, COSTS & TRANSACTION PROCESSING TIME Shy away from SMALLER TICKET TRANSACTIONS UNABLE TO CAPTURE HIGH VOLUME small ticket corporate and SME transactions
    • LOGICAL EVOLUTION OF ISLAMIC CAPITAL MARKETS Unique Solutions • Bespoke transaction platform • Multiple instruments • Global connectivity • Shari’a compliant process
    • SPURRING LIQUIDITY KEY FACTORS AND IMPEDIMENTS
    • FACTORS AFFECTING LIQUIDITY SOVEREIGN PUBLIC SECTOR USD & MYR INITIATIVE Sovereign Securities & REPO Facilities CERTAINTY UNIFORMITY Clear legislative Easily classified & framework and security understandable instruments enforcement rules TRANSPARENCY EFFICIENCY Price discovery, Seamless full information transaction execution, PRIVATE SECTOR disclosure and dissemination settlement & processing INITIATIVE CONNECTIVITY SIZE Unified transaction Invested institutions platform exploiting with market making connectivity capabilities INSTRUMENTS Innovative Asset Backed Negotiable Instruments
    • LIQUIDITY FACTORS & TYPICAL TRANSACTION WORKFLOW INSTRUMENTS CERTAINTY TRANSPARENCY SIZE UNIFORMITY TRANSACTION SOVEREIGN PLATFORM BENCHMARK EFFICIENCY
    • SOVEREIGN SECURITIES Public Debt and Financing Management Asset and Liability / Liquidity Management Frequent Finance Issuance with yielding various maturities Sovereign/Quasi assets and tenures (Shari’a Compliant Assets) Medium Term Note IFI as Investors infrastructure, (MTN) SPV receivables, land Offload Establish non-strategic benchmark assets yield curve REPO Facility Standardised Ijarah/Hybrid Easier to price Instruments Yield curve benchmarking Frequent issuance and maturities for riskier instruments Support exchange between Diversified distribution buyside & sellside (liquidity)
    • UNIFORMITY STANDARDISED DISPUTE CODIFICATION CAPITAL ISSUANCE RESOLUTION OF RULES MARKETS DOCUMENTATION RULES & FORUM PRODUCTS Wakala Ijarah/Hybrid Islamic Murabaha FX /Mudaraba Sukuk Commercial Paper EFFICIENCY CERTAINTY VOLUME AAOIFI IIFM IICRCA DIFC MIFC
    • CERTAINTY TRANSPARENT CONSISTENT Ex-ante Governing Ex-post Laws & Arbitration Dispute Resolution CERTAIN Enforcement of security
    • FEATURES OF AN IDEAL ISLAMIC LIQUIDITY MANAGEMENT INSTRUMENT
    • LIQUIDITY MANAGEMENT INSTRUMENTS Overweight on Murabaha and Wakala Insufficient tradable instruments Lack of market makers with clout Source: Presenter’s estimates
    • SIZE Bank name Country Name World Rank World Rank Total Assets Equity th ASSETS EQUITY th USD USD 2009 2009 Turkiye is Bankasi – ISBANK TURKEY 251 156 86,468,895 10,266,231 Arab Bank Group JORDAN 399 163 50,600,602 8,096,800 Akbank T.A.S. TURKEY 300 168 68,974,073 9,690,355 National Commercial Bank SAUDI ARABIA 302 171 68,653,924 8,229,414 Al Rajhi Bank SAUDI ARABIA 443 178 45,527,923 7,664,240 Emirates NBD PJSC UAE 278 182 76,671,612 8,705,405 Riyad Bank SAUDI ARABIA 425 188 47,039,815 7,529,467 Turkiye Garanti Bankasi A.S. TURKEY 275 199 78,029,708 9,179,556 Maybank MALAYSIA 247 203 88,215,502 7,315,259 Kuwait Finance House KUWAIT 499 213 39,367,852 5,368,898 CHALLENGES SOLUTION Equity not sufficient for trade desks Islamic banks INCENTIVISED to trade – not HTM Market clout – ISSUE + TRADE MEGA ISLAMIC BANK (investment grade rating)- AlBaraka/IsDB?
    • EFFICIENCY – EXECUTION/PROCESSING Pre-Trade RISK Monitoring SEAMLESS TRANSACTION EXECUTION AND PROCESSING News, Data, Analysis Get the Realtime Credit Risk Market Risk prices Islamic Deal Position / Capture Risk Management Automate manual & cost intensive back- Confirmation office processing generations Reduce risk for counterparties AutoPayments Applies to both interbank and government & Swift Msg securities markets Automated Reconciliation Accounting
    • CONNECTIVITY
    • Challenges in Islamic Capital Markets Information search cost very high (Industry : embryonic stage) + Lack of Global Connectivity (community fragmented) + Lack of Structured workflow = Lack of Liquidity
    • CONCLUSION FROM LISTING TO LIQUIDITY GAP: OVER THE COUNTER SOLUTIONS: SCREEN BASED IF ‘GLOBAL SITUATION ROOM’ CONSEQUENCES GLOBAL CONNECTIVITY & DIVERSIFICATION