Concept of Islamic Money Market

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

Introduction

Most of the firms, company and individuals are seeking for the pure markets, which eliminate interest and other prohibited products. In consequence to this, Malaysia especially Central Bank of Malaysia has made an effort of making the Islamic Money Market as one of the vital market as compared to conventional money market. This can be seen from the words of Central Bank of Malaysia Governor, Dr Zeti Akhtar Aziz at the 2 nd International Islamic Finance Conference:

“The Islamic financial industry is ascending to prominence in an environment that is highly competitive and constantly subject to the forces of change. The industry has made significant progress, with the essential fundamentals underpinning financial infrastructure to support its sound expansion in place. The challenge before us is to bring the industry to its next stage of development and reinforce the robustness of the industry in a more challenging environment. Of importance is the need to evolve the strategies that need to be adopted to build key strengths and enhance institutional capacity in the industry. Indeed, collaborative efforts need to be intensified on the global front and integration accelerated. As the decade unfolds, Insya-Allah, the Islamic financial industry will evolve into an increasingly dynamic and vibrant industry.”

Money market defined

Existence of financial market allows the buyers and sellers to be brought together in a means where it aids them to transfer ownership of the financial instruments. Based on the nature of its instruments, this financial market can be divided to money markets and capital markets. Basically, capital market and money market are different in the term of the liquidity of the securities or instruments where the instruments in the capital market usually less liquidate than the instrument in the money market. The securities in the money market are short-term instruments with original maturity of less than one year, low risk and very liquid.

Although the term of money markets is applied in its names, it does not mean that the instrument involves in this market is the fiat money – the currency (like money exchange). It is called as money markets because the securities provided in this market have high liquidation, as they are so close to being money.

Characteristics of Money Market

The instruments in the money markets usually provide low returns because the instruments are low risk and have high liquidation feature as majority of them mature in less than 120 days. Most of the transactions in the money market are in large amount and therefore it prevents the individual investors to interference. Because the transaction does not take place in building but instead it is being settled through phone call and electronically, the money market usually have an active secondary markets. The instruments in the money market are differed in tem of it rates and its liquidity.

The purpose of Money Market

Bank as the financial institution has been regulated by the Bank Negara Malaysia to put aside the deposits in the form of reserves. Theoretically banks should not have any problem to provide the sufficient reserve, but in practical due to the lending activities, the banks may have the deficit in their deposits. Therefore to fulfil the policy they need to borrow from the businesses or any financial institutions (lenders) that have surplus cash money.

Lenders in the money market usually do not aim for high returns on their money market funds. They actually do not want to hold the idle surplus cash because cash money alone can earn no income; idle cash is the opportunity cost in terms of lost interest income (dividend). However they do not want to invest in the capital market because perhaps in the short time they need to use the funds and it will be difficult if they to liquidate in the capital market.

Who participates in the money market

Persons involve in the money market can be either the lender or the borrower. They can be the government, businesses, banks, investment companies (brokerage firms), finance companies (commercial leasing companies), insurance companies (property and casualty insurance companies), or pension funds provider. Because of the high amount of funds needed during the transactions in the money market, the individual investors are difficult to interfere.

In the money market, the state or local governments may raise large sums in the money market by selling short-term obligations called Treasury bills. The bills have largest volume outstanding and the most active secondary market of any money market instrument. Besides, they may also raise funds through the sale of both fixed- and variable-rate securities.

The businesses raise funds in the money market by issuing commercial paper. Meanwhile, business that involved in international trade will raise funds through banker acceptances. The bank may hold the acceptance itself or rediscount (sell) it in the secondary market.

As the participants in the money market banks play role by borrowing the fund to support their loan portfolios and to acquire funds to satisfy non interest-bearing reserve requirements, being dealers in the market for over-the-counter interest rate derivatives, and provide commitments that help insure that investors in money market securities will be paid on a timely basis.

Actually, money market crucially depends on brokers and dealers because they play a role in marketing new issues of money market instruments and in providing secondary markets. They are also act as intermediaries between other participants in the market as they link the borrowers and lenders in the markets.

Islamic money market

Whether it is conventional money market or Islamic money market, they have the same characteristics, purposes, and aims. What does make them differ is the instruments allowed in the Islamic money market are restricted to certain circumstances. The Islamic Money Market refers to the market where the activities are carried out in ways that do not conflict with the conscience of Muslims and the religion of Islam.

Instruments in the Islamic money market shall be adhered to principles established by the Shari'ah or the Islamic law as revealed in the Qur'an and Sunnah. In Islam, it is required that all products involve in the sale and buying (including the instruments in the financial markets) shall be from the ethical sectors or in other words, the profits gained shall not be in or from the prohibited activities.

These prohibited activities include alcohol production, gambling, pornography, interest-base (riba) sector and should be free from the interest-based debt. It is stated in the Holy Qur’an:

… ﺍﻮﺑﺮﻠﺍ ﻢﺭﺣﻮ ﻊﻳﺑﻠﺍ ﻪﻟﻟﺍ ﻞﺣﺃﻮ …

(…and God hath permitted trade and forbidden usury…)

The Islamic money market started in Malaysia during the introduction of Islamic banking in early 1980s. Due to this establishment, the Islamic banking system is regulated to have these three main components: (1) large number of Islamic financial instruments offering Islamic products, (2) large number of financial institutions providing Islamic facilities, and, (3) the Islamic Inter bank Money Market.

The Islamic Inter bank Money Market basically is location where the institutions and the instruments are linked by to operate the purchase and sale of Islamic financial instruments, to conduct the inter bank investment activities (Mudharaba Inter bank Investment – MII) and as the place to settle the clearance of cheque (Islamic Inter bank Cheque Clearing System – IICCS). Only Islamic banks, commercial banks, merchant banks and eligible finance companies and discount houses are allowed to participate in the Islamic Inter bank Money Market.

Although there were no major teething problems during the implementation of the IIMM, one drawback the scheme continues to face is the inadequate amount of tradable Islamic papers. Efforts will have to be expanded to create a critical mass of Islamic financing papers that can be easily traded in the IIMM.

Today, the Islamic money market is one of the crucial components in the overall of the Islamic Financial Markets in Malaysia. The role of it is as essential as other market component in order to generate the economic growth of the country. Same as the conventional money market, the Islamic money market functions and plays the role to the Islamic banking system to widen and deepen the Islamic financial markets in Malaysia.

The Islamic financial instruments that are currently being traded in the IIMM on the basis of Bai al-Dayn are the Green bankers acceptances, Islamic accepted bills, Islamic mortgage bonds and Islamic private debt securities. Bai al-dayn is a sale of debt. To enable the sale to take place, the debts arising out of contract of exchanges or aqad al-muawadhat, such as trade financing of asset sale (based on the underlying contract of bai muajjal or bai bithaman ajil) are securitized.

The importance of Islamic money market has been mentioned by Zeti Akhtar Aziz in the 2nd International Islamic finance conference, 22 September 2003, that;

“Today, the Islamic money market has become an integral part of the Islamic financial system, with transactions of more than RM2 billion a day and a broad spectrum of instruments, among which included the Government Investment Issues, Bank Negara Negotiable Notes, Islamic accepted bills and the Islamic private debt securities.”

Other types of Islamic instruments are Government Investment Issue (GII) which lie under the concept of Al-Bai Al-Inah and Islamic Accepted Bills (IAB) which apply Al-Murabahah or cost-plus financing and Al-Bai’ Al-Dayn or debt financing concept. Moreover, Islamic Private Debt Securities (IPDS) and Negotiable Islamic Debt Certificates (NIDC) which both apply the concept of Al-Bai’ Bithaman Ajil or deferred payment sale and Al-Bai’ Al-Dayn or debt financing. Addition to the Islamic Private Debt Securities (IPDS) is the concept of Al-Murabahah or cost-plus financing.

According to Zeti Akhtar Aziz (2nd International Islamic finance conference, 22 September 2003)

“The development of an Islamic financial system, indeed would include the respective sets of the key components comprising the Islamic banking industry, the Islamic money and capital markets, and the takaful market, given the strong linkages, inter-dependence and synergies among these components in the system.”

Islamic Money Market Products

Al-Mudaraba Interbank Investment

The Al-Mudaraba Interbank Investment (MII) refers to the system whereby an IBD (Islamic Banking Division), (defined to include Bank Islam Malaysia), to obtain funds from another IBD bank on a Mudaraba (profit-sharing) basis. IBD operates under the “Bank within a Bank” concept. The period of investment is from overnight to 12 months. The minimum amount of investment for the MII is RM50, 000. The rate of return is based on the rate of gross profit before distribution for investments of one year of the receiving bank, while the profit-sharing ratio is negotiable.  When an IBD bank obtains investment from another IBD of bank for any period, the principal invested is repaid at the end of the period, together with a share of the profit arising from the use of the fund by the receiving bank.

Islamic Inter bank Cheque Clearing System

IBD of commercial banks also participate in the Islamic Interbank Cheque Clearing System (IICCS) at the Bursa Malaysia Automated Clearing House (BMACH). Currently these banks are required to maintain an IBD of clearing account at the Bank Negara on an Al-Wadiah Yad Dhamanah (guaranteed safe-custody) basis. Bank Negara Malaysia allocates and squares the positions of the surplus and the deficit banks at the midnight clearing. Any surplus funds of the IBD of commercial banks at the midnight clearing are automatically invested with the deficit banks.

Government Investment Certificate (GIC)

Government Investment Certificates were introduced in 1983, with the establishment of the Islamic bank. The government issued for the first time non-interest bearing Government Investment Certificate to meet the special needs of the bank and other corporations who are interested in these securities. The Islamic bank governed by Shariah law, is not allowed to hold interest bearing government securities. The Government Investment Act 1983 under which certificates are issued provides certificates with maturities of one year or more to be issued and for dividend instead of interest, to be paid on the certificates.

2: 275. Those who eat Ribâ (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitân (Satan) leading him to insanity. That is because they say: "Trading is only like Ribâ (usury)," whereas Allâh has permitted trading and forbidden Ribâ (usury). So whosoever receives an admonition from his Lord and stops eating Ribâ (usury) shall not be punished for the past; his case is for Allâh (to judge); but whoever returns [to Ribâ (usury)], such are the dwellers of the Fire - they will abide therein.

Cagamas Mudharabah Bonds

Cagamas Mudharabah Bonds were introduced in 1 March 1994. Cagamas Mudharabah Bonds involved with the purchase of Islamic housing debts by Cagamas from institutions that provide Islamic housing finance to their clients and staff. The issuance of bonds are based on Al-Mudharabah concept by Cagamas for finance these purchases. The purchase of housing debt on Islamic principles by Cagamas is managed based on the Bai’ Al-Dayn concept whereas the issued of Cagamas Mudharabah bonds is based on the All-Mudharabah concept. Under this concept the bondholder and Cagamas will share profits according to ratios agreed earlier together. The agreements pertaining to the purchase of housing debt based on Islamic principles will be sealed between Cagamas Berhad and Bank Islam Malaysia Berhad. Cagamas will purchase housing debts amounting RM30 billion from Bank Islam. As a result of this agreement, a total of RM30 billion of Cagamas Mudharabah Bonds is created. Government has distributed RM30 billion worth of bonds to financial institution that offer Islamic banking.

Islamic Accepted Bills (IAB)

Islamic Accepted Bills as an order to a bank by a bank customer to pay a sum of money at a future date. When the bank endorses the order for payment as accepted, it assumes responsibility for ultimate payment to the holder of the acceptances. These bills can be used for import or purchase and export for sales, with one condition, the trade of “halal” goods.

4: 29. O you who believe! Eat not up your property among yourselves unjustly except it be a trade amongst you, by mutual consent. And do not kill yourselves (nor kill one another). Surely, Allâh is Most Merciful to you.

“Green” Bankers Acceptance

Banks may purchase BA issued by other banks (inclusive of conventional banks) provided that it is a “halal” BA. To be considered as “halal”, the BA must be:

2: 261. The likeness of those who spend their wealth in the Way of Allah is as the likeness of a grain (of corn); it grows seven ears, and each ear has a hundred grains. Allah gives manifold increase to whom He pleases. And Allah is All Sufficient for His creatures' needs, All-Knower.

Repurchase Agreements

Although the application of repo in Islamic banking is not exactly the same as the conventional repo, the conceptual framework is still the same. Thus repo in conventional banking is an agreement under which a seller of securities undertakes to repurchase the securities from a buyer at an agreed price on a specified future date. However in Islamic banking, the agreement to repurchase back the securities is just an agreement and not a condition for the contract to be settled. Thus this means that there are two contracts involved in Islamic repo. The first one is to sell the securities and the second one is to purchase back the securities. The first contract is an outright sale and thus the buyer of the securities is not oblige to sell back the securities to the original buyer if he does not wants to as the title has been fully transferred to the buyer. Thus in the accounting entries of the seller, the transaction is recorded as contingent liability/asset of the bank and not a direct liability. Thus in the first leg of transaction where the securities is sold to the buyer, the transaction is still recorded as contingent liability. However, if the buyer decides not to sell back the securities, the eligible liabilities will cease from the seller’s account.

Islamic Private Debt Securities

Islamic Private Debt Securities (IPDS) has been introduced since 1990. At the moment, IDS have been introduced using different types of Syariah concept namely through Bai Bithaman Ajil, al-Musharakah, al-Mudharabah, Qardhu ul Hassan, Murabahah etc. Bai’ Bithaman Ajil is a contract refers to the sale of goods on a deferred payment basis. Under the concept of Bai’ Bithaman Ajil the financiers will purchase an asset from the borrower and later resell the assets at a higher price which contain the cost and profile element. The loan, which arises from the finance, will be securitized through the issuance of two notes that is the primary notes, which is equivalent to the asset price that is purchased by the financiers from the borrower and secondary notes which is equivalent to the profit value of the resell price.   Both of these notes will be traded in the secondary market under the concept of Bai’ al-Dayn.

Qardhul Hassan is an interest free loan given either for welfare purposes or for bridging short-term funding requirements. Through Qardhul Hassan, the issuer of the notes will be able to arrange the repayment of the loan, which was given by the parent company. The IDS note is the evidence of debt for the amount, which is yet to be repaid. Through the IDS, the loan will be repaid by liquidating the IDS after certain period of time.   The IDS is issued together with the Transferable Subscription Right (TSR). The TSR is the form of a “gift” (hibah) to the holder of the papers. The IDS is an alternative to the issuance of the conventional zero coupon bond.

Conclusion

Years backward, the Malaysian money market only offers the conventional financial instruments until in the year of 1983, where the Islamic financial instruments enter the market as the Bank Islam Malaysia Berhad has been set up and offering the Islamic money market. Basically the Islamic money market is set up to help the Muslim individuals and organizations to finance their businesses. Generally it has the same purpose as conventional money market practices except that it operates in accordance with the rules of Shariah. It does not allow the paying and receiving of interest and promotes profit sharing in the conduct of finance and banking businesses.

That is why nowadays we can discover that there are choices types of products come under various types of instruments under the Islamic money market in order to meet the needs of the Muslim business community in Malaysia. These instruments come by different of own characteristics that may assist the businessman in dissimilar ways. The most important is by following the promoted Islamic practices by the scholars and recommended by the Shariah the unfair trading practices and other activities that are socially harmful can be avoided.

It can concluded that Islamic money market instruments can be applied and implemented in Malaysian society because its based on Islamic principle and stressed more on interest of both parties whether seller and buyer, lessor and lessee, and so on. It is known that some of the instruments in the money market still need to be improved and other instruments needs to be added and introduce due to the changes rapidly in the economic growth of the country. Details research by the scholars still necessary to enhance the quality and the effectiveness of the instruments in the Islamic money market.

Whatsoever reason given, the Muslims themselves required to strive harder to seek the pleasure of Allah by doing activities that may give benefit not only to them but also for the sake of Muslim community as a whole. The pleased activities will harmonize the system itself not only the economic nor financial but also including the social and morality.