Friday, December 23, 2011

Bank Indonesia reverse repo

Bank Indonesia (BI) extended its reverse repo operations to government sukuk on December 1st.  The structure of the transactions are not clear, but based on another article and a BI regulatory document (which is not available in English, so I had to rely on GoogleTranslate) it looks like a wa'd-based repo transaction.  In the past, the sukuk issued by BI were based on ijara (mitigating concerns about the Shari'ah-compliant of trading at prices different from par if it were repo on sukuk based on commodity murabaha). 

However, the repo concept has been tricky to synthesize in a Shari'ah-compliant way, so the BI reverse repo would be a novel transaction.  It appears that the structure is based on wa'd, a unilateral undertaking to purchase or sell.  In the repo transaction (which the article said would be with a 1 month maturity, although that may only be used as an example), BI would sell a sukuk to a bank for the market value (assume for simplicity this is par, 100).  The bank would make a unilateral undertaking to sell the sukuk bank to BI in one month for 100 plus a spread based on a repo rate of 4.6% annualized. 

I think, although I am not familiar enough with the Shari'ah-compliance rules on wa'd to say for certain, that because it is only a unilateral promise, it is permissible to specify a price for the transaction in the future.  If there were two unilateral promises (one by the bank to sell and one by BI to purchase), it would not be permissible.  Presumably since BI is originating the transaction and is the central bank, it is virtually assured that it would purchase the securities without needing to give a binding promise. 

One area where difficulty would arise is if the sukuk rose in price during the repo, for example to 120.  The rules for the reverse repo transaction stipulate that if the bank decides not to honor its unilateral promise to sell, BI will charge the bank a penalty of the difference between the market price (i.e. 120) and the amount that the the bank bought the sukuk (i.e. 20).  This appears to me to be a sticky point for Shari'ah-compliance, although it could be mitigated if the penalty were stipulated to be donated to charity.  Anyway, with the penalty being stipulated as being the profit the bank would realize by not honoring its unilateral promise (removing the financial incentive for the bank to default), it is unlikely that this would ever occur in practice. 

I think this is an interesting idea and I would like to see more documentation about how it works and also the logic by which it was approved by the Shari'ah board advising BI.  I would appreciate any reader comments on the structure, since I am trying to piece together the structure from limited information, some of which I had to base on imperfect translations.

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