Wednesday, January 11, 2012

Indonesia inter-bank money markets

It is difficult to tell exactly how the inter-bank money market will work (described in an article from Bisnis Indonesia).  The article describes:  
 "According to him [an unnamed source at Bank Indonesia, the central bank], the underlying asset in the money market may be in the form of sharia commodity futures. Moreover, collateral may use government’s sukuk.
Taking apart the parts of this sentence, I would imagine that the "sharia commodity futures" refer to using a commodity market (for cocoa, cashew or arabica coffee, as the article suggests later) to back commodity murabaha between Islamic banks in Indonesia.  A commodity murabaha is a common inter-bank money market instrument in the GCC and Malaysia.  The latter has set up an exchange, Bursa Suq al-Sila, to connect palm oil producers with financial institutions that want to use palm oil to back commodity murabaha transactions.

The difference between most commodity murabaha inter-bank lending and the Indonesian plan, from my reading, is that the inter-bank commodity murabaha would be collateralized using government sukuk.  Bank Indonesia announced in the first half of 2011 that it planned to issue 3-, 6- and 12-month Sharia T-bills and was scheduled to issue the first 6-month T-bills in early August

Collateralizing inter-bank commodity murabaha transactions is a good move from a risk management perspective, where lack of confidence by counterparties can lead to withdrawal of inter-bank lending and turn a liquidity crisis at a bank to a solvency crisis.  If the inter-bank lending is collateralized, the counterparties to a bank that runs into a perception that it is in trouble will be less hesitant to withdraw funding to that bank (although they will certainly not be patient for ever).  This is the reason that repurchase (repo) transactions have become a large source of short-term funding for many banks (with the caveat that the security of repo transactions is only as good as the credit of the collateral; the European debt crisis shows that even seemingly solid sovereign credit can lose their value as collateral very quickly).

The difficulty with developing this type of collateralized inter-bank lending is from a Shari'ah-compliance perspective.  The issue of collateralized commodity murabaha was one of the proposals considered by the International Islamic Financial Market (IIFM) (see my initial comments here). It is still not necessarily widespread, but it is a promising way to make inter-bank lending more secure (which prevents funding from drying up as quickly and gives time to deal with troubled banks).  However, there are obstacles--about which I cannot speak with authority---that make it more difficult to ensure it is widely accepted as Shari'ah-complaint.  But, it adds to the forthcoming International Islamic Liquidity Management Corporation (IILM) as a new source of inter-bank liquidity management tools that will strengthen the Islamic finance industry. 

In the end, we will have to wait and see what the final regulations around collateralized inter-bank Islamic lending from Bank Indonesia.  However, I think that the development is positive and could help Indonesia be an area of growth for Islamic finance and banking in 2012 (more in terms of being rapidly growing; not necessarily having a large quantitative impact on the size and growth of Islamic finance as a whole).  One area where it does not have much impact is in moving Islamic finance away from murabaha.  However, it is probably better for Islamic banks and financial institutions to move other parts of their balance sheets away from murabaha and towards profit-and-loss sharing instruments before the inter-bank money markets are shifted away from murabaha.

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