1. Treasury Management in an Islamic Financial Institution Mohammed Tariq Advisor, President IDB Group Islamic Development Bank 3 May, 2011 1

2. Role of Treasury in an Islamic Financial Institution Management of liquidity Resource mobilization Hedging through profit rate and currency swaps 2

3. Management of liquidity What is liquidity?  Availability of funds as and when required.  Hold cash and securities which can be liquefied at short notice.  Securities or instruments should be such which have a minimal negative impact on the sale of such securities, hence, minimum price risk.  Ability to deal in reasonable size or quantity depending on an institution’s needs. 3

4. Management of the liquidity Instruments for Management of Liquidity o Conventional Finance: Interbank market and other investments e.g. treasury bills, commercial papers, bonds, etc. o Islamic Finance: Placement of funds under Commodity Murabaha o How does the Commodity Murabaha work? o Lack of liquidity in such placements. o Reciprocal arrangements through reverse Murabaha. o Credit risks similar to conventional: lines to be set up between counter parties. Limits management o 4

5. Management of the liquidity o Islamic institutions can deal with conventional banks. o Other instruments like Sukuk: problems of longer duration, price risk, lack of liquidity, etc. o Trade finance deals with high quality parties and/or bank guarantee. o Sukuk holdings to be held as part of investment portfolio of the Treasury to earn higher returns. 5

6. Management of the liquidity  Asset Liability Management (ALM) o In order to meet disbursement requirements of the institution, placement of funds should ideally match the liability profile. o Techniques used for matching assets and liability by size as well as maturity. o Need to have active lines with other financial institutions to raise short-term funds as and when needed. o Risks involved, if liabilities are much higher than assets: impact of higher or lower interest rates in future, credit risks etc. 6

7. Management of the liquidity  Role of the Regulators/Central banks o Lender of last resort role o Lack of Shariah compatible financial instruments to intervene in the market for Islamic institutions. o Treasury bills or other such high quality instruments are not acceptable under Shairah rules. o Need for regulators to provide shot-term instruments for Islamic financial institutions. 7

8. Resource Mobilization needs  Central to Treasury functions in an Islamic financial institution o Close involvement of the Treasury with the operational units of the bank to assess short and medium-term business plans and hence resource needs. o Clear assessment of the cost of funds for different periods to be provided to the business units in order for pricing such products. o Pricing Methodology for financing. 8

9. Resource Mobilization needs  Instruments for Resource Mobilization o Short-term: Reverse Murabaha upto 1 year, mostly upto 3 months, Price risk. o Long-term: o Asset backed Sukuk: Over 51% need to be backed by tangible assets e.g. lease rentals, eligible Sukuk, equities, etc. Minority, i.e. less than 50% can be debts e.g. Installment Sales, Istisna’ etc o Availability of acceptable assets o Rollover Commodity Murabaha, upto 3 years, o Issues of fixed vs. floating rate o Asset backed Sukuk tradable, others not so 9

10. Hedging  Profit rate and currency swaps for managing treasury risks o Objectives and methodology o For profit rate swap: fixed vs. floating rate and vice versa o Currency swap 10