Islamic finance body IIFM launches collateralised murabaha standard

The standard will serve as an alternative to repurchase agreements, which are common money market tools used by conventional banks but are largely absent in Islamic finance.

It is the sixth standard issued by the IIFM, a non-profit industry body which develops specifications for Islamic finance contracts.

“Finding a sharia-compliant alternative to repurchase agreements has become absolutely essential and imperative to help meet the liquidity requirements of the industry, and the collateralised transaction is at present the best alternative,” chief executive Ijlal Ahmed Alvi told Reuters.

Collateralised murabaha deals are already taking place, but the agreement will help to standardise them while attracting more Islamic banks that have been awaiting guidance, Alvi said.

Several banks want to have the collateralised murabaha format approved by their own sharia boards, so they can have it in place alongside existing tools in case of any potential liquidity squeeze, he added.

“Clean lending has become more difficult, especially for the smaller Islamic banks, and this helps to keep as a contingency.”

The new template is accompanied by detailed guidance notes, the first the IIFM has published, which clarify issues such as margin maintenance and custodial services, Alvi said.

Sharia-compliant alternatives to repos are scarce: Malaysia and Bahrain have their own approaches but these are approved at the domestic level and limited to local-currency collateral.

In the United Arab Emirates, the first collateralised murabaha transaction occurred in 2011 between National Bank of Abu Dhabi and Abu Dhabi Islamic Bank.

REPO

Conventional repos allow institutions to lend out assets for short periods to generate liquidity; this is disallowed in Islamic finance as it entails the charging of interest. Collateral is often lent out by custodians, a practice known as rehypothecation, which also contravenes Islamic principles.

Even the phrase “Islamic repo” is problematic among scholars who fear the instruments will simply replicate conventional financial products without addressing a real economic need.

Collateralised murabaha is a cost-plus profit arrangement which tries to avoid such issues by having the financier buy the asset at market value and immediately sell the asset to the customer for a mark-up on a deferred payment basis.

Because the mark-up price is agreed up front by both parties, this addresses the element of ambiguity, or gharar, a key principle in Islamic finance.

Transactions can be secured by any sharia-compliant assets, including equities and sukuk (Islamic bonds). The standard expressly forbids rehypothecation.

The IIFM has previously launched standard contract templates for sharia-compliant profit rate swaps as well as hedging and treasury transactions. It is working on standards for cross-currency swaps, foreign exchange forwards, and several common sukuk structures, including convertible and exchangeable sukuk.

The body started operations in 2002, founded by the Islamic Development Bank and the central banks and monetary authorities of Bahrain, Brunei, Indonesia, Malaysia and Sudan. Additional members include the State Bank of Pakistan and the Dubai International Financial Centre. -Reuters