CONTENT

◻ OVERVIEW OF ISLAMIC FINANCIAL

MARKETS
Wan Mohd Ashraf Adlin
◻ FUNCTION OF ISLAMIC FINANCIAL

wan_ashraf@msu.edu.my
MARKETS
◻ CONDITION OF ISLAMIC FINANCIAL
MARKETS
◻ TYPES OF ISLAMIC FINANCIAL MARKETS
ISLAMIC
FINANCIAL MARKETS
OPERATIONAL ASPECTS & PRACTICES

INTRODUCTION
3 4

◻ In early stages of their establishment, the focus of Islamic
banks was on providing various deposit and financing
facilities which were riba-free.
◻ The overwhelming support from Muslim depositors
resulted in an extraordinary liquidity problem for Islamic
banks.
◻ In many cases, the banks’ funds could not be mobilized and
remained idle because of limited investment opportunities
since they are restricted from channeling these funds into
interest-based financial instruments.
◻ Consequently, Islamic banks were unable to invest the
excess funds and reap returns from their investment. In the
conventional system, however, a mechanism that allows
surplus banks to loan out their excess funds to deficit banks
exist. Various financial instruments are also available to the
surplus banks to invest any excess funds they have.
◻ In light of the problems facing Islamic banks, the
global Islamic banking system viewed that having its
own financial markets was essential for further
growth.
◻ In principle, the financial market is the meeting place
of two parties with mutual needs – one party requires
funds to support its financial needs, and the other has
unused surplus funds which it intends to invest for the
purpose of attaining returns or income.
◻ Realizing the existing problems, intellectuals directly
involved in Islamic banking system began to put their
thoughts into how an Islamic financial market could
be created and the form of mechanism required.

FUNCTION OF IFM
5 6

◻ Islamic financial instruments also needed to be developed 1. Allows transfers of funds from
as alternatives to the conventional ones. person or business without
investment opportunities to one
◻ These financial instruments must, however, possess the who has them.
following features of conventional financial instrument: 2. Improves economic efficiency.
They must be negotiable, that is, it must be easy to transfer the
ownership of the instruments from one holder to another.
They must be liquid, that is, they may be easily sold when cash
is required.
They must carry minimum risk.
They must easily valued and priced.
◻ Due to the fact that Islamic financial markets are at a
developing stage, these new concepts have raised many
theoretical and practical questions.
◻ The issues of religious rules (hukum) also sometimes
causes confusion and continuous debate not only among
the local intellectuals but also between countries.
 CONDITION OF IFM
7 8

◻ Main function is to facilitate transfer of investable

funds from those having surplus to those requiring
funds. Achieved by selling of securities
(Bonds/Sukuk and Shares). Short-Ter
◻ Islamic Financial Instruments must comply with m
the following: Long-Term
Prohibition of Riba (Interest). Financing Financing
Avoidance of Gharar (Ambiguity) in agreements.
Prohibition of Maisir (Gambling).
No involvement in production, distribution in
prohibited commodities.

TYPES OF ISLAMIC FINANCIAL Classification of Financial Market of

MARKET Malaysia
9

◻ As in conventional finance, there are many different types

of Islamic financial markets with each market having its
own purpose and objectives. The most common types of
financial markets are as follows: Debt Market
Money Markets • Sukuk

Capital Markets
Commodities Markets Money Market
IFM

• Islamic Interbank Money Market

Derivatives Markets

Futures Markets
Equity Market
Insurance Markets
• i-ETF
Foreign Exchange Markets • i-REIT
• Bursa Suq al Sila

11

Wan Mohd Ashraf Adlin

wan_ashraf@msu.edu.my

Q&A
ISLAMIC
FINANCIAL MARKETS
ISLAMIC MONEY MARKET
 CONTENT INTRODUCTION
13

◻ INTRODUCTION OF ISLAMIC MONEY ◻ The Islamic money market (IMM) is an essential and
MARKET integral component of the financial system.
◻ IMM PARTICIPANTS ◻ Common function by providing an avenue for
◻ COMPONENTS OF ISLAMIC MONEY transactions of financial assets between buyers and
MARKET sellers and between borrower and lenders.
◻ ISLAMIC MONEY MARKET INSTRUMENTS ◻ IMM can be described as the financial market for
◻ FUNCTIONS OF ISLAMIC MONEY MARKET transactions in wholesale short term funds.
◻ The tenure of IMM transactions is from overnight to
◻ THE NEED FOR ISLAMIC MONEY MARKET
12 months (the most common tenure is three month
◻ DIFFERENCES BETWEEN CONVENTIONAL or less).
& ISLAMIC MONEY MARKET
◻ ISLAMIC MONEY MARKET PRODUCTS

15 16

◻ IMM provide the Islamic financial institutions SURPLUS DEFICIT

with the facility for funding and adjusting
portfolios over the short-term and serving as a Services
channel for the transmission of monetary policy. Banking
Takaful Industrial
◻ Financial instrument and interbank investment
would allow surplus banks channel funds to deficit Pension Funds Agriculture
banks, also maintaining the funding and liquidity Savings TH, etc Financial Markets
mechanism necessary to promote stability in the Tourism
Individual
system. Other economic activities

HISTORICAL IN IMM ISLAMIC MONEY MARKET

17
DEVELOPMENT PARTICIPANTS
◻ IMM was introduced on January 3, 1994 as a short-term • The main participants in the IMM are banks, non
intermediary to provide a ready source of short-term
investment outlets based on Shariah principle. bank financial institutions such as takaful and
◻ The Islamic banks and banks participating in the Islamic insurance companies, business corporation, the
Banking Scheme (IBS) would be able to match the funding government treasury and the central bank.
requirements effectively and efficiently.
◻ Bank Negara Malaysia (BNM) issued the guidelines to • Banks use the money market for liquidity purposes,
facilitate proper implementation of the IMM. especially to adjust the mismatch of asset and
◻ Criteria for proper functioning IMM: liabilities in their balance sheet.
* Marketable Instruments
* Market Players
• They will use the money market to obtain liquidity
* Infrastructure for settlement of payment. or to place their surplus funds over limited period.
◻ Activities of Islamic Money Market:
Interbank Investment
Wadiah Acceptance
Trading of Financial Instruments
 ISLAMIC MONEY MARKET COMPONENTS OF ISLAMIC MONEY
PARTICIPANTS MARKET

ISLAMIC ISLAMIC MONEY

INTERBANK MARKET
MARKET INSTRUMENTS
NON-BANKING BANKING INSTITUTION
-insurance co. -central bank Bank borrow and lend among
themselves.
-pension/EPF -commercial bank Mismatches in daily cash
flow.
-unit trust co. -investment bank
e.g. Imbalances between
-business corp. -money brokers customer deposit and
withdrawal.

ISLAMIC MONEY MARKET FUNCTIONS OF ISLAMIC MONEY

INSTRUMENTS MARKET
1. Liquidity Management
◻ TRESURY BILLS
❑ IMM serve as an avenue for financial instrument to
◻ REPURCHASE AGREEMENTS (REPOs) source daily funding or short term investment. Access
◻ NEGOTIABLE CERTIFICATES OF DEPOSIT to IMM enables financial instrument to maintain
(CDs) optimal liquidity thereby allowing them to meet the
demand of their customers at any time.
◻ COMMERCIAL PAPER (CPs)
◻ BANKER’S ACCEPTANCE (BAs)

2. Secondary Trading 3. Channel for the Central Bank

❑ IMM also serve as an avenue for secondary trading of
money market instruments. IMM participants depending
on their view of rates of return will either buy or sell
IMM instrument in anticipation of obtaining investment
returns.
❑ IMM used as a channel for the central bank to conduct
its monetary policies. Due to the links that the money
market has with both capital market and banking system
it represents an ideal platform for central banks to
conduct monetary operations.
 THE NEED FOR ISLAMIC MONEY
DIFFERENCES
MARKET
◻ The IMM enables market players to perform
• MANAGING LIQUIDITY
similar functions as those of the conventional
market but with the exception that the instruments
• While the CMM serves as a suitable avenue for used to perform these function are based on
banks to implement proper liquidity management Shariah laws and principles.
practices, Islamic banks cannot use the instruments
offered because they are non shariah compliant.
• All instruments in the CMM are interest bearing and
cannot be utilised by Islamic banks.

Comparison between Islamic and

Conventional Money Market
27

ISLAMIC CONVENTIONAL

Interbank Market Utilizes Shariah compliant Debt contract

contract
Shariah
Money market instrument
Approved
Securities * Issuance Process Must be shariah compliant Only regulatory authorities
approved by SAC and SC approval

* Investors Both Islamic and Conventional investors

conventional investors

• Structure Asset and equity based Debt based

Individual
Investors Corporate
Investors

ISLAMIC MONEY MARKET

PRODUCTS
1. Mudharabah Interbank Investment (MII) or
Mudharabah Interbank Deposit (MID)
2. Wadiah Acceptance
3. Government Investment Issue (GII)
4. Bank Negara Monetary Notes-i (BNMN-i)
5. Sell and Buy Back Agreement (SBBA)
6. Cagamas Mudharabah Bonds
7. Islamic Accepted Bills (IABs)
8. Islamic Negotiable Instruments (INIs)
9. Ar-Rahnu Agreement-i (RA-i)
1. Mudharabah Interbank Investment (MII)
or Mudharabah Interbank Deposit (MID)
◻ A mechanism where a deficit Islamic banking
institution (needs fund) can obtain investment from a
surplus Islamic banking institution (excess fund)
based on Mudharabah contract.
◻ Period of investment
= from overnight to 12-months
(less than 1 year)
◻ The profit sharing ratio
= negotiable among both parties
i.e. 70/30, 60/40

◻ The actual rate of return

= based on the rate of gross profit
before distribution of investment
(1-year) of the borrower.

◻ The principal invested is to be repaid at the end of

the period together with a share of the profit
arising from the used of the fund by the investee
bank/entrepreneur.

2. Wadiah Acceptance • The tenor for this product is from overnight to

• This is a transaction between Bank Negara Malaysia
(BNM) and the Islamic banking institutions which
have surplus.
• The Islamic banking institutions placed their surplus
fund with BNM based on the contract of
Al-Wadiah.
12-months.
• Under this contract, the acceptor/custodian of the funds
(BNM) is not obligated to pay any return to the
depositor of the fund (Islamic banking institutions).
• Thus, any dividend paid later by the custodian is
perceived as a hibah.

3. Government Investment Issue (GII)
◻ GII is one of the liquid papers allowed by BNM for
Islamic Banks to hold in order to meet the statutory
liquidity requirements as well as park its idle fund.
◻ The GII was introduced by the Malaysian
Government in July 1983 under the contract Qard
Al-Hasan. Due to that, GII is not a tradable
instrument in the secondary market.
◻ On 15 June 2001, the Malaysia Government (with the
advice by BNM), issued a 3-year GII of RM2.0
Billion under the contract of Bai Al-Inah and this
contract allows the GII to be tradable in the secondary
market via the contract of Bai Ad-Dayn (debt
trading).
◻ Subsequently, on 16 March 2005, the Malaysia
Government issued the first Profit-Based GII 5-year
tenure of RM2.0 Billion under the contract of
Mudharabah where the issuer pay half yearly profit
(coupon) to the investors.
4. Bank Negara Monetary Notes-i (BNMN-i)
◻ Issued by BNM for purposes of managing liquidity
in the Islamic financial market.
◻ The maturity of the issuance
= 1-year to 3-years
◻ Issued either on a discounted or a coupon-bearing
basis depending on investor’s demand.
6. Cagamas Mudharabah Bonds
◻ This sukuk (Islamic Bonds) was introduced on 1
March 1994 by Cagamas Berhad.
◻ This contract based on Mudharabah contract (profit
sharing)
7. Islamic Accepted Bills (IABs)
◻ IABs was introduced in 1991 and also known as
Interest-Free Accepted Bills.
◻ The contract used is Al-Murabahah (deferred
lump-sum sale or cost-plus) and Bai Ad-Dayn (debt
trading – sale of a debt arising from a trade
transaction in the form of a deferred payment sale).
◻ It is a bill of exchange drawn on or drawn by a bank
payable at specific date in future to evidence the debt
that arise out of trade transaction.
5. Sell and Buy Back Agreement (SBBA)
◻ SBBA is an Islamic money market transaction entered
by two parties, SBBA seller and SBBA buyer.
◻ Where the seller sells the underlying assets to the
buyer at an agreed price.
◻ Subsequently, the buyer promises to sell back the said
underlying asset to the seller at an agreed price (the
promises require another separate agreement between
the buyer and seller).
◻ The dividends (profit) will be shared between sukuk
holders and the issuer according to the agreed
pre-determined profit sharing ratio.
◻ The purpose of issuance of sukuk is to finance the
purchase of Islamic housing debts from Islamic
financial institutions that provides Islamic house
financing to the public.
2 types of financing under IABs facility, namely:-
1) Imports and local purchases
o Islamic bank will appoint the customer as it agent to purchase the
required asset from seller on behalf of bank.
o The asset will resold to the customer on murabahah basis (markup
price) with agreement to pay back within 365 days.
o The sale of good on defered to the customer classified as debt
security (bill of exchange)
o Bank can sell the IAB certificate before the maturity at discount (on
principle bay al-dayn).
o Alternatively, bank can wait until maturity and receive the full
selling price
2) Exports and local sales
o After the exporter(seller) get approval for export
trade finance facilities and fulfill the
documentation, then the document will sent to the
importer bank (buyer bank).
o The exporter bank then issued the IAB (bill of
exchange). The bill indicate that the bank promise
to pay the full amount the exporter upon maturity.
o The bank can hold IAB until maturity and receive
full selling price or alternatively sell it to third
party at discount before the maturity.
9. Ar-Rahnu-i (RA-i)
◻ The contract used is Qard Al-Hasan
◻ Under this agreement, the lender (Islamic Bank)
will provide a loan to the borrower (customer).
◻ The borrower will pledge securities as collateral for
the loan granted.
48
◻ The purpose of this issuance is act as liquidity
management tool for BNM in money market
operations.
◻ Return from the RA-i will be in the form of hibah
(gift) and is determined based on the average
interbank money market rates.
8. Islamic Negotiable Instruments (INIs)
* Will be explained in the next topic under the
Deposit Accounts Product.
◻ In the default payment event where the borrower fails
to repay the loan on maturity date, the lender has the
right to sell the pledged securities and use the
proceeds from the sale of the securities to settle the
loan.
◻ Any surplus of money arising from the sale above
against the outstanding loan will be given back to the
borrower.
SUMMARY
◻ The role of the IMM and how it fulfills the three
important functions: liquidity management, avenue for
trading of IMM instruments and channel for the
central bank to transmit its monetary policy.
◻ The two main components of an IMM are the Islamic
interbank market and the trading of IMM instruments.
◻ The developments of various IMM instruments.
◻ If the IMM is to fulfill its many function, it has to
have many types of participants, varieties of Islamic
securities based in different risks, yields, and tenure,
and various interbank investment market.
49 50

◻ Reading list
http://iimm.bnm.gov.my

Q&A

51 END OF CHAPTER