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The Islamic Money Market

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 Ch apter 5

The Islamic
Money Market

Hanudin Amin
Mohd Faisol Ibrahim
Mohd Zulkifli Muhammad

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 82 Islamic Financial Institutions and Markets

The Islamic
Money Market
Hanudin Amin • Mohd Faisol Ibrahim
• Mohd Zulkifli Muhammad
Ch a pter 2

Introduction

The Islamic money market was introduced by Bank Negara Malaysia (BNM)
to promote a comprehensive Islamic banking system in the country. The
development of Bank Islam Malaysia Berhad (BIMB) was aimed at
promoting more players in the Islamic banking system. In encouraging
conventional banks to participate in the system, BNM introduced an
Interest-Free Banking Scheme (SPTF). Later the scheme was called the
Islamic Banking Scheme (IBS). The next step was to create a comprehensive
Islamic financial market. Bank Negara introduced the Islamic money market
in 1994 to promote the mobilisation of funds from banks with surplus funds to
banks that were in deficit in order to fulfill the need for liquidity injection in
the Islamic money market system.

The money market is the financial market for short-term borrowing and
lending, typically for terms of less than a year. This contrasts with the capital
market for longer-term funds. In the money markets, banks lend to and borrow
from each other using short-term financial instruments such as the Negotiable
Islamic Certificate of Deposit (NICD), Government Investment Issues (GIIs)
or other instruments such as Islamic Accepted Bills (IABs) and Islamic
Treasury Bills (ITBs). Generally, the Islamic money market provides
short-term to medium-term liquidity in the global financial system. The
Islamic money market performs a vital function within the economy by
providing an efficient means for economic units to adjust their liquidity
positions. Fundamentally, this market offers short-term funding for
individuals, businesses and the government. The Malaysian experiments in
Islamic banking have become significant because it has attempted to establish
an Islamic money market, a feature that is absent, in other Islamic banking
models (Ausaf, 1997).

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 The Islamic Money Market 83

This chapter aims to explain the Islamic money market in the Malaysian
context, which theoretically provides us with a framework of the market.
In addition, this chapter is useful for teaching and learning, and provides
guidelines for academicians and practitioners of the Islamic money market in
the country.

The chapter will discuss the characteristics of the Islamic money market and
its objectives while Section 4 provides an explanation of the key players or
participants in the Islamic money market. Section 5 seeks to elucidate the
Islamic money market in Malaysia. Section 6, briefly explains the methods
used by BNM to manage the liquidity of the Islamic money market. Section 7
explains the Islamic money market instruments, which are different in terms

Ch a pter 5
of concepts, principles and goals.

Characteristics of the Islamic Money Market

In this subsection, we discuss four characteristics of the Islamic money

market: First, the transaction volume which involves huge sums of money.
For instance, Islamic Treasury Bills (ITB) amounted to RM1.7 billion in
April 2005 while Bank Negara Negotiable Note-i (BNNN-i) had an
outstanding amount of RM6.5 billion.

Secondly, the low risk of default in the Islamic money market. The
government tends to provide a safer structural framework for the Islamic
money market with proper guidelines, laws and procedures to perform
transactions between various parties. In order to promote transparency in the
market, the government issued guidelines for Sell and Buy Back Agreements
(SBBA) in August 2002 and guidelines for Islamic Negotiable Instruments
(INIs) to ensure fair transactions and reduce the risk of defaults.

Thirdly, the instruments to be transacted in the Islamic money market have

a maturity of less than a year. Therefore, Islamic money market securities
are usually more widely traded than longer-term securities because of their
liquidity. Hence, Islamic money market securities are more liquid than that
of the capital market. These securities are transacted in light with Islamic
teaching by the use of Islamic principles such as al-inah principle in
Government Investment Issues (GIIs). Other securities of the market are
Islamic Treasury Bills (ITBs), Islamic Accepted Bills (IABs) and Bank
Negara Negotiable Notes-i (BNNNi), to name a few. These securities are
some of many examples of Islamic money market instruments or securities.

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 84 Islamic Financial Institutions and Markets

Fourthly, the instruments to be traded in the Islamic money market are

shariah-compliant. There are no interest elements found in the market, only
profit rates are allowable, which are fixed in order to reflect shariah rulings,
and therefore able to reduce settlement risks. In order to ensure the
instruments are shariah-compliant, Islamic principles such as bay al-inah,
qard hassan, mudarabah and bay al-dayn are employed.

Objective of the Islamic money market

Ch a pter 2

In this subsection, an explanation of the roles of the Islamic money market are
given including its functions. At the end of this subsection, we will point out
the principal Islamic financial instruments used in the Islamic money market.

Roles of the Islamic money market

Generally, the money market deals with short-term instruments and its
function is to bridge economic units temporarily to minimise the gap between
their cash receipts and payment such as providing liquidity. As such, the
Islamic money market is able to provide short-term capital injection to deficit
units and at the same time to offer mechanisms for investors to place their
surplus funds. The Islamic money market, like all financial markets, provides
a channel for the exchange of financial assets for money. The Islamic money
market is the mechanism through which holders of temporary cash surpluses
meet holders of temporary cash deficits.

The provision of such a mechanism generally fulfills several important

functions. In the following, we show what these functions are.

(1) Investment opportunities: The Islamic money market provides

opportunities for investment of surplus funds in various Islamic
instruments which are Shariah- compliant such as mudarabah, bay al-
dayn and bay al-inah. Additionally, many investors use the Islamic money
market as an interim investment potential that provides a higher return
than holding cash or money in banks.

(2) Working capital: Provides a means to fulfill the working capital

requirement for businesses and to provide the government short-term
funds as a substitution for tax collection.

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 The Islamic Money Market 85

(3) Liquidity: Provides a means of raising funds by converting securities and

financial assets in the form of cash.

(4) Warehouse for surplus funds: Firms or financial institutions can store
surplus funds until they are needed. Similarly, the Islamic money market
provides a low cost source of funds to firms, the government and
intermediaries that need a short-term infusion of funds.

(5) Policy determination: Enables adherence to government policies aimed at

achieving the goals of high employment, low inflation, economic growth
and stability.

Ch a pter 5
The Islamic money market versus the conventional money market

In this subsection, we discuss the differences in the philosophical and

ethical viewpoints of both kinds of markets. The conventional money market
is based on secular philosophies and principles. On the other hand, the Islamic
money market is non-secular. The philosophy of the Islamic money market is
based on shariah principles whereby the individual is not considered absolute
owner of his property.

In the Islamic philosophy of economy, a person is recognised as abd (servant

of Allah) in which he should manage all of his properties properly, and pays
any extras as zakat or sadaqah. This is a prerequisite prior to calling the person
caliph (vicegerent) of Allah on earth. This is true since Allah owns everything
that includes ups and downs, whereas the person is a trustee only. In view of
this statement, all parties in the Islamic money market are considered trustees
who should work honestly and diligently for the betterment of the market to
ensure the success in the world hereafter.

The conventional money market, however, regards the individual as the exclu-
sive owner of his property with an absolute right over his wealth.

How does profit generate in both markets? The conventional money market
is based on interest rates on the securities offered by the market. Interest rate
movements can affect the values of virtually all securities. They have a direct
influence on the market values of debt securities in the money market and
interest rates are the main determinants of the market value of each security.
In the Islamic money market, interest rates are impermissible. The Islamic
money market is based on profit sharing and loss, gift and compensation
instead of interest rates. Why then are interest rates prohibited?

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 86 Islamic Financial Institutions and Markets

There is a simple reason for this, riba is to be found to increase a

concentration of income and economic power in the hands of a few, while
the Islamic money market is based on profit and loss sharing principles. The
concept of gifts or rewards and compensation will result in a more equitable
distribution of wealth in the hands of many.

The Islamic money market principles

The Islamic money market is an avenue for short-term funds, providing a

ready source of funds for deficit units, and as an investment outlet for
surplus units. Deficit units could raise funds from the Islamic money market
Ch a pter 2

by borrowing from interbank players, through the sale of papers or by

borrowing from the Central Bank. However, the instruments used in this
market must be shariah-compliant. Any instruments that are against shariah
principles are regarded as void ab initio. There are several principal
instruments in the Islamic money market like mudarabah, bay al-dayn, bay
al-inah, qard hassan, bithaman ajil, musharakah, murabahah and so on.

First is bay bithaman ajil (BBA), an agreement that refers to the sales and
purchase transaction for the financing of an asset on a deferred payment basis
within a pre-agreed payment period. The sale price will include a profit
margin. Second is bay al-inah, defined as a transaction which involves the
sale and buy-back of an asset by the seller. The seller will sell the asset to the
buyer on a deferred basis and later buys back the same asset on a cash basis at
a price which is lower than the original selling price. Third is mudarabah, an
agreement which is made between two parties to finance a business project.
The parties are a rabb al-mal or investor who provides the capital and a
mudarib or the entrepreneur who will manage the project. Profits derived from
the project or investment will be distributed based on a pre-agreed ratio and
any loss will be borne by the investor. Fourth is murabahah, an agreement
that refers to the sale and purchase transaction for the financing of an asset
or project whereby the costs and profit margin mark-up are made known and
agreed to by all parties. The settlement for the purchase which can be done in
cash or in installments will be specified in the agreement. Fifth is musharakah,
a partnership arrangement between two parties or more, to finance a business
project whereby all parties contribute capital either in the form of cash or in
kind for the purpose. Any profit derived from the project will be distributed
based on a pre-agreed profit sharing ratio, but losses will be shared on the
basis of equity participation. Sixth is qard hassan, a contract of loan between
two parties on the basis of social welfare or to fulfill a short-term financial
need of the borrower. The amount of repayment must be equivalent to the
amount borrowed. It is, however, legitimate for the borrower to pay more than

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 The Islamic Money Market 87

the amount borrowed as long as it is stated or agreed at the point of contract.

Seventh is bay al-dayn, sale and purchase transaction on a quality debt i.e.
the default risk of the debtor is low, and the debt must be created from the
business transaction that conforms to Shariah. Finally, hibah, hiwalah, and
ibra. By definition, hibah refers to a gift awarded to a person on voluntary
basis. Hiwalah refers to a contract that allows the debtor to transfer his debt
obligation to a third party. Ibra refers to an act by a person to withdraw his
right to collect payment from a person who has the obligation to repay the
amount borrowed from him.

Ch a pter 5
Who participates in the Islamic money market?

Central Bank, Bank Negara Malaysia (BNM)

Bank Negara introduced the Islamic money market in 1983 in a two-phased

approach. In the first phase, the bank wanted to ensure that the Islamic
banking system contained all the three important components of a viable
banking system. The first phase was to develop a large number of Islamic
financial institutions providing Islamic financing facilities and the introduction
of an Islamic interbank money market. In the second phase, the bank wanted
to create a large number of financial instruments offering Islamic products
with the introduction of Islamic Banking Services (IBS).

Commercial banks

In Malaysia, commercial banks can basically be divided into Islamic banks and
conventional banks. Commercial banks buy government securities, however
in the Islamic money market this has been extended into selling negotiable
Islamic certificates of deposit (NICD). They also utilise short-term financing
and use the surplus to create more funds by placing these into the respected
Islamic financial instruments such as Islamic Interbank Cheque Clearing
System (IICCS) and Mudarabah Interbank Investments (MII).

Businesses

Islamic financial instruments have become a concern for many businesses in

terms of providing funds for future benefit. Consequently, the Islamic money
market provides funds for deficit units and also provides returns for surplus

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 88 Islamic Financial Institutions and Markets

units. We agree that the Islamic money market is able to increase liquidity of
the commercial banks through short-term securities. These securities provide
liquidity to deficit banks and to governments.

Investment companies

The general function of investment companies is to “make a market” for

money market securities by maintaining an inventory from which to buy or
sell. These firms are important to the liquidity of the money market because
they ensure that both sellers and buyers can readily market their securities.
On the other hand, finance companies such as Maybank Finance, AmFinance
Ch a pter 2

can raise funds in the money markets primarily by selling commercial paper.
They then lend the funds to consumers for the purchase of durable goods such
as cars, boats or for home renovation. Insurance companies such as Takaful
Nasional and Takaful Ikhlas must maintain liquidity because of their
unpredictable need for funds. Therefore, the Islamic money market offers a
method to raise cash.

Pension funds

In Malaysia, the Employees Provident Fund (EPF) has a huge amount of cash
in hand due to regular contributions from employees and employers. These
contributions suggest a steady growth of EPF over the years. This government
body is responsible for investing a portion of its accounts in the money
market via financial instruments.

The Islamic money market in Malaysia

In Malaysia, the Islamic money market comprises the interbank market, where
the lending and borrowing of short-term funds takes place; and the market
for short-term money market papers, consisting of GIIs, ITBs, IABs and
Islamic Negotiable Instruments of Deposit (INID). The market is integral to
the smooth functioning of the Islamic banking system. Normally, the idea of
having a money market is to mobilise resources for financing surplus or deficit
economic needs.

The role of the Islamic money market is to provide Islamic financial

institutions (IFIs) with facilities for adjusting portfolios over the short-term,

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 The Islamic Money Market 89

usually less than a year. The second function is to channel and increase
transaction volumes and hence act as a mechanism for the transmission of the
monetary policy. Transmission of monetary policy is a way to improve the
liquidity in Islamic financial institutions.

The Islamic money market in Malaysia basically has three roles; the trading
of Islamic financial instruments, Mudarabah Interbank Investments (MII), and
the Islamic Interbank Cheque Clearing System (IICCS). These aspects are
designed for several reasons. The following section provides further insight
about three aspects:

Ch a pter 5
Trading of Islamic financial Instruments

The establishment of the Islamic money market in January 1994 helped

facilitate funding for Islamic banks, Islamic subsidiaries and Islamic windows.
Banks that faced deficits could increase their cash through issuing securities.

In the market, there are two parties involved, deficit and surplus units. The
deficit unit is a party who has a shortage of funds and wishes to use the funds
for investment and consumption purposes. Contrary to this, the surplus unit is
a party who has an excess of funds and they wish to lend them to the deficit
unit. Further, the advent of the Islamic money market is seen as a platform
for the surplus unit to make investments by lending the fund to the deficit
unit. Say for instance, households on average placed RM1,000,000 into the
banking institution. In return, the households were able to obtain profits in
the form of dividend/hibah payments through the savings. These funds, on
the other hand are lent out to deficit units such as firms for investment and
consumption purposes. In the context of the Islamic money market, the deficit
unit can be a banking institution, which has a shortage of funds, whereas the
surplus unit can be a banking institution, which has a surplus of funds. In this
case, the surplus bank could take advantage of a fruitful investment by lending
funds out to the deficit bank for profit.

Mudarabah interbank investments (MII)

The MII refers to a mechanism whereby an Islamic bank with surplus funds
can invest in a bank facing a deficit based on mudarabah. The profit-sharing
ratio is negotiated between the parties but the rate of return is based on gross
profit before distribution for an investment of one year by the receiving
bank. MII enables IBS to obtain funds from another IBS bank on Mudarabah
basis. The period of investment is from overnight to 12 months. The minimum

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 90 Islamic Financial Institutions and Markets

amount for the AMII is RM50,000. The rate of return is based on the rate of
gross profit before distribution for investments of one year by the receiving
bank, while profit sharing ration is negotiable MII:

Formula:
PRT(k)
X =
36500

X = amount of profit to be paid to the provider of funds

P = principle of investment
R = rate of gross profit
Ch a pter 2

T = number of days invested

k = profit sharing ratio

In addition, the profit sharing ratio is based on the tenor of investment, which
can be described as follows:

1. Less than 1 month, the profit sharing ratio is 70:30 where 70% will go to
rabbul mal (provider of funds).

2. More than 1 month, but not exceeding 3 months, the profit sharing ratio
is 80:20.

3. More than 3 months, the profit sharing ratio is 90:10 where the rabbul mal
will earn 90% of the total investment.

The following example illustrates how the MII works:

Case 1: Suppose that, Public Bank provides Bank Muamalat Malaysia Berhad
(BMMB) RM10 million for a period of three months, with a profit sharing
ratio of 80:20. Public Bank at this point of time, would not know the exact
rate of return as the formula is only crystallized into actual figures towards the
end of the three month period. At the end of this period, BMMB returns RM10
million plus a share of BMMB’s profit from the use of funds, calculated on the
basis of the standard formula and the profit sharing ratio of 80:20. If BMMB’s
profit rate for one year’s investments is 9% per annum, the profit elements
that BMMB pays to Public Bank for the three-month period is calculated
as follows:

X = (10,000,000 x 9 x 90 x 0.8 ) / 36500 = RM 177,534.25

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 The Islamic Money Market 91

Thus, Public Bank will earn RM 10,177,534.25, whereby BMMB will earn
RM 44,383.56 from the transaction.

Islamic interbank cheque clearing system (IICCS)

IBS commercial banks also participate in the IICCS at the Kuala Lumpur
Automated Clearing House (KLACH). Currently these banks are required
to maintain an IBS clearing account at BNM. BNM allocates and squares
the positions of the surplus and the deficit banks at the midnight clearing.
Any surplus funds of the IBS commercial banks at the midnight clearing are
automatically invested with the deficit bank, by applying the same formula
used in the MII. The profit sharing ratio used for the calculation of profit is

Ch a pter 5
fixed at 70:30 in favour of the provider of the funds. Surplus funds distributed
to the deficit banks are allocated on the following principles:

1. Where the total surplus is larger than the total deficit, the total investment
of a surplus bank (for instance, Maybank) is calculated as follows:

TI =
SB x OD
TI =
OS

TI = Total investment
SB = Surplus bank
OD = Overall deficit
OS = Overall surplus

The funds derived from the formula are first invested with the bank with the
largest deficit, and any remaining balance to the next deficit bank and so on.

2. Where the total surplus is less than the total deficit, the entire surplus
of each bank is invested on the principle that the bank with the largest
surplus first invests with the bank with the largest deficit.

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 92 Islamic Financial Institutions and Markets

Table 5.1 Islamic Interbank Cheque Clearing System

Surplus Bank RM million Deficit Banks RM million

Maybank 20 HLB 10

Bank BBMB 10 OCBC 05

RHB Bank 05

Total 35 Total 15
Ch a pter 2

Based on Table 1, the first principle is involved, which means the total surplus
is larger than the total deficit (RM35, 000,000 > RM15, 000,000). Therefore
the formula to be used is:

SB x OD
TI =
OS

In the above case, Maybank’s investment is RM8.57 million [ (20x15)/35

], BBMB’s investment is RM4.29 million and RHB Bank’s investment is
RM2.14 million. Maybank invests RM8.57 million with HLB and BMMB
invests RM1.43 million with HLB. BMMB invests RM2.86 million with
OCBC while RHB Bank invests RM2.14 million with OCBC. The next day,
the two deficit banks refund the three surplus banks, the principal amount
invested plus a profit element based on their respective profit figures.

Managing liquidity in the Islamic money market

BNM employs two (2) financial tools in managing liquidity. First, the
mudarabah money market tender (MMT). In August 1999, BNM introduced
the MMT to further enhance the operations of the MII. The MMT is conducted
through the acceptance tender and the investment tender. Second, bay al-inah
contract (BAIC). BAIC refers to issuance of Islamic papers by BNM to
inject funds to banking institutions that face difficulties in meeting their daily
cash flow requirements, particularly those which could not meet the minimum
benchmark rate in the MII. The BAIC paper however, can only be traded
between BNM and the participating banking institutions.

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 The Islamic Money Market 93

The availability of these instruments has assisted BNM in absorbing and

injecting liquidity into the Islamic money market in an efficient manner
as well as enabling BNM to use appropriate instruments for different
circumstances.

Managing liquidity in the Islamic money market

A variety of money market instruments are available to meet the diverse

needs of market participants. One security will be perfect for one investor; a

Ch a pter 5
different security may be best for another. In this section, we gain a greater
understanding of the characteristic of Islamic money market securities
characteristics and how Islamic money market participants use them to
manage their liquidity.

Islamic treasury bills (ITBs)

ITBs are securities sold by the Malaysian government with initial maturities
of less than one year. They are often considered the lowest-risk securities
available. Only Islamic banks such as BIMB and Bank Muamalat Malaysia
Berhad (BMMB) and principal dealers with IBS are allowed to tender for
ITBs. However, both conventional and Islamic banking institutions are
allowed to trade ITBs in the secondary market. ITBs will be traded based on
the principle of bay al-dayn. Bay al-dayn refers to the sale of a debt arising
from a transaction in the form of a deferred payment sale. The secondary
market trading of ITBs will be in terms of yield. Therefore the banding system,
which is associated with Malaysian Treasury Bills is also applicable to ITBs.

Government investment issues (GIIs)

Government Investment Certificates (GICs or GIC) that were introduced

in 1983 are non-interest-bearing instruments issued by the government to
enable Bank Islam Malaysia and other institutions to invest their liquid
funds according to Islamic principles. The Islamic bank governed by Shariah
Law, is not permitted to hold interest-bearing government securities. The
Government Investment Act 1983 (GIA) under which certificates are issued,
make available certificates with maturities of one year or more to be issued
for dividends instead of interest, to be paid on the certificates. The returns
are declared by the government on the anniversary date of the certificates’

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 94 Islamic Financial Institutions and Markets

issue. For the first time, the initial instrument called Government Investment
Certificates were issued based on the qard hassan principle where no return is
contracted. Consequently, these GICs are not allowed to trade in the secondary
market and the redemption is upon maturity. Therefore, in June 2001, a new
form of Government Investment Issue was introduced based on the contract
of bay al-inah. This instrument can be traded in secondary markets based on
bay al-dayn and is used as a monetary instrument by the Central Bank. Since
2001, GIC increased by 127% and market acceptance revealed trading volume
had increased by 15 times. In March 2005, the Government introduced the
profit-based Government Investment Issue to offer a stable stream of income
for longer tenure reflecting Government commitment in building the Islamic
benchmark yield curve.
Ch a pter 2

Formula:
100 + (r X t X 100)
Price of GIC =
365

For example, supposing that the Malaysian government issues GIC with a rate
of return equal to 5% per annum. This issuance of GIC is for a period of 30
days from the issuing date. Based on this fact, we can calculate the price of
the GIC:

Price = 100 + (5% x 30 x 100) / 365 = RM 100.41

In other words, 30 days after the issuing date, the bank may receive proceeds
of RM1,004,100 from BNM on the sale of its GIC with nominal value of RM1
million. Therefore the following shows the income earned from GIC:

Profit/income = RM 1,004,100 – RM 1,000,000 = RM 4,100

Bank negara negotiable notes-i (BNNN-i)

Bank Negara Negotiable Notes- Islamic (BNNN-i) are short-term Islamic

financial instruments for liquidity operations issued by Bank Negara
Malaysia for the Islamic inter-bank money market. These saving notes are
based on the bay al-inah principle in which Bank Negara Malaysia offers
assets (in the form of stocks listed at Bursa Malaysia) for purchase by eligible
financial institutions that are allowed to trade in Islamic financial instruments.
Bank Negara will repurchase these notes at the face value of RM1 million
each. These notes were introduced in 1999. The time and amount for the
issuance of BNNN-i is based on Bank Negara decisions. Similar to

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 The Islamic Money Market 95

government investment certificates, these notes are issued based on

unscripted transactions. Only the purchasing record such as the name of
buyer and amount purchased are documented. The transaction of these notes
in the secondary market is based on the principle of bay al-dayn.

Islamic negotiable instruments

The rapid development of Islamic banking has accelerated the need to cre-
ate an Islamic version of Negotiable Instruments of Deposits (NID). There
are two types of NID. The first are Islamic Negotiable Instruments (INI),
structured on the concept of bay bithaman ajil for Negotiable Islamic Debt

Ch a pter 5
Certificate (NIDC). The second, Islamic Negotiable Instruments (INI)
which are structured on the concept of mudarabah for Islamic Negotiable
Instruments of Deposits (INID).

The operation of NIDC is divided into ten stages:

1. The customer wishing to buy NIDC approaches the bank.

2. The bank sells its assets (shares) in cash to the customer.

3. The customer pays the purchase price in cash.

4. The bank transfers the assets to the customer.

5. Simultaneously, the customer sells back the assets to the bank on credit
where the selling price is higher than the purchase price.

6. The difference between the selling price and the purchase price is the in-
vestment of the customer.

7. The banking institution issues NIDC based on syahadah al-dayn to the

customer as evidence of the banking institution’s debt to the customer.

8. Payment is deferred to an agreed future date.

9. The deferred period is the investment duration by the customer as in the

practice of investment accounts and upon maturity.

10. The customer will present NIDC to the bank and receive the nominal
value of NIDC.

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 96 Islamic Financial Institutions and Markets

Illustration of NIDC:
For instance, a customer wishes to place RM1 million in NIDC with an
Islamic bank. In this transaction, the bank sells a specific asset worth RM1
million (such as share certificates) to the customer. Consequently the bank
now secures a RM1 million as a new deposit. The customer then sells the
share certificates back to the bank at a deferred price, which is based on a
profit rate of (for instance) 7.5% for duration of 6 months. The selling price
is at RM1,037,500 where the customer earns RM37,500. The issue of the
NIDC is undertaken as evidence of the RM1,037,500 debt that the bank owes
the customer. Upon maturity, the NIDC is redeemable at par value where the
customer gets back the RM1 million deposits, plus a profit of RM37,500.
Ch a pter 2

On the other hand, in INID, the modus operandi consists of three stages.
First, the customer deposits his money with an Islamic bank. The Islamic bank
accepts the deposit and issues INID to the customer as evidence of the deposit
and upon maturity, the customer will present the INID to the Islamic bank and
will receive the nominal value of the INID and the declared dividend.

Illustration of INID:
On day 1, the customer approaches the Islamic bank with say RM1 million as
a deposit placement. The Islamic bank accepts the deposit and issues an INID
of RM1 million with several terms: tenor: 6 months; profit sharing ratio: 80:20
(80% to customer; and dividend is paid on a quarterly basis. On day 180, the
customer presents the matured INID to the Islamic bank. The Islamic bank
declares a net dividend rate of 7.5% p.a. (gross dividend rate of 9.375%) and
pays the customer RM1,018,750 of which RM18,750 is the dividend received
for the last dividend period.

Islamic accepted bill (IAB)

IAB is a bill of exchange, which is drawn by the bank and accepted by the
purchaser, thus creating a debt owing to the bank. The bank, in turn, may sell
the IAB in the secondary market at a discount value under the bay al-dayn
concept. IAB can be divided into two: IAB-Import or Purchase and
IAB-Export of Sales.

IAB-Import or purchase: Letter of credit murabahah is an import trade finance

facility whereby the bank purchases the goods at cost and sells to the importer
on a mark-up basis payable at a determinable future date. In short, this is
also known as a local purchase trade finance facility. The bank securitises the
murabahah amount in the form of an IAB draft. Bay al-dayn or debt trading
is a short term trade finance facility where the bank sells the rights to the debt

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 The Islamic Money Market 97

which is securitised in the form of IAB draft arising from the import or a local
purchase transaction to another party at a discount in the secondary market.

Murabahah formula:
[1+{r x t}]
SP = FV
36500

SP = Selling price
FV = Invoice value
r = mark-up rate or annual rate of return
t = tenor

Ch a pter 5
For example, say the amount to be paid to exporter’s bank is USD100, 000,
and to be converted to RM380,000. In addition, the mark-up rate is 10% p.a.
and tenor or maturity is 90 days. Therefore, the selling price is RM389,369.86.
Additionally, the importer’s bank can sell the IAB draft in the secondary
market at a discount by employing the following formula:

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 98 Islamic Financial Institutions and Markets

Sales of IAB in the secondary market:

[1+{r x t}]
PP = FV
36500

PP = Purchase price
FV = Face value or maturity value
r = annual rate of return
t = tenor

Say the FV is RM389,000, r is 4% and t is 60 days, therefore the purchase

price is RM386,442.20 that will be received by the importer’s bank.
Ch a pter 2

IAB-Export of Sales: this IAB is a bill of exchange, which is drawn by the

exporter and accepted by the exporter’s bank. If the exporter’s bank buys the
debt from the exporter;

Bay al-dayn formula:

[1+{r x t}]
MV = FV
36500
MV = Market value
FV = Face value
r = annual rate of return
t = tenor

Say the invoice value is RM100,000, r is 10% and t is 180 days, therefore the
market value is RM95,068.49. Whereas if the exporter’s bank sells the debt
in the secondary market, say the FV is RM100, 000, r is 8% p.a. and t is 170
days, therefore the MV is RM96,273.97.

Green Banker Acceptance (GBA)

Banks may purchase BA issued by other banks (inclusive of conventional

banks) provided that these are “halal” ones. To be considered as “halal” the
BA must be;

1. An export or sales BA.

2. Drawn to finance “halal” goods or commodity.

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 The Islamic Money Market 99

Formula:

Market price = F (1- [r x t/365])

Where; F = Face value
r = Annual rate of profit
t = Number of days remaining to maturity

As an example, an IAB with a face value of RM 1,000,000 is sold at a discount

of 4%. It has 60 days remaining to mature. What is the market price?

MP = 1,000,000 ( 1- [4% x 60/365] )

Ch a pter 5
= RM 993,425.6575

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 100 Islamic Financial Institutions and Markets

Conclusion

This chapter offers an overview of the Islamic money market in Malaysia.

Fundamentally, the Islamic money market comprises the interbank market and
money market. The major market players are the commercial banks, merchant
banks, finance companies, discount houses and Cagamas Berhad. In this
overview, only a few of the Islamic money market instruments such as ITBs,
GIIs, BNNN-i, INID, IABs and GBA have been explained.

Additionally, the success of the Islamic money market stems from the
government “helping hand”, especially with the introduction of the Islamic
Ch a pter 2

Interbank Money Market in 1994 to promote the purchase and sales of Islamic
financial instruments. Islamic banks and IBS banks being the foundation of
an emerging Islamic money market have finally become a reality. Therefore,
it is hoped that these banks can demonstrate co-operation in order to create
invaluable short-term funds for transacting parties. The Islamic money market
provides flexibility to these banks in their fund management, by allowing the
banks with temporary surpluses to earn returns and also by providing ready
source term funds to deficit banks. It is suggested that the government could
consider offering more Islamic money market instruments to the public at
large to increase public participation.

References

Ab. Mumin Ab. Ghani. (1999). Sistem Kewangan Islam dan Perlaksanaan-
nya di Malaysia. Kuala Lumpur: Jabatan Kemajuan Islam Malaysia
(JAKIM).

Abd. Ghafar Ismail .(1991). Pasaran Wang: Alat, Peranan Institusi dan Dasar
Kewangan.

Kuala Lumpur: Dewan Bahasa dan Pustaka.

Ausaf Ahmad. (1997). Towards an Islamic Financial Market: A study of

Islamic banking and finance in Malaysia. Jeddah: Islamic Research and
Training Institute.

Chapter 5.indd 100 3/15/2013 1:58:41 PM

 The Islamic Money Market 101

Bank Negara Malaysia (1999). The Central Bank and the Financial System
in Malaysia: A Decade of Change 1989-1999. Kuala Lumpur: Bank
Negara Malaysia.

Bank Negara Malaysia, Annual Report (1996, 2002 and 2004).

Bank Negara Malaysia. Guidelines on Islamic Negotiable Instruments.

Bank Negara Malaysia. Guidelines on Islamic Treasury Bills.

Sudin Haron. (2005). Sistem Kewangan dan Perbankan Islam. Kuala

Lumpur: KLBS.

Ch a pter 5
Muhammad Loqman. (1999). A Brief Note on the Islamic Financial System.
Managerial finance, 25 (5), pp.52-59.

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 102 Islamic Financial Institutions and Markets
Ch a pter 2

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