Management of Short Term Liquidity The Malaysian Experience

Management of Short Term Liquidity The Malaysian Experience Conference on Islamic Banking Central Bank of the UAE, Abu Dhabi Muhammad bin Ibrahim muhd@bnm. gov. my 10 th December 2005

The Malaysian financial market… Composition of Malaysian Bond Market (2004) … • The Malaysian model of a dual banking system illustrates long-term viability to have an Islamic financial market in an entrenched Conventional banking system. • As at end-2004, the size of Malaysian bond market stood at RM 363 billion or 81% of GDP and Islamic securities accounted for 25% (RM 97. 8 billion) of the total market. Source: BNM Statistics • Growth in shariah compliant investment instruments provide alternative to investors Increasing growth in Islamic debt… RM billion 100 Public 80 Private 82. 7 60 62. 7 40 34. 7 20 4. 0 50. 2 20. 0 0 76. 8 4. 3 5. 0 6. 9 10. 0 15. 1 Growth 1999 2000 2001 2002 2003 2004 % 0. 0 62. 5 41. 7 26. 0 24. 8 12. 6 • Large growth in corporations issuing Islamic private debt securities (IPDS). Government, including Central Bank led the public sector issuance. • 818 shariah - compliant corporations listed on the Malaysia Bourse (Market cap of RM 440 billion), experiencing growth of 52% between 2002 to 2005 Source: BNM Statistics 2

Islamic Financial Market Infrastructure… PRIMARY MARKET SYSTEMS SECONDARY MARKET Issuers RENTAS Investors/ Interbank Players FAST BIDS Money Brokers & Principal Dealers Investors/ Interbank Players Market Players - 33 interbank players with Islamic windows; 4 full-fledged domestic Islamic banks, and 3 foreign Islamic banks Intermediary Channels - 8 money brokers as intermediaries and 10 principal dealers to provide two-way quotations in secondary market Primary and Secondary Market - fully automated system for tendering (FAST), bond information dissemination system (BIDS) provides near realtime prices, and market information IIMM Website Investors/ Interbank Players Settlement Mechanism - real-time gross settlement and custodian system for scriptless securities trading, reduces settlement risks Legal framework - Islamic banking act, takaful act, DFI, Anti Money laundering act. Operational & Regulatory framework - central bank and securities commission issued various guidelines e. g. repo, money broker, principal dealer and product guideline, Accounting and tax system - adoption of generally accepted accounting principles, easily understood tax regime 3

Benefits of a Vibrant Islamic Bond and Money Markets… Efficient allocation of resources • Promote economic growth • Efficient mobilization of funds between surplus and deficit parties Efficient Liquidity Management • Avenue to manage asset and liability mismatch • Large number of products to suit investors’ requirement • Undertake large volume of demand at low transaction cost Platform for monetary policy implementation • Use to mop-up liquidity consistent with prevailing monetary policy • Can act as a market signalling mechanism Portfolio Diversification • Varieties of financial instruments with different assets classes • Portfolio diversification if sufficiently liquid • Provides trading opportunity at competitive yield Facilitate risk management • Provide avenues in managing market risk • Improve investors’ confidence • Enhance attractiveness of the market 4

Milestones in Islamic Bond and Money Market… evolving and growing at a steady pace 1983 • Enactment of Islamic Banking Act and Takaful Act – paving the way for an Islamic Financial System • Enactment of Government Investment Act – empowering Government to issue Government Investment Issue 1993 • Establishment of Securities Commission (SC) – mandated to supervise and develop the capital market • Issuance of Cagamas Mudharabah Bonds – world’s first MBS issued and structured according to Islamic securitisation principles 1994 • Introduction of Mudharabah Interbank Acceptance – tool for interbank players to manage daily liquidity 1996 • SC’s Syariah Advisory Council was formed, with the approval of MOF • Islamic Financial Accounting Working committee was formed to provide guidance on accounting treatment on Syariah-compliant transactions 2001 • Unveiling of the Capital Market Masterplan – part of its objectives is to establish Malaysia as an international Islamic capital market centre • Introduction of tradable Government Investment Issue – allow GII to be traded in the secondary market 2002 • Guthrie Group issued first global corporate Islamic bond • Malaysian Government issued the inaugural global sovereign Sukuk Ijarah 2003 • Tax deductions on expenses incurred in issuing Islamic securities • Launch of first institutional Islamic stock broking service • Introduction of Wadiah acceptance – tool for BNM in managing liquidity 2004 • Launch of the Islamic Money Market Website to promote transparency and dissemination of information • Guidelines on Offering of Islamic Securities introduced to facilitate structuring of new Islamic products • Sarawak Economic Development Corporation launches first global Sukuk Ijarah in the form of floating rate trust certificates 2005 • Issuance of Islamic debt security by Multilateral Development Banks and Multilateral Financial Institutions • Introduction of Islamic forward contract –tool to hedge currency exposure for interbank players and corporations 5

Some Important • Basic requirements of a viable Islamic money market Lessons Learnt… • Diversity and sophistication of Islamic instruments • Government support in market development Creating a vibrant money market that is liquid and comprehensive would require a series of initiatives, • Active participation by the market players coupled with strong support from the public and private sectors • Transparency framework • Clear future direction 6

Basic Requirements for a Viable Islamic Money Market… Products/ Instruments • Meet various needs of banking institutions and investors • Provide depth and breath to the Islamic market • Improve efficiency via competition Large Number of Players • Provide breadth and depth to the Islamic market, especially secondary • Improve efficiency via competition • Reduce captive market Transparent Market • Dissemination of primary and secondary market information improves efficiency and attracts more participants in the Islamic securities market Efficient Principal Dealership Network • Promote liquidity in the secondary market providing two-way quotations for Islamic securities • Ensure success in primary auction of Islamic securities Efficient Settlement System • Real-time gross settlement system reduce settlement risk in Islamic securities transaction • Custodian for scriptless securities trading Robust Regulatory Framework • Guidelines on Islamic MM and products provide clear operating environment • Government commitment to issue Islamic securities ensures sufficient supply of instruments 7

Increasing Diversity and Sophistication of Islamic Instruments Concept - 2004 • Evolved from primarily deferred payment and cost-plus-sale • Diversity of concept – reflect evolving needs, sophistication and innovations Istisna (project finance) Ijarah (leasing) Musharakah (profit and loss sharing) • Appealed to both conventional and Islamic-based investors – guaranteeing access to a larger investors’ base • Meeting needs and competitively price primary reason for popularity Murabahah (cost plus sale) Bai bithaman Ajil (deferred payment sale) Source: Islamic Finance Information Services • Diverse type of Islamic instruments provides issuers and investors a wide choice of selection based on their financing needs, preference and risks profile • Wider acceptance of concepts will create and promote cross-border trading 8

Diverse Type of Islamic Short-term Instruments… Malaysia Islamic Treasury Bills RM billion • Introduced in 2004, based on Bai al Inah concept - RM 2. 0 billion in October 2005 • Traded 1. 5 times of its outstanding in 2005. • Created an active short term benchmark yield curve Source: BNM Statistics Bank Negara Negotiable Notes RM billion BNNN Volume • An instrument for managing liquidity based on Bai al Inah and traded on Bai ad Dayn concept. • Average yearly growth of 50% with current outstanding amount of RM 6. 5 billion • Actively traded in the secondary market – more than 4 times of its outstanding amount in 2004 and 2005. Source: BNM Statistics 9

Diverse Type of Islamic Short-term Instruments… continue to meet investors’ need Islamic Acceptance Bills – Trading Volume RM billion • Introduced to encourage and promote domestic and foreign trade • IAB has recorded a growth in volume traded of 165% (in 2004) reflecting the increase in demand for the instruments • Reflect increasing role of Malaysia as a trading nation Source: BNM Statistics Negotiable Islamic Depository Certificates – Trading Volume RM billion • Represent Certificate of Deposits with negotiable features. • Ample liquidity intensified NIDC creation to mobilise medium and long-term deposits • Significant growth since introduction - RM 4. 2 b – Dec 03 to RM 14. 6 b – Oct 05 Source: BNM Statistics 10

Diverse Type of Islamic Short-term Instruments… provides avenue for daily liquidity requirement Mudharabah Interbank Investment • Widely used by the interbank players in managing daily liquidity Mudharabah Interbank Investment Volume RM billion • Marked growth from RM 0. 4 bil in 1994 to a high of RM 485 bil in 2004, with tenures up to 3 months Wadiah acceptance • Tool for BNM in managing monetary policy implementation, • Issued via FAST based non-competitive tendering Sale and Buy Back agreement Source: BNM Statistics • Involves sale and buy back transaction of Islamic securities for short-term liquidity requirement Commodity Murabahah • Short term financing/deposit involves sale and buy back of the underlying commodity based on Murabahah contract 11

Government Policy to Support Market Development… continuous supply of Government Investment Issue (GII) • Initial issuance based on Qardul Hassan (benevolent loan) concept Government Investment Issues RM billion • June 2001, new concept introduced which allows secondary trading ü Entails sale and purchase of Government asset between the Government and banking institutions ü Secondary market trading based on Bai ad Dayn (debt trading). • Significant increased of outstanding amount by 178% since 2001 reflecting the Government’s commitment in building the Islamic benchmark yield curve. Source: BNM Statistics • Actively traded in secondary market – about 5 times of the outstanding amount in 2003 • March 2005: introduction of profit-based GII to offer a stable stream of income (profit) for longer tenure. 12

Active Participation of Market Players… enhance market liquidity and wider issuer and investor base Islamic Bonds raised in the Private Debt Securities Market RM billion % • Islamic PDS corporations issued by large • Maturity tenures range from 3 to 15 years • Experienced significant growth of 62% in 2004. Source: BNM Statistical Bulletin Monthly Trading Volume of Ringgit Islamic Bonds • Effective dissemination of trading information via BIDS and Islamic Money Market website facilitate issuers in formulating issuance strategy • 2004 – Total issuance of RM 9. 1 billion or 32% of total PDS issued • As at end-Aug 2005, Islamic bonds accounted for 35. 3% of total outstanding PDS Source: SC Statistics 13

http: //iimm. bnm. gov. my… BNM initiative to promote knowledge sharing and market transparency An official platform for knowledge sharing and exchange of ideas from the global users • Informative content which include literatures in Islamic banking and development in international Islamic financial market and other new innovative products • Interactive feedback and enquiry function. Participants need to update their profit rate via the website – ensure active participation from visitors Search function to enhance information finding • Accessibility Instill transparency of BNM’s operations in IIMM for better investment decision • Features An effective information dissemination to fulfill the global investors sophisticated needs • Contents • • The Objectives Graphing facility for analytical purposes • Direct access and via BNM Web site • Content will be accessible to mobile devices like Personal Digital Assistant (PDA) and WAP-capable new generation hand phones 14

Snapshots of the Website… a one-stop information centre 15

Snapshots of the Website… comprehensive data and information 16

Snapshots of the Website… also provides information on international sukuk 17

CMP charts the future growth of Islamic capital market 2001 - 2003 Phase 1 Strengthen domestic capacity, and develop strategic and nascent sectors 2004 - 2005 2006 - 2010 Phase 2 Further strengthen key sectors and gradually liberalise market access Phase 3 Expand market processes & infrastructure for fully-developed capital market, enhancing international positioning in areas of comparative and competitive advantage • Launched in February 2001 to chart the strategic positioning and future direction of the Malaysian capital market over the next 10 years to support national economic growth in an environment of deregulation and liberalisation • Formulated by the Capital Market Strategic Committee, comprising representatives from SC, BNM, experienced local and foreign professionals Objectives 152 Recommendations ü as the preferred fund-raising centre for Malaysian companies Market Institutions ü promote an effective investment mgmt industry and more conducive environment for investors Equity Market Bond Market ü enhance competitive position and efficiency of market institutions ü ensure stronger and more facilitative regulatory regime Derivatives Market Islamic Capital Market Areas ü develop a strong and competitive environment for intermediation services Stock broking Industry Investment Mgmt Corporate Governance Regulatory Framework ü establish Malaysia as an international Islamic capital market centre Facilitate development of wider range of products and services Technology & ECommerce Create market for effective Islamic fund mobilization Ensure comprehensive accounting, tax & regulatory framework Enhance the recognition of Malaysian market internationally 18

What the Future Holds? Vibrant international Islamic financial market Global strategic alliances Future Growth Harmonisation of Shariah interpretation Intensify product innovation Align practitioners’ needs with underlying Syariah principles Current Creating awareness and enhance knowledge Adopt pragmatic and gradual implementation approach to instill confidence Timeline 19

An Integrated Global Islamic Financial Market… Building the necessary infrastructure to facilitate efficient capital and trade flows Creating a vibrant financial markets Towards a Global Islamic Financial Market Strengthening information sharing and human talent management Promoting the adoption of international standard regulation and market practices 20

For more information on Malaysian Financial Market… Websites • http: //www. bnm. gov. my - Bank Negara Malaysia • http: //iimm. bnm. gov. my - Islamic Money Market • http: //rmbond. bnm. gov. my - Ringgit Bond Market • http: // www. sc. com. my - Securities Commission Malaysia • https: //www. fastweb. bnm. gov. my/fastweb/public/mainpage. do - FAST 21