Islamic finance

Malaysia has spearheaded the development of sharia-compliant financial services in Asia, with the government giving its full support to the development of Islamic finance for more than two decades. One of its latest efforts is designed to help banks with their funding operations by supporting the use of commodity murabaha underpinned by the country’s rich supplies of palm oil.

As our article on pages I2-5 explains, while deposits will likely remain a favoured liquidity tool for Islamic and conventional banks for some time, it is hoped murabaha instruments will emerge as useful funding instruments priced across a range of interbank yield curve maturities, unlike the more popular mudarabaha, which – due to uncertainty of profit-rate levels set mid-month – is only really useful as a short-term funding tool.

However, the growth of murabaha is not without problems, with scandals emerging about transactions with ‘phantom’ underlying commodities as well as some Islamic scholars questioning the appropriateness of murabaha.

Controversy in Islamic finance is nothing new. One of the biggest inhibitors for the spread of Islamic banking is securing consensus among the difference schools of Islamic thought. The creation of an International Swaps and Derivatives Association tahawwut master agreement last year. represented a milestone for the Islamic derivatives industry, but took up to five years to achieve with more than a 20 redrafts, according to some parties familiar with the process.

A lack of conformity for collateral agreements, and no real legal certainty surrounding close-out netting in many jurisdictions, means the Islamic derivatives market is still a long way from maturity.

Nonetheless, the Islamic structured products market continues to grow – albeit only really in Malaysia, with many structures still banned in Indonesia. Nevertheless, many sharia-compliant products performed better than their conventional peers during the financial crisis. The result is that investors are slowly gaining more confidence in these instruments.

Christopher Jeffery, editor

Further reading

• Structured products

Malaysia’s commodity murabaha push still has a way to go

• 01 Mar 2011

• Structured products

Islamic structured products gain credibility in Asia

• 01 Mar 2011

• Structured products

Long road for standardised Islamic derivatives documentation

• 01 Mar 2011