By Peter Bokma
The day of a treasury function in an Islamic bank means having activities relating liquidity and foreign exchange management, i.e. the borrowing and placing of funds and the execution of customer-related foreign exchange transactions.
In Islamic treasury environment, it is important to note that for any product or process, Shariah Committee/Shariah Board approvals are required, before any other processes, to ensure the pureness of the Islamic banking to remain intact.
Further, the execution of transactions agreements must be in place with counter parties the Islamic treasury is transacting with, for which also before any of these executions, review and approvals by the Shariah Committee/Shariah Board must be obtained. The process of Islamic banking and in this particular subject Islamic treasury, means being well-guided by the Shariah Board’s principals every step of the way.
For the execution of liquidity management, there are a limited number of liquidity tools available used in the Islamic treasury — the “Wakala”, which is can be either a placement or borrowing of funds for or by the bank. It’s an “agency agreement”, whereby the counter party or the bank itself (in case of borrowing of funds) provides an estimated profit rate of return, and the recipient can cancel the transaction in the event the prospective profit rate is not as the expected rate of return, and therefore then demanding the return of the funds with the accrued profit amount. This does not happen very often though.
The other liquidity product is the “Murabaha” transaction based most commonly on commodities, which is a money market transaction whereby the principal amount is created from the purchase and sale of a commodity transaction. The profit rate is being fixed for the tenor of the borrowing or placement funds.
Besides the dealings with counter parties, other forms of liquidity tools are Qatar Central Bank offerings of Qatar Central Bank Treasury Bills. From an Islamic banking perspective, the Treasury Bills issued are also commodity-based (Murabaha-based) as well.
The Central Bank also regularly supplies “Government Sukuks”, which are capital market products (Bonds with fixed profit rates of returns) with longer tenor issuances.
One very important area of business is the hedging of the balance sheet. The bank’s exposure (natural gap, mismatches of tenors, foreign exchange risks) are being monitored by the treasury, which in fact is the “Asset and Liability” (ALM) function of the department.
Any exposure relating to the balance sheet that entails a mismatch of tenors, may mean to attract either longer term funds, or hedging using the “Profit Rate Swap”, which is a derivative product, whereby the principal amount is never exchanged, but purely a mechanism to fix a longer term profit rate (in conventional terms the fixed interest rate part).
In the event that long term profit rates are increasing, the “Profit Rate Swap” fixed profit rate contract that has been executed (contractually agreed with the counterparty), will remain the same until it’s maturity, hence the bank’s balance sheet exposure is then protected.
The foreign exchange exposures a bank may have, are due to foreign currency asset and liabilities mismatches, i.e. more-, or lesser assets then the liability side. This exposure can be managed by buying foreign exchange spot (two working days into the future settlement date), or using a “foreign exchange Waad” transaction, which is an ‘in to the future’ settlement date longer than the spot date. Both possibilities would eliminate the exposure of foreign currencies.
The means of communication used inside the Islamic treasury is no different from conventional ones. There are direct dealing systems for communication with banks worldwide, and foreign exchange platforms to execute the transactions that daily are forthcoming. Information flows from the various departments providing the cash flow requirements of the bank and the commodity transactions needed to create the monetary flows, are the daily activities. The supplying of foreign exchange rates for the branches for customer transactions purposes are the start-of-the-day processes.
Islamic treasury management means being Shariah-compliant in managing every process according to very important principles. Further, whatever a bank selects to do regarding its product range, be it customer-driven or liquidity- or foreign exchange management for either Islamic- or conventional banking, ultimately it’s all dependent on the risk appetite of the bank.
* The author is chief of Treasury & Investments at International Islamic, QIIB. The views expressed are his own.