Islamic Finance and Banking

Prepared By:
Dr. H. M. Mosarof Hossain
Professor
Department of Finance
University of Dhaka
mosarof@du.ac.bd

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 Islamic Money Market
Introduction:
The money market is an essential and integral component of the
financial system also known as gear of capital market. The tenure
in this market transactions is from overnight to 12 months with
common tenure is 3 months. Transactions in the primary and
secondary markets take place over-the-counter via electronic
telecommunication but some are done in an exchange market.
Instruments traded include futures, options, swaps and forward
rate agreements.

Participants:
Banks, Non-bank financial institutions, business corporations, the
government treasury, the central bank, investment banks,
discount houses and money brokers.
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 Money market instruments

i. Treasury bills
ii. Repurchase agreements
iii. Negotiable certificates of deposits
iv. Commercial papers
v. Bankers acceptance

Functions of a money market:

i. Liquidity management
ii. Trading of financial instruments in secondary market
iii. Acting as a channel for the central bank to conduct its
monetary policies.

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 The need for Islamic money market
i. The money market is a key appendage of the banking
system because this market manages banks liquidity
positions.
ii. It resolves the mismatch problem of asset-liability of banks.
iii. Facilitates using of surplus funds and arranging of deficit
funds by participating in interbank market.

There is need for an islamic money market with instruments

that allow islamic banks to achieve the abovementioned goal
of liquidity management by complying with Shariah.

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 Differences between islamic and
conventional money market
i. Islamic money market utilises shariah-compliant contracts
such as mudarabah, murabahah and wakalah ,whereas
conventional money market issues debt contract for placement
of funds.

ii. Islamic money market must be shariah-compliant and

approved by both the council and shariah committee, whereas
conventional money market must be approved by respective
regulator.

iii. In islamic money market there are both islamic and

conventional investors participating, whereas in conventional
money market there is only conventional investors
participating.
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 Components of islamic money market

i. Interbank money market it is a means by which banks

borrow and lend among themselves. The necessity for a bank
to borrow and lend in the money market arises from the
mismatches in its daily cash flows. These mismatches in the
daily cash flows are due to imbalances between a customers
deposits and withdrawals, and the offset balance of the
cheque clearing process. Given this, a bank may face cash
shortfalls or surpluses on a daily basis depending on whether
withdrawals exceed deposits and vice-versa. Since banks
have little influence on the causes of cash imbalances,
managing these temporary shortfalls is of crucial importance,
and this is where the money market comes in handy. Their
ability to borrow and lend among themselves allows banks to
manage their liquidity.
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 Components of islamic money market

It includes the followings:

(a) Mudarabah interbank investment
(b) Commodity murabahah
(c) Wakalah investment
ii. Trading of islamic money market instruments it is aimed at
facilitating placement of financial instruments among the
money market players through the issuance or purchase of
these that can be easily traded in the secondary market.
Therefore, this makes it easy for banks that purchase money
market instruments to sell or liquidate them whenever they
want without waiting until the maturity of the instruments. An
active secondary market is, therefore necessary to facilitate
the trading of money market instruments before maturity,
thereby reducing liquidity risk and enhancing the efficiency in
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the market.
 Components of islamic money market

The following instruments are commonly traded in this market:

(a) Government investment issues
(b) Islamic treasury bills
(c) Monetary notes
(d) Sukuk bank ijarah
(e) Islamic negotiable instruments
(f) Negotiable islamic debt certificates
(g) Islamic negotiable instruments of deposits
(h) Islamic accepted bills
(i) Sell and buyback agreement
(j) Sanadat mudarabah cagamas
(k) Islamic corporate sukuk