The SBP had started conducting auctions of Ijara Sukuk in September 2008, providing Islamic banks (IBs) an opportunity to place their surplus funds in zero-risk, Shariah-compliant government bonds. So far, 15 auctions have been held, with the latest on last Monday. The decision to conduct Sukuk OMOs is the second important step taken since then.
If they run short of funds, their coffers will not remain dry for weeks, and nor will they have to pick the required funds from conventional banks using a complex system to make the transactions Shariah-compliant.
Central bankers say Sukuk open market operations will help Islamic banks in short-term liquidity management and also improve the transmission of monetary policy signals “In the first case, the SBP will sell Ijara Sukuk to lift excess liquidity for a while. And in the second case, it will buy Sukuk from IBs to inject short-term liquidity,” explains the treasurer of a local bank.
The SBP has told IBs that it can conduct Sukuk OMOs either on the basis of Bai-Muajjal, a Shariah-compliant equivalent of deferred payment, or on ready payment basis.
Explaining the modalities, the SBP has informed the market that all eligible participants in Sukuk OMOs will send their bids as per the required format, detailing the face value of the security and the deferred price (in case of Bai-Muajjal) or the price (in case of ready payment). Prices should include accrued profit and can be quoted up to four decimal places.
Each eligible participant will be allowed to submit a maximum of three bids in an OMO. The minimum bid size will be Rs25m, with subsequent bids a multiple thereof. The SBP has the discretion to accept the bids on a ‘pro-rata volume’ basis. The auction’s result will be announced on the same day, according to the SBP’s press release on this subject.
Central bankers say Sukuk OMOs will not only help IBs and Islamic banking units of conventional banks in short-term liquidity management, but also improve the transmission of monetary policy signals in a financial market where the liquidity levels of IBs matter due to their growing share in overall banking.
Besides this, the selling and purchasing of Ijara Sukuk by the SBP would expand the overall volume of Sukuk in the market, thereby creating room for their onward sale by banks to other Islamic and conventional banks and also to individuals.
This would help the government diversify its domestic debt market on the one hand and give people a Shariah-compliant mode of investment for which the demand is high and growing.
In the latest three-year Sukuk auction held on October 20, the cut-off margin was below 200 basis points less than the rate for T-bills. When the central bank conducts Sukuk OMOs, IBs can expect to park their funds at higher rates. Unlike in auctions, there will be no benchmarking with T-bills in OMOs.
This should, in turn, lead to fiercer competition between T-bills, PIBs and Ijara Sukuk, which would deepen secondary markets for all three debt instruments and help in the development of a more reliable yield curve.
Islamic bankers say once their short-term liquidity management improves after the start of Sukuk OMOs, their financing and investment pattern might also change. If a bank’s net investment is high and it’s financing low due to problems in projected adequacy of surplus funds, it can now enhance financing without worrying too much about liquidity by participating in OMOs.
Similarly, if another bank’s net investment is higher than it’s financing because it has been more adequately liquid for some time, it can reset the financing-investment mix, hoping that the surplus liquidity would be siphoned off through OMOs.
The total outstanding stock of Ijara Sukuk is currently Rs326bn, including last year’s fresh issue of Rs49bn. Islamic bankers say conducting Sukuk OMOs is not enough to create more depth in the Sukuk market, and add that fresh releases of the bonds are equally important.
Lack of new Ijara Sukuk issues has hit IBs’ investments, and the Islamic banking industry’s net investment has been declining lately. By end-March, the industry’s net investment showed a year-on-year decline of about 18pc. Bankers say IBs can absorb Rs150-Rs200bn of new Ijara Sukuk immediately.