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121ISLAMIC BANKING MANAGEMENT, ASSETS AND LIBILITIES
Oybek Akhrorjon Abduqaxxor Muhammadrizo
Akhmadjonov Abdullayev Abdupattayev Sultonov
Kokand university
ABSTRACT
In this paper, we are going to consider assets and liabilities management (ALM) structure and instrument in Islamic banking. Since in Islamic banking depositors take partnership in benefits of the bank, so Islamic banking follows to maximizing benefits of beneficiaries and among them depositors. Therefore, there are dissimilarities between ALM approaches in Islamic banking and conventional banking. First, this dissimilarity comes from differences in the accounting system in Islamic banking in comparison to conventional banking. Secondly, usury illegalness and its related jurisprudence specifications indicate that time is not the solely the effective factor on increasing equity (deposited capital) return; but profit and loss sharing resulted from investment in the real economy sector is the essential base in monetary transactions. These two important factors are considerable factors in Islamic ALM.
Keywords: Islamic banking, ALM, Capital adequacy, Risk management
1. Introduction
Assets and Liabilities Management (ALM) consists of technical instruments and methods, which consider both value creation and controlling of risks for shareholders. Since one of the main duties of banks' financial management is ALM. Therefore, banks apply ALM techniques to increase more benefits by covering themselves from risks and minimize losses coming from transactions. The appropriate assessment of a bank's ALM requires a deep understanding of assets and liabilities, customers, economic environment, and competitive conditions of the bank. Thus prior to going through into Islamic banking respects of assets and liabilities, it is necessary to introduce Islamic banking assets and liabilities structures, market, customers, and other effective factors on ALM.
2. Compatibility and incompatibility of economic theories with Islamic banking
One of the main purposes of Islamic economics is real value-added creation and social welfare maximization in the economy. On the other side, welfare economics, new business administration concepts, and also new international banking theories follow the value creation and maximizing of shareholders' benefits. Probably, one of the usury illegalness reasons in Islamic banking may come from the affection of money market
fluctuation on a real economic sector that causes economic divergence from long-run stability growth and imbalances in money market and other markets as well. Therefore, the compatibility between conventional
economics and Islamic economics theories can be observed, though this compatibility cannot be observed in all theories. The main contradictory between Islamic economics and conventional banking comes from usury illegalness principle, and usury and non-usury considerations on transactions are influenced by intellectual deduction of jurists, and Islamic economists and existence of contradictories among opinions in this realm are inevitable. Bidabad and Harsini (2003)1 by scrutinizing usury definition and using theosophy principal of jurisprudence defined some criteria to distinguish usury from non-usury transactions. It seems that these criteria may be accepted as an ending point of usury definition. The criteria are:
1.Loaner must share in profit/loss of the economic activity of borrower.
2.The rate of interest must not be determined and conditioned before.
3.Interest in consumption loans is usury.
4.Foreign currency exchange (without interest) is not usury.
Based on the above criteria, non-usury banking performance requires specific ALM approaches to make necessary coordination that applying those ALM techniques improve the efficiency and effectiveness of this type of banking. Islamic banking, as same as conventional banking follows maximizing shareholders assets but digressing that the real stakeholders of Islamic banks embrace all beneficiaries as depositors, investors, and business partners. The shareholder's assets are measured by the market value of shares, amount of payable profit, and also created value added. The share's market value or created value-added are affected by three factors: cash flows resulted from the financial ability of shareholders, cash flows' time scheduling, and risks of cash flows. The maximizing shareholder's equity in Islamic banking is considered by maximizing of value creation as well but must consider the principles of usury prohibition mentioned above. In this paper,Economic Value-Added (EVA) index will be considered as value creation criterion
3. Assets and Liabilities structures in Islamic banking
The cognition of assets and liabilities structure in Islamic banking requires assets and liabilities items to be considered on the basis of Islamic Shariah. General structure of assets and liabilities in Islamic banking ASSETS
• Cash and short-term funds Deposits and placements with banks and other
financial institutions
• Short term investment (i.e., Sukouk)
• Allowance for bad and doubtful financing
• Financing and advances based on Islamic contracts
• Direct investment
• Other assets
• Fixed Assets
• Property, plant, and equipment
• Other tangible assets TOTAL ASSETS
• Off Assets
• Customer commitment and contingencies LIABILITIES AND SHAREHOLDER'S EQUITY
Bidabad, B. Harsini, A. (2003), Religious-economic analysis of usury in consumption and investment loans and shortages of contemporary jurisprudence in finding the rules of religion legislator. Monetary and Banking Research Academy, Central Bank of Iran, 2003.
• Deposits from customers
• Deposits and placements of banks and other financial institutions
• Bills and acceptances payable
• Other liabilities
• Provision for taxation and zakat
• Ordinary share capital
• Reserves
• Shareholder's equity
• TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY
• Bank commitment and contingencies
4. Assets and Liabilities in Islamic Banking
The source and origin of assets in Islamic banking same as conventional banking come from net benefit and liabilities. On the other words, the essential pillar of profit acquiring in Islamic banking is assets from internal sources of shareholder's equities and from an external source as liabilities. Productive assets in Islamic banking, which are classified as uses are affected by monetary resources and shareholders' equity or deposits of depositors which are categorized in Islamic contracts according to their liquidity degrees.
Cash
Similar to conventional banking, in Islamic banking, this type of assets is maintained for covering bank commitments. Low or lack of return of this type of assets and also its undesired effects of inadequate liquidity are very important for maintaining this type of assets. In other words, increasing losses of liquidity risk stimulated the Assets and Liabilities Committee (ALCo) topropose some guidelines to preserve the tradeoff
between costs of maintaining liquidity and liquidity risk. Generally, optimum liquidity amounts to be maintained by the Islamic bank can be calculated by equation (1).
1) ¿R^dki^
' 1 ELNt
AL:Liquid assets
ELS: Estimated acquired liquidity based on liability sources ELN: Estimated liquidity needs
The above equation shows the optimum liquidity ratio, and it should be greater than a in absolute value. In Islamic banking, the required cash flow (ELN) variation is lesser than conventional banking. Because the rate of return in Islamic banking comes from rate of productivity in the real economy sector in correspondence to profit and loss sharing (PLS) mechanism and this will stabilize interest rate and loaning and depositing flows. According to figures (1) and (2), the rate of return and loans and deposits flows in Islamic banking are more stable than conventional banking. Figure (3) indicates liquidity risk curve shiftsdown (increases slope) in Islamic banking; thus, optimum liquidity in Islamic banking will be lesser than conventional banking.
Figurel: Conventional banking Figure2: Islamic banking
Following figure (3), the optimum amount of liquidity can be calculated as the point of intersection of the cost of maintaining liquidity curve and the cost of insufficient liquidity curve in both types of banking. In other word, optimum liquidity measure is reached where liquidity costs are minimized as shown in the following figure.Lower liquidity needs in Islamic banking will cause the liquid assets to be allocated for investment in high-return assets. Therefore, since the liquidity in Islamic banking is lesser than conventional banking, the opportunity cost for maintaining liquidity in Islamic banking is lesser than conventional banking as well. The liquidity needs in Islamic banking and conventional banking are shown with bPLS and bCon parameters, and we can realize this relation: bCon > bPLS
Trading off the cost of maintaining liquidity against the cost of insufficient liquidity
High liquid Assets:
Islamic banking may buy some return based assets instead of their cash hoardings. Despite being highly liquid, these assets have positive returns, and the bank can get profits of a joint venture in investment projects. Sukuk and Mosharekah bonds (Oragh-e-mosharakah) are samples of this type of assets in Islamic banking, which are replacements for bonds in conventional banking. The decision for maintaining this type of assets will be based on liquidity, inflation, rate of return of the real economy sector,
and also economic conditions and regulations and etc.....
Accounts and Notes Receivable
The origin of this kind of assets comes from Islamic bank credit facilities as a form of debt buying (Kharid-e-Dayn) contraction. Purchasing of this type of assets will depend on customer credit position, rate of return, and economic conditions. Claims
The banking claims include those purchased assets that go into the credit risk. Total outstanding claims, allowance for bad and doubtful financing of government and nongovernment claims, debts of paid L/C on the base of Islamic contracts, irrecoverable receivable notes, and others are classified in this group. The qualities of this type of assets regarding their returnsin banks, whether Islamic or non-Islamic are different and depend on the type of collaterals, mortgage or non-mortgage and cash or non-cash. So for calculating the allowances for bad debts and determining credit risk measure are considered by ALCO. The standard measure for allowances for bad debts (sum of public and specific reserves) to net loans should be at an acceptable level (the standard measure is 2% of net financing and advances). One of the advantages of Islamic banking in comparison to convention al banking is the transparencies of the balance sheet items. Because profit and loss sharing (PLS) will decline allowances for
bad and doubtful financing. In the case of bankruptcy and investment loss, amounts of investment are directly booked in costs accounts, and therefore, the financial statement is more transparent in Islamic banking than conventional banking.
Financing and advances based on Islamic contracts
The main activity of financial intermediary institutions is credit loaning or financing and advances. In other words, financial intermediary institutions as economic firms are active in two markets. They demand financial resources from depositors (in deposit market), and on the other side, they supply credits to investors (in the credit market) Revenue of these institutions comes from differences between received and paid interest or interest premium. Prohibition of usury (riba) in Islam and other divine religions and also work and do as bases of value creation are main characteristics of Islamic banking products and services, so this type of banking tend toward Musharakah contracts with pre-undetermined profit/return rate.Generally, selling assets as forms of credit products can be separable according to the following table. Although, many of these products will enter into usury domain, but are used by Islamic banks like Iran.In many Islamic countries which applying Islamic banking, PLS contraction has not developed deeply; for example, the PLS paradigm of Islamic banking in Malaysia has been much slower on the asset side than on the liability side. On the asset side, only
0.5. of Islamic bank financing is based on the PLS paradigm of mudarabah (profitsharing) and mosharakah (joint venture) financing.
Economic value added (EVA) maximization in Islamic banking
In non-usury banking, the monetary resources for investment come from two sources of debt capital and equity capital. The Islamic bank after deduction of legal reserves and provident funds by using the resources on the basis of Musharakah contracts (with floating profit) can invest them undividedly and distribute their returns on the basis of accrual accounting system among the stakeholders. The object of Islamic banking is to maximize the benefits of stakeholders, which include depositors and beneficiaries (legal owners). In this section, by introducing economic value added (EVA) index as a value creation criterion, we will compare Islamic banking and conventional banking. Calculation of EVA is done by different methods of theoretical economics by reduction of the opportunity cost of capital from the net profit of the firm (after deduction of the taxes).
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