The UAE central bank, which recently launched Islamic certificates of deposit to help Islamic banks manage their short-term excess liquidity needs is being expanded into a full repo (repurchase agreement) offering. I will discuss the structure in a little more depth (as much as I can based on the information now available), but the first point I find interesting is that it would be based on one model proposed in a paper by the International Isalmic Financial Market released last year, which I reviewed on my blog at the time it was released.
The structure that Reuters is reporting is being used is one based on murabaha. There is nothing new about commodity murabaha being used for liqudity management, but the repo product would use commodity murabaha with the central bank's Islamic CDs being offered by the bank as collateral for the loan. There are currently AED12 billion ($3.27 billion) in Islamic CDs held by Islamic banks in the UAE, giving a relatively large pool of assets for the repo transactions to use as collateral.
The need for a repo facility is clear for both central banks and Islamic banks, but the model that will be used is the most cynical possible outcome. When I read the IIFM report last year, I commented on the collateralized murabaha: "The addition of transfer of securities as collateral (without compensation) on top of the use of commodity murabaha would raise the most objections, I believe, on grounds that the product is cynical and does nothing to really help the industry develop new products." At that time, I saw the collateralized commodity murabaha as cynical because, although it tries to find a solution to a problem, it does so by further entrenching commodity murabaha into the Islamic financial industry.
The UAE repo facility goes one step further. Not only does it use the collateralized commodity murabaha between the Islamic banks and the central bank, it uses as collateral an Islamic CD which itself is based on commodity murabaha between the central bank and an Islamic bank. So, if an Islamic bank has surplus capital, it can loan it to the central bank by buying an Islamic CD, in which it buys a commodity and sells that commodity to the central bank and the central bank will repay the debt sometime within the next year (depending on the agreed upon maturity). However, if the Islamic bank needs liqudity before the CD matures, it can pledge that debt owed by the central bank to the central bank in exchange for a loan structured as a commodity murabaha.
If one takes this a step further and the central bank finds a way to have enable 'netting' of the commodity murabaha products, then it will have developed a way to trade debt (final payment for commodity murabaha represent a debt), which is mostly (outside of Malaysia at least) viewed as not permissible. As much as the short-term liquidity management tools are needed for Islamic banks (and for the central banks that want to engage in open market operations), creating a system where the central bank and Islamic banks are trading back and forth debts from commodity murabaha seems like the worst possible way to find a solution that has any lasting impact on the Islamic finance industry besides just solving the problem of the hour.