Working of Sukuk Funds in Islamic Banking
Sukuk, the Islamic Bonds, are sold in the market to raise funds for a particular project. Funds raised are used to purchase assets therefore they are asset based securities. By the use of those funds, derived benefits or rewards are distributed among Sukuk holders on pro-rata basis.
Source of Liquidity to Islamic Banks:
Corporates issue Sukuk in order to reduce their reliance on costly funding facilities offered by the banks; Sukuk are also among other few options available to Islamic financial institutions to support their liquidity position on short- term and long term basis.
Due to restrictions on trade of debt and other securities in the market, Islamic Financial Institutions have limited options to cope with liquidity crunch. Conventional banks have options of Short-term interbank lending as well as “last resort” lending from the Central bank to meet their liquidity requirements but no such option is available to Islamic banks due to prohibition of Riba. Therefore, Liquidity Risk is not only vital for Islamic banks but it is also vibrant issue for Sukuk as well.
Keeping in view the requirements of Islamic Financial Institutions, Malaysia has succeeded in developing inter-bank lending based on profit/loss sharing, but no other countries have such instrument which could serve the purpose.
While traditional banks are available with various options to manage their liquidity, Sukuk remains one of very few options available to Islamic banks.
Islamic banks are in great need of Long-term investment instruments but most of sukuk issues have a short-term maturity. This would result in serious mismatch between long-term loans provided by Islamic banks and their short-term assets, mainly through deposits. Sukuk with longer maturity can help in resolving the issue.
One of the reasons behind pervasiveness of short-term sukuk issues is the relatively new concept of Islamic financial institutions. Most of Islamic Financial Institutions have been established during the last decade. As compare to the conventional financial markets, they are relatively small thus cannot provide sustenance to large, long-term sukuk. The situation can change as the Islamic banks grow stronger and more experienced.
Sukuk market is also facing challenge of diversification. As Islamic financial institution have very limited investment opportunities and due to absence of any kind of diversification of risks, riskiness of portfolio can be increased significantly.
Lack of expertise of professionals in Islamic banks is one of the major reasons behind concentration of sukuk in certain areas. Due to absence of proper knowledge, they have left with no option except to focus in areas that they are familiar the most.
Sukuk are not an attractive option to most Islamic banks because of high proportion of short-term assets.
Investment banking, underwriting, lead managing and book making services are provided by islamic banks along with conventional banks having Islamic windows. While issuing and listing Sukuk, the Shariah board of arranging Islamic bank can issue Fatwa as the Reporting Entity may not have its own Shariah board.