Islamic Money Markets is an essential part of the Islamic Finance system around the world. For the beginning, let’s start with the concept of Money Markets
Understanding Money Markets
We can describe the money market as the financial market for wholesale short-term fund transactions.
The money market is a necessary part of the world’s financial system. The country’s financial market consists of several markets, such as money market, capital market, derivative market, commodities market, and foreign exchange market. They have a similar purpose to provide a means of communication. Additionally, it is a channel for financial asset transactions between buyers and sellers as well as between lenders and borrowers.
Money market transactions have a duration ranging from overnight to 12 months. However, three months or fewer is the most typical tenor.
Functions of the Money Market
- Liquidity management: The money market allows financial institutions to obtain daily funding or make short-term investments. Therefore, financial institutions with access to the money market can maintain optimal liquidity, allowing them to meet consumer demands at any time.
- Secondary trading of money market instruments avenue. Money market players will buy or sell money market instruments in expectation of an investment return, based on their view of the rate of return. Moreover, it offers investors a variety of risk, return, and maturity options.
- A channel for central banks to conduct their monetary policies. The money market is an ideal platform for the central bank to perform monetary operations for its connections to both the capital market and the banking sector. The open market operation allows a central bank to buy and sell eligible securities as well as offer short-term credit directly to banks in deficit. In this method, the central bank can control liquidity and affect the money market’s benchmark rate.
Differences between Islamic and Conventional Money Markets
Market participants in the Islamic money market can perform similar activities to those in conventional markets, with the exception that the instruments used to perform these functions are Shariah-compliant. Money market players can use Shariah-compliant methods to invest surplus funds or obtain short-term funding. It also allows players to trade Shariah-compliant money market instruments. Swaps that are Shariah-compliant are also available.
While the money market allows banks to apply good liquidity management techniques, Islamic banks are unable to use traditional interest-based instruments due to their shariah non-compliance. As a result, there is a need for an Islamic money market with instruments that may help fulfil the above-mentioned liquidity management goal while also adhering to shariah rules and principles.
| Islamic | Conventional | |
| Interbank Market | Uses Shariah-compliant contracts such as mudarabah, murabahah, and wakalah. | A debt contract is used for placement of funds. |
| Issuance process | Must be Shariah-compliant and approved Shariah Council | Approved by regulatory authorities only. |
| Types of structure | Based on assets, equity, and debt. | Based on debt only. |
| Investors | Both Shariah-Compliant and conventional investors. | Conventional investors only. |
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