Research Proposal on FX

Research proposal on development of foreign exchange hedging instrument for Islamic banks in Bangladesh

Bashir Uj Jaman Mihe, University of Gloucestershire 1

Research proposal on

Development of Foreign Exchange Hedging

Instrument for Islamic Banks in Bangladesh

By:

Bashir Uj Jaman



Table of Contents

1.0 Introduction:.................................................................................................................... 3

1.1 Research Aims:............................................................................................................ 3

2.0 Background study:........................................................................................................... 4

2.1 Islamic Banking in Bangladesh:................................................................................... 4

2.2 Hedging:...................................................................................................................... 5

2.3 Foreign Currency Exchange:........................................................................................ 5

2.4 Foreign currency exchange mechanism in Conventional Banking: ............................... 6

2.5 Recent Development for FX for Islamic banking around the world: ............................. 6

3.0 Importance of the Research: ............................................................................................ 8

4.0 Nature of research: .......................................................................................................... 9

4.1 Sampling: .................................................................................................................... 9

4.2 Research Questions:................................................................................................... 10

5.0 Time plan: ..................................................................................................................... 11

6.0 Ethical Issues: ............................................................................................................... 12

7.0 Expected outcomes:....................................................................................................... 12

Reference:........................................................................................................................... 13



1.0 Introduction:

Islam is not only a religion but also a complete code of life. It gives solution to all the

problems of humanity from personal, social, political and economic life. Though Islamic

economists had written about Islamic banking and finance from the beginning of nineteenth

century, it got its framework at the beginning of 1960’s with small mutual saving project in

Egypt (Schoon, 2009). It started to take off from 1990’s and it is a trillion dollar business

now growing at the rate of 15%-20% annually. But in terms of product development it is

facing significant obstacles because of the lack of expert human resources with the

combination of both banking and sharia skills.

1.1 Research Aims:

To develop a foreign exchange hedging instrument for Islamic banks in Bangladesh.



2.0 Background study:

To understand this concept properly, we need to first understand history of Islamic banks in

Bangladesh and it current status, Analyse hedging from sharia point of view, Solution of

Foreign exchange (FX) forward from conventional counterpart and recent development for

Islamic foreign exchange hedghing.

2.1 Islamic Banking in Bangladesh:

Islamic bank Bangladesh Ltd (IBBL) started its journey at 1983. Now there are seven full

fledge Islamic bank in Bangladesh with 496 branches. Seven Bangladeshi conventional banks

and two foreign commercial banks have 21 islami banking branches.

Full fledge Islamic banks are:

1. Islami Bank Bangladesh Ltd (http://www.islamibankbd.com/home.php)

2 ICB Islami Bank Ltd (http://www.icbislamic-bd.com/)

3. Al-Arafah Islami Bank Ltd (http://www.al-arafahbank.com/index.php)

4. Social Islami Bank Ltd (http://www.siblbd.com/html/homepages.php)

5. EXIM Islami Bank Ltd (http://www.eximbankbd.com/)

6. First Security Islami Bank Ltd (http://www.fsiblbd.com/)

7. Shahajalal Islami Bank Ltd (http://www.shahjalalbank.com.bd/)

Local banks with Islamic windows are:

1. Dhaka bank Ltd.

2. Arab Bangladesh bank Ltd.

3. Bank Asia Ltd.

4. South East Bank Ltd

5. Premier Bank Ltd.

6. The City Bank Ltd.

7. Jamuna Bank Ltd.

International banks with Islamic windows are:

1. HSBC -Amanah

2. Standard chartered – Sadiq



With this huge network of Islamic banks in Bangladesh and increasing demand of Islamic

products day by day, Islamic banks are still in search for sharia compliant foreign exchange

hedging instrument.

2.2 Hedging:

Hedging is simply any technique used to minimize any financial risk. Islamic banking

encourages profit and loss sharing. It is based on the principle ‘’ No risk, no gain’’. Islamic

banking does not prohibit hedging but it prohibits transfer of risk. While two party in

contract, one party should not transfer all the risk to other party. Islamic principle is based

upon minimizing risk and uncertainty and after making the risk in minimum level, islam

directs people to share it in a co operative manner. Therefore, hedging is encouraged in islam.

Opposite of hedging is speculation. In speculation, instead of minimizing risk, excessive risk

is taken in order to receive excessive gain with the change of price in future without intention

of taking any real delivery. Speculating simply means guess or prediction of future

occurrence which leads to gharar and maysir. So, speculation is not allowed in islam.

2.3 Foreign Currency Exchange:

Foreign currency exchange is an integral part of banking system to facilitate international

business. Export and import, foreign company investment or local company investing in

foreign countries requires currency exchange.

Exchange rate changes at every moment depending on different factors; mainly depend on

demand and supply. The higher the demand of a specific currency, the strong the currency is

compared to demanding currency. Demand increases because of price of commodity, interest

rate and other business factors.

Currency can be exchanged on spot or on future time period. Islamic Sharia does not have

any complain about using paper money as a monetary value and exchanging foreign

currencies on spot basis. We can even see from the sunnah of prophet (pbuh) exchanging

Saudi riyal to Yemeni dirham when he went to do business in Syria.



In today’s economy of free market it is unavoidable to fix the exchange rate of different

currencies for future exchange to avoid exchange rate volatility in order to hedge risk of

counter currency devaluation. But from sharia point of view, both the commodity in

exchange cannot be transferred on future date. Either price should be paid in spot (Salam) to

receive the commodity in future or the commodity (Murabaha) should be transferred on spot

to receive the price on deferred payment basis. Therefore, it is essential to find out an

alternative approach to meet the demand of future foreign exchange market for Islamic

banking industry.

2.4 Foreign currency exchange mechanism in Conventional Banking:

Conventional banks practised following mechanism to exchange foreign currency.

FX Forward

FX option

FX Swap

Muhammad Obaidullah in his paper ‘’FINANCIAL CONTRACTING IN CURRENCY

MARKETS: AN ISLAMIC EVALUATION’’ has showed that none of the above methods is

Islamic because, it leads to riba, gharar and speculation. In all of the above mechanism,

contract is done today but exchange is taken place in future which goes against the general

role of Islamic jurisprudence ‘’ Once cannot sell something what he does not own’’.

2.5 Recent Development for FX for Islamic banking around the world:

Islamic Foreign Exchange hedging is a mechanism to minimize market participants’ exposure

to market currency exchange rate which is volatile and fluctuating. Although Islamic FX

hedging functions almost similarly as its conventional counterpart, its structure must not

contravene with the principles of Shariah. In other words, Islamic FX hedging mechanism

should be free from any elements prohibited by Islam like usury (riba), gambling (maysir)

and excessive ambiguity (gharar).



Dr. Asyraf Wajdi Dusuki has shown how a Islamic FX swap is possible in his paper ‘’

Shariah Parameters on Islamic Foreign Exchange Swap as Hedging Mechanism in Islamic

Finance’’.

Dr. Dusuki in his another article ‘’ Islamic perspective on Islamic FX Forward’’ argues about

using wa’d and Wa’dan as an alternative to conventional FX forward.

Wa’d is simply a unilateral promise. Wa’dan is also two unilateral promises given by two

parties to each other but are not connected to each other.

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in its

Shari’ah Standard No.1 on trading currencies clearly states that, ‘A bilateral promise is

prohibited in currency trading when it is binding upon both parties, even when it is done to

treat the risk of decline in a currency’s value. As for a unilateral promise from one party

only, that is permissible, even if it is binding’. Despite the criticisms, unresolved Shari’ah

matters and the complexities inherent in the issue of two unilateral promises in structuring the

Islamic forward currency product, many Islamic financial institutions especially in the

Middle East are applying it (Dusuki, 2009).

Meera, A,K,M (date unknown) argues using gold as a medium of foreign exchange in

hispaper named ‘’ Hedging Foreign Exchange Risk with Forwards, Futures,

Options and the Gold Dinar: A Comparison Note’’.

The Prime Minister of Malaysia Dr. Mahathir Mohamad had called on countries to formulate

a gold payment system – the gold dinar – to settle their bilateral and multilateral trades

among them and thereby also hedge against foreign exchange risk. In this mode, gold is used

as a medium of exchange instead of national currencies. Price of exports and imports are to

be quoted in weights of gold. It is important that in this structure that gold itself is used for

pricing and not national currencies backed by gold, for otherwise it would not be different

from the gold standard of the past. Instruments backed by gold are subject to easy

manipulation that caused the failure of the gold standard (Meera, date unknown).



3.0 Importance of the Research:

Islam does not allow dealing with derivatives such as forward, future and swaps specially for

foreign exchange purposes. All the matters related to money fall under the jurisprudence of

bai al sarf in sharia which says gold, silver and any such monetary unit including today’s

paper money should be exchanged spot basis, hand to hand without any increment.

But the hadith mentioned was mainly for gold or silver like monetary unit which has intrinsic

values within it whereas papar money does not have any values. So, there is a difference of

opinions among Islamic scholars whether paper money should falls under bai al sarf or not.

So with this doubt in mind and lack of research, Islamic bank Bangladesh only deal on spot

basis and does not use any risk management instrument on foreign exchange dealing rather

leave it to central bank to decide for them. Hence, it is a matter of great importance to

research on this subject to enhance efficiency and profitability of Islamic banks in

Bangladesh.



4.0 Nature of research:

This research will be an analytical one. Research can be of two types; Descriptive and

analytical. Descriptive research includes surveys and fact-finding enquires of different kinds.

On the other hand in analytical research, researcher has to use facts or information already

available, and analyze these to make a critical evaluation of material (Dr. C R KOTHARI, 2009).

In this research author will gather all the previous studies on Islamization of foreign

exchange, analyse it with Islamic parameter and present findings of primary research to the

sharia scholar and Islamic banker of Bangladesh for further quantitative and qualitative

research.

This research will be based on both primary and secondary data. Secondary data will be

collected from website of both conventional and Islamic banks in Bangladesh to compare

profitability ratio in terms of foreign exchange from income statements for at least five

conventional banks and five Islamic banks. Literature review will deal with the published

articles and journals on this topic. Primary data will be collected by designing a closed ended

and open ended questionnaire. So, research will be a mix of qualitative and quantitative

approach. Questionnaire will be emailed to respective person. Qualitative data will be

collected by recording telephone interview.

4.1 Sampling:

This research is being done for all the Islamic banks in Bangladesh mentioned above

(population) .So, sample of the research should be big enough to represent whole population.

Currently, all of the seven full fledge Islamic banks have 3-5 sharia scholars in their sharia

board, making a total of average 28 sharia scholars. If we take 25% this is, 8 sharia scholar.

So, interviewing 8 sharia scholar will be representative enough to generalize the theory.

Similarly on an average same number of members consists of the executive management

body of the Islamic bank. Therefore interviewing eight senior Islamic bankers will help to

generalize the theory. This research can be done in conjunction with Central Sharia board for

Islamic bank of Bangladesh (http://csbib.org/). As far as I know this center is recently

thinking of doing a research on similar topic. So, with CSBIB’ s help I will be able to connect

to sharia scholars and Islamic bankers in Bangladesh.



4.2 Research Questions:

To find solution of this problem, opinions of sharia scholars as well as Islamic bankers of

Bangladesh is a must. I believe, finding answer to following questions will help develop a

suitable model for problem mentioned.

How conventional banks in Bangladesh manage FX hedging?

How does lack of FX hedging instrument impacts profitability of Islamic banks in

Bangladesh.

What are Islamic FX instruments have been developed and practiced around the globe?

What are the positive and negative views of sharia scholars about those instruments?

How does Bangladesh sharia scholar perceive those instruments?

What does Islamic banker in Bangladesh think about the viability of those instruments from

practical point of views?

What is the best instrument which satisfies requirement of sharia and can be applied in

modern day transaction in Bangladesh perspective?



5.0 Time plan:

Planning is required in order to finish the dissertation on time. I have to be able to submit my

dissertation on 28th of June’2011. In order to finish the dissertation on time, following time

frame will be maintained.

Time Interval Task Activities14th of March Initial proposal submission Writing proposal25th of March Meeting head of department Taking initial guideline on

structuring dissertation and reading materials

15 th of April Finalizing Literature review Writing literature review30th of April Finalizing Research

methodology.Reading at least two books on research methodology.

15th of May Establishing contacts with respondents.

Contacting central sharia board of Bangladesh.

Selecting people to take interview. And to have a ice breaking phone calls with

them.25th of May Finalizing questionnaire Showing it to supervisor1st of June Emailing questionnaire to the

respondents10th of June Finishing all interviews Recording and translating all

interviews into English.15nd of June Analysing data20th of June Presenting findings Showing it to Supervisor25th of June Finishing complete

dissertation reportGetting print out beforehand.



6.0 Ethical Issues:

I will make sure research follows ethical guideline at every moment. I must make sure, I do

not harm privacy or secrecy of any respondent.

It is a requirement of this research to publish name of each respondent and their views on

subject matter. I will take prior permission from respondents about publishing their name and

views.

7.0 Expected outcomes:

There are some instruments developed and practiced in some countries such as Malaysia on

this issues mainly based on Tawarruk and wad. Current practice of Tawarruk based FX

instrument has been strongly criticised by Islamic Fiqh academy and if certain issues strictly

not followed it will become forbidden. On the other hand FX instrument based on Wa’ad is

accepted by sharia but completely not feasible from bankers point of view. Some other

instruments under research are based on arbun and salam concept.

Recently, IIFM and ISDA has developed ‘’Tahawwud master agreement’’ for overall

hedging purposes. Can it be used to develop instrument for FX hedging purpose?

After doing efficient literature review and outcome of primary data, hopefully we may get a

suitable instrument for Bangladesh perspective.



Reference:

Dusuki, W, A. (2009), ‘’ Shariah parameters on Islamic foreign exchange swap as hedging

mechanism in Islamic finance’’, International Conference on Islamic Perspectives on

Management and Finance, University of Leicester.

Dr. C R Kothari.,(2009), ‘’Research methodology’’,2nd ed: publisher unavailable, Accessed from

google books on 13th of March,2011, available at

http://books.google.co.uk/books?id=hZ9wSHysQDYC&printsec=frontcover#v=onepage&q&f=false

Meera, A,K,M. (date unknown),‘’ Hedging Foreign Exchange Risk with Forwards, Futures,

Options and the Gold Dinar: A Comparison Note’’,IIUM.

Muhammad Obaidullah, (Date unknown), ‘’Financial contract in currency markets-an Islamic

evalution’’, International journal of Islamic financial service, vol 3, No.3.

Schoon, N. Dr, (2009), Islamic Banking and Finance, 1st ed: Spiramus press Ltd, London.

Research Proposal on FX

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