The use of Islamic hedging instruments as non-speculative risk management tools

Abstract

The objectives of this research were, first, to examine how an Islamic hedging instrument can be used as a risk management tool, second, to identify the factors that influence the demand for Islamic hedging, and third, to examine the challenges faced by an Islamic financial institution in promoting the use of Islamic hedging instruments. This research is an exploratory study and involves a qualitative research methodology using case study analysis. Data were gathered using published literature and information from official websites as well as interviews with industry practitioners on Islamic hedging instruments from Bank Muamalat Malaysia Berhad and CIMB Islamic Berhad. The two banks are selected because they are among the major players in the Islamic hedging market in Malaysia. This study reveals that the Islamic hedging instruments offered to corporate clients by the two Islamic banks under study are Islamic Forex, cross-currency and profit rate swaps, and commodity hedging instruments. This study also suggests that price, documentation, bank reputation, awareness, and ownership are factors that influence the demand for Islamic hedging products. Islamic Shariah-compliant hedging instruments are meant to appeal more to clients who are looking for Shariah-compliant hedging instruments to hedge their risk exposure and less to investors who are looking for speculative ventures to gain large returns much like investing in hedge funds. Its use is still limited and it appears that it is more a question of marketing and branding, as Islamic hedging is still unknown even though the needs for it could easily be established to many corporate clients.