Innovative Islamic Hedging Products: Application of Wa'd in Malaysian Banks

Abstract

The principle of Wa’d or promise can be used to structure innovative shariah compliant hedging instruments. Conventional hedging products such as forward currency contracts and currency swaps are prohibited in Islamic Finance principally due to the issue of riba and to the violation of bay al-sarf rule which requires currency trading to be done on 'spot' basis only. The usage of wa’d has grown rapidly in recent years since it offers great flexibility and many of the world’s first shariah compliant derivatives such as Islamic cross currency swaps and Islamic profit rate swaps have been developed by Malaysian banks using wa’d. This paper discusses and examines wa’d applications in seven selected Malaysian Islamic banks, specifically in its application as an Islamic hedging instrument. Based on a survey of the banks’ official information disclosed to the public, the finding of this research indicates that all Islamic banks under study have used wa’d in structuring their Islamic hedging products. This paper represents an early study of wa’d applications in the Malaysian banks and the study shows that wa’d is a flexible mechanism and has the prospect to play a vital role in facilitating Islamic financial institutions manage their business risks and liquidity effectively.

Keywords: Islamic hedging, wa’d, shari’ah compliant, Islamic banks

JEL Classification: E44, F31, G29, G13