Shariah Compliant FX Swap: An Islamic Instrument for Central Bank Policy Making in Iran

Abstract

The foreign exchange swap (FX swap) is a contract that is designed as a hedging mechanism to minimize market participants’ exposure to volatile and fluctuating market currency exchange rates. Many central banks worldwide make use of this instrument for managing the FX market. However, because of the Shariah rulings, countries like Iran (where Islamic banking is in practice) cannot make use of the conventional FX swap. Considering this, the main purpose of this paper is to come up with new Shariah Compliant FX Swap that can be used by the Iranian central bank for alleviating foreign exchange risks. In terms of methodology, Content analysis and Ijtihad (independent jurisprudential reasoning) approach are used in this study. The results show that it is possible to revise the contracts of the conventional Central Bank Swap to make it Shariah compliant. The paper argues that the Central bank of Iran could efficiently use this instrument to mitigate foreign exchange volatilities, reduce risks, manage liquidity, and improve monetary policy operations in a cash-constrained environment. This paper for the first time proposes a way forward in reconciling traditional Swap contracts with the Iranian Islamic banking system that can be used by the central bank for managing the FX market.