Islamic banks struggle with limited liquidity management options
Islamic banks in many countries continue to face a limited range of Islamic liquidity management instruments (ILMI) compared with conventional banks despite recent initiatives in a number of markets, Fitch Rating says.
ILMI can provide Islamic banks with more funding options and can help them invest their excess liquidity. Gaps in ILMI are more prominent in countries where Islamic banking is still developing and niche.
Sharia-compliant liquidity facilities from central banks can provide Islamic banks an additional source of short-term funding.
In February 2024, Central Bank of Jordan introduced new short-term liquidity facilities to Islamic banks. In Bangladesh, the central bank introduced new Islamic liquidity facilities after Islamic banks faced sizable customer deposit outflows in 2022-2023 amid reports of financing irregularities. Central bank Islamic liquidity facilities are also offered in most of the GCC countries, Malaysia, Turkiye, Indonesia, Pakistan, and Tunisia.
However, these facilities, which could help avert a liquidity crunch, are not present in Oman, Morocco and Kazakhstan.
Islamic interbank markets are much shallower than conventional markets, more so in countries with few Islamic banks.
Fitch noticed cases, including in the UAE, where Islamic banks are unable to place funding with conventional banks unless the latter use it for their Sharia-compliant business and the contract is Sharia-compliant. In markets like Oman, regulations prevent Islamic banks and Islamic windows from placing funds with conventional banks. This limits counterparty choice.
Government sukuk can grant
Islamic banks more options to invest their excess liquidity in high-quality liquid assets (HQLA).
These can also serve as collateral for Islamic repos. In 2023 and 2022, the UAE federal government and the Qatar Central Bank started issuing local-currency Treasury sukuk for the first time. Government sukuk are also available in Saudi Arabia, Malaysia, Bahrain, Indonesia, Türkiye, Bangladesh, Pakistan, Oman, and Nigeria.
However, regulatory hurdles are causing unavailability in some markets. In Kuwait, the lack of a public debt law prevents the government from issuing sukuk or bonds. In some markets, government sukuk are issued in lower volumes than bonds.
While government sukuk could qualify as HQLA, its liquidity features are constrained by the buy-and-hold nature of Islamic investors stemming from limited sukuk supply in both the primary and secondary markets.