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Islamic banking faces liquidity risk: Expert

By Satish Kanady Doha: Islamic banking sector is increasingly facing liquidity risk across all geographical regions. The situation is more challenging in the GCC region, said an expert.

He called for the industry leaders and the regulators to create new instruments and develop fresh policy tools for the liquidity risk management in the Islamic industry sector.

Dr Salman Syed Ali of Islamic Research and Training Institute, Saudi Arabia, cautioned that the Islamic banking sector might also go the way of conventional banks, unless effective tools are not in place immediately.

Dr Salman, who was in Doha to attend the International Conference on Islamic Economics and Finance, told The Peninsula: "The structure of liquidity of Islamic banks have changed significantly over the years. From an era of liquidity surplus in the beginning of the decade Islamic banks are now in the era of liquidity shortages. In general, the banks have moved from a position of positive gap to a negative one or from a negative gap to a more negative one."

The level of liquidity in Islamic banking has been decreasing while liquidity risk has been increasing in all geographical regions over the past decade. The risk has further increased after the global financial crisis.

Contrary to the general perception, the liquidity of Islamic banking industry in the GCC is lowest with highest liquidity risk when measured by liquidity ratio and financing to deposit ratio.

There has been a major structural change in the maturity profile of assets and liabilities of Islamic banks between the years 2000 and 2009 from a position of positive short-term maturity gap to a negative gap. This, according to Dr Salman, is a strong indication of a liquidity risk.

In comparison with the conventional banks, the Islamic banks, despite downward trend in their liquidity ratio, are holding much higher proportion of liquid assets. Even during the financial crisis the liquidity in Islamic banks was more than twice the liquidity of conventional banks. This, among other factors, may have helped Islamic banks to ride out of the crisis. But things are changing in the industry.

For want of updated Islamic instruments for liquidity management, the fully fledged Islamic banks face more difficulties compared to the conventional banks and the Islamic banking windows of conventional banks. A comprehensive review liquidity management practices and policies of Islamic industry is an urgent need.

"Out of the box thinking is needed to come up with solutions. Researchers and policy makers need not confine their thinking within the present model of commercial banking and the set-up of the existing financial sector", he said.

Among the GCC countries, Kuwait had consistently low liquidity ratio over the period. UAE is the country where liquidity ratio dropped most and remained lowest during the global crisis. Among other countries, Jordan has the highest liquidity ratio consistently since 2004 followed by Malaysia. The liquidity ratio in Sudan has been consistently showing a downward trend since 2004.

An important measure of liquidity risk is the Financing to Deposit Ratio - a situation that captures the relationship between changing nature of demand for financing and deposit gathering ability of banks to fund that demand. This ratio is quite high in the GCC and Mena when compared to other regions, Dr Salman said.

© The Peninsula 2011