For banks, liquidity plays a similar role to oxygen in people - namely that in its absence it's very hard to survive.
One of the greatest inhibitors to growth that Islamic finance has had to contend with is the lack of Shari'ah compliant liquidity - something that has been exacerbated by much of the industry's global assets being based on illiquid real estate. The generally illiquid nature of Islamic finance has held it back from a number of business areas where it should be enthusiastically involved, including microfinance lending, Islamic venture capital and an expansion of Shari'ah compliant SME financing - or so say the Islamic bankers I have talked to.
That is why the recent innovations in global Islamic finance should be applauded and enthusiastically supported by the world's Islamic banking fraternity. In Malaysia Bank Negara is firmly behind the International Islamic Liquidity Management Corporation (IILM) and BNM's governor Dr Zeti Akhtar Aziz recently announced that the new body would be in a position to issue its first Sukuk in the next six months. The IILM was established earlier this year in order to strengthen the liquidity management of Islamic financial institutions, with the collaboration of the central banks of Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the UAE and two multilateral institutions, the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector. The raison d'être of the IILM is to enhance the availability of liquid Shari'ah-based Islamic financial market instruments - a crucial step in promoting more efficient cross-border liquidity management for Islamic financial institutions to support increased cross-border flows.
Hot on the heels of the birth of the IILM is Thomson Reuters' Islamic Interbank Benchmark Rate (IIBR), launched last week in Bahrain. This follows in the footsteps of another Malaysian innovation, the Islamic Interbank Money Market (IIMM) established in 1994, which Bank Negara uses to manage liquidity in the Malaysian Islamic banking system by either mopping up excess liquidity or injecting liquidity when required. The IIBR attempts to internationalize the idea first proposed by Bank Negara's IIMM.
Attempts to develop more liquid Islamic finance markets have, in the past, met with only limited success due to a lack of availability of suitable Shari'ah compliant instruments and the weaknesses in the supporting infrastructure. The IFSB said in a report released in 2008 that the reliance on interbank arrangements with institutions offering only IF services implied interbank money markets were likely to be segmented between Islamic and conventional banks and not well integrated into the overall money markets in most jurisdictions.
However, the IIBR tries to combat this perennial problem, it has to negotiate the internal dialogue in the industry where many Islamic bankers question the need for a Shari'ah compliant benchmark, arguing that the current use of LIBOR is sufficient. They maintain that although LIBOR is not a pure Islamic benchmark, it acts as a neutral proxy and the Shari'ah purity of Islamic finance institutions using it indicatively is not compromised as LIBOR is being used for guidance purposes and no actual forbidden transactions are being made.
Despite many in the industry scratching their heads as to the practical use of the IIBR, innovation and initiative need to be encouraged; wherever they end up. Elsewhere, Bahrain's International Islamic Financial Market (IIFM) is trying to develop an Islamic alternative to Repos and issued a reference paper in July that provides a basis in terms of finding a widely acceptable and market-based solution, which will play a major role in liquidity management as well as in the creation of a more active Sukuk secondary market. The paper explored the concepts and structuring possibilities of an Islamic alternative to Repo and collateralization based on Murabahah.
Initiative needs encouragement, as without it the festering boil that is the lack of liquidity will never be lanced, without which the industry will not be able to evolve. If Islamic bankers want to see the Islamic banking sector prosper, they need to support these initiatives and look for creative ways themselves to make the industry a better place.
© The Islamic Globe 2011
