Fitch Ratings-Dubai/London: The limited range of Islamic liquidity management instruments (ILMI) is a long-standing challenge for Islamic banks in many countries, especially in niche and developing Islamic banking markets, Fitch Rating says. Mainstream markets – including those in the Gulf Cooperation Council (excluding Oman) and Malaysia – have a wider range of ILMI despite some product gaps.

We expect ILMI to develop slowly due to unsupportive regulations, sharia-compliance complexities, limited standardisation, the small number of Islamic banks and the underdeveloped financial sector in many Organisation of Islamic Cooperation countries.

ILMI are used to help banks efficiently manage their excess liquidity or as a source of alternative funding. They include tradable government sukuk, Islamic interbank placements and Islamic liquidity facilities with central banks. Islamic banks cannot access interest-bearing liquidity facilities available to conventional banks due to sharia-restrictions.

Islamic banks in most key markets use wakala, tawarruq and murabaha for Islamic interbank placements, which replicates conventional interbank placements to some extent. However, its usefulness is challenged by unresolved sharia concerns for tawarruq, additional administrative processes, and lower market depth of Islamic interbank market compared to conventional markets, more so in countries with few Islamic banks.

Regulatory hurdles also hinder development. Tawarruq is not allowed in Oman, Jordan and Morocco, which limits interbank products. In markets like Oman, regulations prevent Islamic banks and Islamic windows from placing funds with conventional banks, which limits counterparty choice.

In the GCC and other markets, liquidity held by Islamic banks is mostly placed in low-return level 1 high-quality liquid assets (HQLA) such as cash and central bank deposits, in order to meet Basel III liquidity requirements. While Islamic banks can invest in short-term government sukuk, this product is not available in Kuwait, UAE, Saudi Arabia, Oman, Jordan and Nigeria, placing Islamic banks at a disadvantage to conventional banks in these markets. Short-term sukuk are issued in Malaysia, Bahrain, Indonesia, Turkiye, Bangladesh, and Qatar. While Islamic banks invest in longer-term government sukuk, its liquidity is dampened by buy-and-hold nature of sukuk investors.

Central bank Islamic liquidity facilities are uneven across countries. Islamic repo facilities that provide an additional source of short-term funding on a secure and lower-cost basis are available in Malaysia, Bahrain, Saudi Arabia, UAE, Qatar, Türkiye, Indonesia, Pakistan and Tunisia.

But Islamic repo facilities do not exist in Oman, Bangladesh, Jordan and Morocco, which could be problematic during tight liquidity. This was an issue in Oman in 2020 when the Central Bank of Oman created OMR8 billion (USD 20.8 billion) of liquidity by reducing interest on repo facilities. However, Omani Islamic banks didn’t benefit directly because there were no Islamic repo facilities.

Remunerative Islamic deposit accounts and standing liquidity facilities with the central bank are present in Malaysia, UAE, Bahrain, Saudi Arabia, Qatar, Indonesia, Pakistan and Nigeria, but not in Oman and Jordan. In 2021, the Bank of England introduced an alternative liquidity facility. Moreover, Islamic lender-of-last-resort facilities from central banks are absent in Bangladesh, Oman, Nigeria, Jordan, Egypt, and Morocco.

As part of our analysis on a bank’s standalone creditworthiness, weak access to liquidity due to shallow markets or regulatory policies is likely to have a negative impact on our assessment of the bank’s funding and liquidity and potentially it’s Viability Rating. The lack of liquidity management instruments could therefore impact our assessment of Islamic banks compared to conventional banks.

In the GCC and other markets, Islamic banks are adequately liquid in general and are significantly funded by retail deposits, which tend to be sticky and low-cost. Regulatory authorities in the GCC have a strong propensity to support all domestic banks should there be liquidity pressures.

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Matt Pearson
Communications Associate, Corporate Communications
Fitch Group
30 North Colonnade
London
E14 5GN
E: matthew.pearson@thefitchgroup.com