Sharia-compliant solutions: Finding short-term financial instruments for Islamic lenders

The effort to increase the range of liquidity management solutions available to Islamic banks is an international one, and one in which Qatar has historically played a prominent role. An announcement in 2013 by the Islamic Development Bank (IDB) suggests that Qatar will soon take an even greater part in closing the liquidity gap that faces sharia-compliant lenders.

Interest Answers

The issue of liquidity is a significant challenge to Islamic banks. The three major liquidity management instruments available to conventional lenders – the interbank market, the secondary market for debt instruments and the “lender of last resort”, that is, Qatar Central Bank (QCB) – are all founded on an interest rate principle that is forbidden according to Islamic law. One answer to this challenge has emerged in the form of sukuk, the sharia-compliant bonds that have rapidly grown in popularity in recent years, growing by 54% in 2012 to reach $131bn globally, according to research by Kuwait Finance House. Qatar has taken part in this phenomenon through sovereign sukuk issuances made via the QCB, and in 2012 it launched a $4bn dual-tranche sukuk with terms of five and 10 years that was the largest in the Gulf region for the year. The country has also played an important part in the promotion of sukuk issuance at an institutional level, through its membership of the International Islamic Liquidity Management Corporation (IILM). The IILM was established in 2010 by the various central banks and monetary authorities of Qatar, Indonesia, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Turkey and the UAE. From its Kuala Lumpur headquarters the IILM has sought to develop and issue short-term sharia-compliant financial instruments to facilitate liquidity management, and at its 10th meeting in Doha in April 2013 it revealed details of a new short-term sukuk programme. The US dollar-denominated instrument, with an A-1 rating, will be issued in Kuala Lumpur and London with maturities of up to a year and will directly address this problem of scarcity in short-end liquidity options. However, despite the popularity of sukuk and the efforts of the IILM to increase the availability of short-term debt instruments, the number of market participants is limited in comparison to the conventional market, while secondary market activity is low or nonexistent in many jurisdictions, with banks tending to buy up sukuk offerings and carry them to term.

Inter-Bank Option

The short end of Islamic banks’ liquidity requirements, therefore, remains the principal challenge, and this is where Qatar’s recently announced joint effort with yet another international institution, the Islamic Development Bank (IDB), offers potential amelioration. The IDB, headquartered in Jeddah, Saudi Arabia, is owned by 56 shareholding member states, the largest of which, on the basis of paid-up capital, are Saudi Arabia, Libya, Iran, Egypt, Turkey, the UAE, Kuwait, Pakistan, Algeria and Indonesia. Its activities range across the fields of education in Islamic finance to infrastructural development, as well as past attempts to address the challenge of sharia-compliant liquidity management through the issuance of sukuk. In 2013 it signed a memorandum with the Saudi conglomerate Dallah Al Baraka Group, the interests of which lie in fields as diverse as media, construction, Islamic finance and tourism, and the government of Qatar to establish a new Islamic bank with a paid-up capital of $1bn. The new bank, to be based in Doha, will complement the IILM’s efforts to address the short-term liquidity challenge by facilitating the development of an inter-bank market for sharia-compliant lenders.

Speaking at the IDB’s annual meeting in the Sudanese capital of Khartoum, Ahmad Mohamed Ali Al Madani, chairman of IDB, stated that although the new bank will not completely solve the liquidity problems of Islamic lenders, it “will help the Islamic institutions manage their liquidity in a more professional manner”. The fostering of an inter-bank lending regime for sharia-compliant banks would be a significant advance over the current scenario, and Doha’s position at the core of the project will enhance its reputation as a centre of finance.