Bahrain takes steps to solidify standards and improve access to liquidity

The Islamic banking sector might be outstripping its conventional counterpart in terms of growth, but the rapidly developing industry still faces a number of challenges which ordinary lenders are not confronted by. One of the most salient of them is the question of liquidity, which has existed as a potential impediment to growth since the birth of the modern sharia-compliant financing industry.

Easing Liquidity

The problem, put simply, is a lack of options: where conventional lenders generally have an array of profitable instruments at their disposal when it comes to parking their excess liquidity, the range of destinations has always been more limited for Islamic players. Unable to direct excess liquidity to interest bearing facilities due to the precepts of sharia, the amount of liquidity in the Islamic banking sector has traditionally exceeded the supply of short-term instruments. The absence of a well-developed Islamic money market continues to act as a hurdle to the development of the sector and, while initiatives such as the Islamic Liquidity Management Corporation have begun to address this challenge, the global Islamic banking industry remains at a disadvantage compared to its conventional counterpart.

The situation has been further complicated in recent years by the gradual implementation of the Liquidity Coverage Ratio (LCR) requirements of the Basel Accords. The new standard establishes minimums for the amount of highly liquid assets, such as cash and available reserves placed with the central bank and marketable, zero-risk-weighted government-type assets that must be carried by lenders. The adoption of the LCR by regulators in the region has therefore highlighted the need for Islamic institutions to be granted access to a greater range of liquidity management tools.

Walakah Standard

In Bahrain’s case, Islamic banks have historically managed their short-term liquidity through cash deposits at the Central Bank of Bahrain (CBB) and by buying into the CBB’s monthly issues of 91- and 182-day sukuk (Islamic bonds) – a simple, but limited, approach. As of 2015, however, Bahrain’s sharia-compliant financiers have recourse to a powerful new liquidity management tool. In March the CBB issued its first one-week Islamic deposit facility based on a wakalah agent contract, by which the regulator invests cash on behalf of the lender. Retail banks wishing to make use of the new instrument are asked to sign a wakalah agreement which appoints the CBB as an agent to invest cash on behalf of the bank. Accordingly, the CBB will invest these funds in an investment portfolio containing sukuk, allocated in advance. The duration of the wakalah is one week, and is available for Islamic retail banks every Tuesday. The facility brings the liquidity management capacity of Islamic banks closer to that enjoyed by conventional lenders and, being a CBB instrument, is classified as a level-one asset according to Basel definitions. The introduction of the new instrument is well timed to coincide with the push to bring the sector in line with Basel’s LCR requirement.

The Manama-based International Islamic Financial Market (IIFM) established the wakalah standard after a consultation process which began in 2012, involving the IIFM’s own sharia board, around a dozen companies in the Islamic finance segment, a number of law firms and a range of sharia scholars. As a result of this lengthy consultative process the CBB was able to use the standard as the basis for its one-week contracts, gaining the approval to do so from its internal sharia board. The implementation of the novel instrument is one of the most significant institutional advances of 2015, a fact alluded to by Sheikh Salman bin Isa Al Khalifa, executive director of banking operations at the CBB, at its launch. “This service is a new product in Islamic banking and reconfirms Bahrain’s commitment to develop sharia-compliant products to serve the growing Islamic banking industry,” he said.