Moody’s: New IFSB Liquidity Guidelines Are Credit-Positive for Islamic Banks

On 12 October, the Islamic Financial Services Board (IFSB), a standards setting body for Islamic Financial Institutions (IFIs), issued an Exposure Draft presenting their proposed principles on liquidity risk management. As a global standard setter for IFIs, the IFSB principles are often adopted by the relevant supervisory authorities and hence are an important step in improving stability of financial systems where IFIs operate. This draft is credit-positive for IFIs as it translates a set of globally recognized best practices for liquidity management into the Shari”ah-compliant banking context.

In 2009, the IFSB set up a Task Force on Liquidity Management composed of representatives of all central banks participating in the IFSB. This group has been instrumental in laying out the 22 guiding principles presented in the Exposure Draft, which include specifying the roles and responsibilities of the board of directors and senior management, addressing funding diversification, contingent funding plans and the issuance Shari”ah-compliant liquidity instruments, among numerous other principles.

A set of principles is also laid out for national regulators, inviting them to actively monitor liquidity at a systemic level and to supervise directly how IFIs are managing their liquidity. We observe that a relative lack of sophistication in most IFI liquidity management practices is a constraint on their standalone creditworthiness. However, the IFSB has no legislative power and hence relies on national regulators to adopt its prudential standards. Hence, the ultimate effect of these principles will depend on the willingness of each national authority to implement them.

Liquidity for IFIs remains constrained by the absence of a deep and globally integrated Shari”ah-compliant money market, particularly in liquid, short-dated and high-quality issuance. To address this problem, the task force set up by the IFSB created the International Islamic Liquidity Management Corporation (IILM). Fully operational since the beginning of 2011, this organisation is supported by 12 central banks and its mission is to issue short-term sukuk (fixed-income certificates compliant with the ethical investment guidelines of Islam) in global reserve currencies. IILM”s first issuance is expected by year-end. With this money market infrastructure being set up and the IFSB guiding principles for liquidity management now established, IFIs are gradually closing the qualitative gap with their conventional peers in terms of liquidity management.

Regards
ZULKIFLI HASAN

Kyoto, Japan