Industry leader urges central banks to help back Islamic banks

Islamic banks have far fewer short-term financing options than their mainstream peers. Mosab Omar / Reuters

LONDON // The Arabian Gulf’s central banks must act as lenders of last resort for Islamic banks, which are vulnerable to a credit crunch or depositor bank run without such backing, the secretary general of the Islamic Financial Services Board said.

"Any jurisdiction where the size of the Islamic bank sector is large and you have a growing number of Islamic banks that are domestically systemically important, I think yes, you have to see [Central Banks act as lenders of last resort]", said Jaseem Ahmed, the IFSB secretary general, told The National on the sidelines of the London Sukuk Summit last week.

Mr Ahmed identified the UAE, Qatar, Saudi Arabia, Kuwait and Yemen as countries that have "systemically important" Islamic banking sectors. In each of these countries, Islamic assets account for more than 15 per cent of total banking system assets.

Regional central banks, including those of Bahrain, the UAE and Qatar, have moved to introduce more liquidity tools. But they do not offer the full gamut of short-term liquidity instruments available to conventional banks and do not act as lenders of last resort to Islamic banks.

The 19th century economist Walter Bagehot wrote in Lombard Street, a study of an 1866 financial crisis, that during a credit crunch, the role of the lender of last resort should be to lend "freely … to merchants, to minor bankers, to 'this and that man', whenever the security is good".

But Sharia scholars require that both the security deposited at the bank and the loan extended to “this and that man” be underpinned by Islamic assets.

And analysts including Mr Ahmed say that there just are not enough high-quality, liquid, Sharia-compliant assets to go around.

The UAE offers an overnight mudarabah facility, which allows Islamic banks to settle their balance sheets at the end of the day.

Tirad Mahmoud, the chief executive of the Abu Dhabi Islamic Bank, recently said he would like to see the UAE Central Bank extend the facility to offer liquidity instruments over a longer period of time.

But Islamic banks have far fewer short-term financing options than their mainstream peers. Less than 5 per cent of sukuk issued last year had a tenor of less than 1 year, according to analysis from the South African asset management company Oasis Crescent.

The failure of the Sharia-compliant Dubai mortgage lender Amlak, which ceased issuing loans in 2008, was caused by a liquidity crunch that followed the collapse of Lehman Brothers. Unable to roll over its short-term financing arrangements with a consortium of local banks, Amlak accepted a Dh1.7 billion bailout from the Ministry of Finance and the UAE Central Bank, and froze the trading of its shares on the Dubai Financial Market.

While the government's intervention allowed Amlak to repair its balance sheet and negotiate with its creditors over a period of six years, greater availability of short-term liquidity tools might have made a difference to the lender's short-term asset position.

“During the financial crisis, the most important tool that the US government and Federal Reserve used to stop financial markets from collapsing and to restore confidence was to inject huge amounts of liquidity into the financial system,” Mr Ahmed said.

Datul Rifaat Ahmed Abdel Karim, the chief executive of the International Islamic Liquidity Management Corporation, agrees.

The 2008 credit crunch had a big impact on Sharia-compliant lenders, he said, because of the “clear lack of tradable, Sharia-compliant, globally recognised short-term financial instruments.”

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