This document discusses liquidity management challenges for Islamic financial institutions. It summarizes that Islamic banks have fewer short-term funding options than conventional banks. It then outlines some liquidity management tools available to Islamic banks, including sukuk, inter-bank placements, and commodity murabahah transactions. The document reviews developments in 2014, including increased sukuk issuance, and previews expected challenges in 2015 from Basel III liquidity regulations. It concludes that effective liquidity management remains a challenge for Islamic banks due to the lack of an Islamic interbank market and sufficient short-term Shariah-compliant instruments.

1. ANNUAL GUIDE
2015
The World’s Leading Islamic Finance News Provider

2. 34 March 2015The World’s Leading Islamic Finance News Provider
sector reportsector report
Islamic financial institutions (IFIs) face great difficulties in
managing their liquidity. The dearth of financial instruments at
the disposal of IFIs makes for less efficient liquidity management
(LM), as more than necessary cash is held, thereby reducing
their profitability.
Some of the avenues of effective LM at the disposal of Islamic
financial institutions include:
• Sukuk
• Inter-bank Musharakah/Mudarabah-based pools
• Islamic placement accounts
• Commodity Murabahah transactions
• Trading/hedging currencies
• Shariah compliant equities and mutual funds.
This report will assess the developments in LM over the past year
in the Islamic finance industry with an emphasis on the Sukuk
market. This report will also look at the expected developments
and challenges the industry might face vis-a-vis LM in 2015 and
beyond including the effect of Basel III and LM of Islamic financial
institutions.
Preview of 2014
Sukuk
Compared to 2013 which saw a slowdown in Sukuk issuances,
the Sukuk market in 2014 was very active. Governments and
Liquidity management in the Islamic
finance industry
Liquidity is a financial institution’s capacity to readily meet its cash and collateral
obligations at a reasonable cost. When it comes to managing their liquidity,
conventional credit institutions have at their disposal well-developed interbank
markets that can be tapped for short-term funding, as well as a plethora of
instruments. But this is not the case for Islamic financial institutions. MUJTABA
KHALID looks at the developments and challenges of liquidity management for
Islamic financial institutions.
Liquidity management

3. March 2015 35The World’s Leading Islamic Finance News Provider
sector report
sovereign issuances were especially lively with 19 jurisdictions
tapping the Sukuk market. The Sukuk market saw the entry of
Hong Kong, Luxembourg, Senegal, South Africa and the UK
— giving a boost to the Islamic finance industry. 2014’s other
prominent issuers included Jordan, Maldives, the Emirate of
Sharjah, Goldman Sachs and Japan’s Bank of Tokyo-Mitsubishi
UF. Total Sukuk issuance in 2014 surpassed the US$100 billion
mark, which was a significant improvement of almost 25%
compared to 2013.
The previous year also saw Islamic finance actually make
a move towards the actual spirit of Islam. In 2014, innovative
ethical Sukuk structures such as the World Bank’s Immunization
Sukuk based on a Murabahah model backed by pledges made
by leading global economies were initiated. The Securities
Commission Malaysia launched the sustainable and responsible
investment (SRI) Sukuk framework to facilitate the financing of
sustainable and responsible investment initiatives.
Despite their growing circulation, a reliance on medium and
long-term Sukuk for liquidity management purposes has several
drawbacks. They bear a higher market risk, and this problem
is exacerbated by the insufficient development of secondary
markets. Moreover, only a minority of countries has developed a
regular Sukuk issuance program.
LM tools
One of the most-used instruments in LM operations was the
commodity Murabahah. However, the high fixed costs make
shorter-term maturities particularly expensive. Similarly, another
widely used instrument was the Mudarabah interbank deposit
(MID). Under the MID, a deficit Islamic bank can obtain liquid
funds from a surplus bank for a predetermined period of up to
one year. It is often difficult to calculate overnight pricing of this
instrument — in practice, however, it is often predetermined and
the principal is paid back at maturity.
Preview of 2015
Basel III
Basel III introduces two new ratios (liquidity coverage ratio and
net stable funding ratio) that banks must maintain as a minimum
at virtually all times to help ensure they maintain sufficient
liquidity to withstand cash obligations even under stress. As
Basel III requirements start to roll in from 2015, the deficiency of
alternative Shariah compliant liquidity management tools and the
absence of a developed Islamic money market, could adversely
affect the operations of Islamic banks. The idea that Islamic
financial institutions are immune to liquidity risk has proven to
be wrong with the default of many Sukuk-oriented Islamic funds.
Organizations such as IFSB are already revising their regulatory
and supervisory rules in line with the Basel III framework. The
magnitude of the impact will basically depend on other factors,
such as the jurisdiction where the IFI operates and the nature of
banking activities within each institution.
Socially responsible investments (SRI) funds
Momentum is being built towards realizing connectivity of
Islamic funds with the global US$3.7 trillion socially responsible
investment funds. Given that Islamic funds are relatively miniscule
even within the Islamic finance space, they can benefit from
broadening the current primary focus on ‘negative’ screenings to
a wider socially-conscious investment consideration (i.e. positive
screening). This will appeal and attract both Islamic capital as
well as a wider global interest.
The way forward
To promote liquidity management, regulators and other Islamic
finance market stakeholders need to work on:
• Building a global robust, integrated cross-border liquidity
infrastructure which includes a money market and second-
ary market – the International Islamic Liquidity Management
Corporation and the Bahrain Liquidity Management Center
are a step in the right direction
• A globally accepted legal and Shariah regulatory framework.
Conclusion
The 2015 year is projected by many experts and analysts to send
Islamic finance soaring into the mainstream. On the backdrop
of this growth, LM especially in the short run continues to be a
challenge for Islamic banks and financial institutions. Although
these have shown some improvement, the following hurdles
continue to hinder effective LM for Islamic banks:
• Absence of an effective global Islamic inter-bank market
• Lack of a range of Shariah compliant alternatives, both at a
micro and macro level.
www.IslamicFinanceConsulting.com
www.IslamicFinanceEvents.com
www.IslamicFinanceNews.com
www.IslamicFinanceTraining.com
www.MIFforum.com
www.MIFmonthly.com
www.MIFtraining.com
www.REDmoneyBooks.com
consulting
Mujtaba Khalid is the senior manager and assistant professor
at Center for Islamic Finance CIIT. He can be contacted at
mujtabakhalid@ciitlahore.edu.pk.
Liquidity management
Momentum is being
built towards realizing
connectivity of Islamic funds with
the global US$3.7 trillion socially
responsible investment
funds