It can also provide some support to Islamic banks' earnings generation
capabilities through a lower cost of funding due to the collateral held.
However, issues with sharia-compliance, the lack of standardisation and
regulatory hurdles are hindering the growth of the Islamic repo market and its
acceptance among counterparties.
The economic downturn caused by the coronavirus pandemic and the sharp fall in
oil prices are reducing banks' liquidity in Islamic finance's core markets,
namely Gulf Cooperation Council (GCC) countries and Malaysia. While each of
these countries is at a different stage of development, Malaysia's money and
repo markets are the deepest and most liquid. The country has well-developed
domestic debt capital markets that drive a broad range of collateral eligible
for repos under sale and buy back agreements (SBBA) with the central bank
ranging from sovereign sukuk to Islamic private debt securities. Funding
options for Islamic banks in Malaysia are broader than in other countries due
to the longer repo tenors available.
In the GCC, the Central Bank of Bahrain is leading the way by introducing
sharia-compliant liquidity management tools, such as the Islamic Sukuk
Liquidity Instrument (ISLI) and the Wakalah, an intraday credit (IDC) facility
available to Islamic banks against their tradable Islamic securities holdings
(Sukuk-al-ijara). The latter is designed to ensure a level playing field
between Islamic and conventional banks, and increase the efficiency of the
monetary policy. However, banks' recourse to repo funding in the past has been
limited as high oil prices have supported banks' liquidity through strong
deposits inflows from government and government-related entities, which
represent about a third of total deposits on average.
However, during the previous oil price shock in 2015-2016, we saw Gulf central
banks injecting liquidity into the banking system through repo facilities with
commercial banks which had suffered from tightening liquidity, thereby
providing banks with contingent liquidity sources. This was accompanied by
tenor extension of repo operations, particularly in Saudi Arabia and Qatar, and
broadening the range of collateral eligible for repo operations in the UAE.
With the economic boycott of Qatar, the Qatar Central Bank's (QCB) repo
operations skyrocketed to QAR413.9 billion in 2017 from QAR3.4 billion in 2016
to alleviate banks' liquidity pressures.
Should the economic disruptions caused by the coronavirus continue and oil
prices remain low, we expect central banks across the GCC to increase repo
facilities and provide additional sources of liquidity to banks. Most GCC
countries have already announced that additional liquidity will be made
available to support the banks if needed and this includes banks' access to
repo funding at their respective central banks.
Compared to their conventional peers, Islamic banks face several constraints to
raise funding through repo markets, especially for bank-to-bank transactions.
These constraints include differences in sharia interpretation, lack of
standardisation and regulatory hurdles faced by Islamic banks. Malaysia's
Islamic repo structure, SBBA, is not viewed as sharia-compliant in GCC
countries, where Murabaha, Ijara and Tawaruqq are mainly used. This lack of
harmonisation hinders growth.
To address the issue of standardisation and provide an alternative to
conventional repo, the Bahrain-based International Islamic Financial Market
published the Master Collateralized Murabaha Agreement in 2014. While we view the
creation of the standard as a positive step, its uptake has been low with
implementation mostly limited to the UAE. To support short-term liquidity
management at Islamic banks and liquidity in secondary markets, the
International Islamic Liquidity Management Corporation, based in Malaysia and
owned by various central banks, has issued about USD53 billion of short-term
and tradable sukuk denominated in US dollars since 2013. However, we believe
this amount would need to be inflated to create a functioning and liquid
Islamic repo market.
Regulatory hurdles are another challenge. Some countries with less-developed
Islamic finance ecosystems, such as Oman, Jordan and Morocco, do not have any
Islamic repo facilities with central banks or have a very limited offering.
This places Islamic banks at a disadvantage to their conventional peers, which
is especially problematic given the current tight liquidity conditions.
However, some other jurisdictions are being proactive in developing
sharia-compliant liquidity management tools. In 2018, Turkey launched the
Committed Transactions Market of Sukuk, which enables bank-to-bank repo
transactions, while banks can have access to repo funding through the central
bank through sovereign sukuk and lease certificates as collateral, albeit with
shorter tenors than conventional banks. In the UAE, the adoption of the
Accounting and Auditing Organization for Islamic Financial Institutions
standards has been compulsory for Islamic banks since September 2018; its
impact on the Islamic repo market is evolving and is still being assessed.
GCC Islamic banks' funding profiles continue to benefit from strong retail
networks, a high share of low-cost customer deposits and low reliance on
wholesale funding, all of which support the stability of their funding base.
Their liquidity is supported by a good proportion of liquid assets (in the form
of cash balances with central banks and held-to-maturity domestic sovereign
sukuk) relative to their customer deposit base. Nevertheless, Islamic banks'
Viability Ratings factor in their lower ability to access contingent liqudity
through sharia-compliant repo funding.