Dubai: The liquidity coverage ratio (LCR) prescribed by Basel Committee on Banking Supervision (BCBS) requires banks to maintain high quality, unencumbered assets that exceed their stressed cash outflows over a 30-day horizon.
The net stable funding ratio (NFSR) effectively assesses the behavioural maturity of each side of the balance sheet over a one-year horizon. Haircuts are applied to each category of assets and liabilities according to their liquidity and expected stability in a stressed scenario, and the available stable funding must exceed the required stable funding.
The BCBS made specific reference to Islamic banks’ liquidity, because their high quality liquid assets (HQLA) can be insufficient. The committee gave the national supervisors the discretion to define Sharia-compliant financial products, including sukuk, as alternative HQLA subject to haircuts that they can impose.
The intention is to take into account the specificities of being Sharia-compliant and the associated practical challenges. The availability of level 1 HQLA, apart from cash and central banks’ reserves, is currently low in Islamic finance, and central banks.
Another challenge to the implementation of the LCR stems from the treatment of profit sharing investment accounts (PSIAs). The calculation will probably exclude restricted PSIAs as they are not commingled with other sources of Islamic bank funding and their assets are held separately and off balance sheet. The run-off rates on unrestricted PSIAs and whether these will be viewed by regulators as equivalent to deposits for conventional financial institutions are still to be determined.
An initial IFSB quantitative impact study of 32 banks in seven countries highlighted that Islamic banks can meet the LCR, based on cash and central bank reserves that are present in their assets. The IFSB reported an average LCR for these banks of 241 per cent and an average NSFR of 120 per cent. HQLA consisted primarily of cash and central bank reserves.
According to rating agency Standard & Poor’s Basel III creates a window of opportunity for the industry to resolve long-standing weaknesses related to the lack of liquidity management instruments. “We think that regulators, the IILM, and the IDB could play an important role through the issuance of sukuk that may qualify as HQLA. This could also prompt sovereign issuers and corporates with high credit quality to list their sukuk in developed and liquid capital markets,” said Mohammad Damak, an analyst at S&P.
