Dubai: GCC based Islamic banks are generally better off in their access to low cost retail deposits compared to some of the Asian counterparts, however the relatively low availability of Sharia compliant high quality liquid assets (HQLAs) make their liquidity coverage ratios (LCRs) vulnerable. “When compared with conventional peers, Islamic banks in some jurisdictions clearly face a shortage of Sharia-compliant high-quality liquid assets (HQLAs), putting them at a disadvantage,” said Khalid Howladar, Moody’s Global Head of Islamic Finance.
In the GCC most Islamic bank liquidity management instruments consist of low-profitability assets, such as cash and central bank deposits. Sukuk are primarily offered as over-the-counter instruments and only a limited amount of them are listed on developed and liquid exchanges.
“Limited availability of HQLAs means large, low-yielding buffers of cash or bills are commonly held, posing a persistent profitability challenge for Islamic banks in most GCC countries when compared with the situation for their counterparts in Malaysia, Indonesia and Qatar — a GCC member — where the sovereigns are supportive of the industry through frequent issuance of sukuk,” said Howladar.
In Kuwait, the scarcity of HQLA-eligible instruments mainly affects the Islamic banks, as reflected in their higher proportion of liquid assets in cash and central bank placements. Meanwhile, conventional banks in Kuwait and other GCC countries have access to regular issuance of bonds and treasury bills from the central bank.
Legal framework
Moody’s attributes the banks’ low holdings of HQLA securities to the small pool of outstanding Sharia-compliant sovereign and corporate sukuk in the Kuwaiti market. This situation is due to consecutive years of government budget surplus — until 2014, which has reduced the need to borrow through public debt issuance, and the absence of a legal framework for sukuk, which continues to hamper domestic issuance.
However, with a budget deficit forecast of around 10 per cent of GDP for 2016 and a new sukuk legislation in progress, the government is expected to launch its first issuances before year-end, and thereby provide the banks with this much-needed instrument for liquidity management.
In Saudi Arabia too the scarcity of Sharia-compliant HQLAs is visible. The Saudi government has thus far chosen to issue only bonds and not sukuk. Such a situation puts Islamic banks at a disadvantage relative to conventional banks as it means that Islamic banks only have cash and short-term, very low yielding, Sharia-compliant bills with the central bank, Saudi Arabian Monetary Agency (SAMA) as their only forms of HQLA-eligible assets.
Attracting liquidity
Since mid-2015, the government has issued more than $40 billion (Dh147 billion) of conventional domestic bonds to local banks as it seeks to cover a budget deficit of about 12 per cent of GDP for 2016. It is also expected to borrow again in October and is targeting to attract liquidity from the US and Europe where investors are less familiar with sukuk structures.
Future issuances are likely to be in the conventional format, similar to those seen recently in the UAE and Qatar, and hence the shortage of Sharia-compliant HQLAs in Saudi Arabia is unlikely to improve in the near future.
Further sukuk issuances by the GCC sovereigns will also support the development of the domestic corporate sukuk markets and increase the availability of HQLA for Islamic banks.
In contrast to Saudi and Kuwait, Malaysia, Indonesia and Qatar have been frequent sovereign sukuk issuers in recent years, providing a solid stock of Sharia-compliant HQLAs for both their domestic Islamic and conventional banks.
