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Tuesday, 21 April 2015

IFSB guidance for Islamic banks may spur sukuk issues, deposit insurance

The Kuala Lumpur-based Islamic Financial Services Board (IFSB) has released final guidance on liquidity risk management for Islamic banks, which may spur national authorities to issue more sukuk and establish sharia-compliant deposit insurance schemes.
The guidance note, known as GN-6, clarifies the tools that Islamic banks can use to meet Basel III regulatory requirements, now being phased in for both conventional and sharia-compliant banks around the world.
It defines the types of high-quality liquid assets (HQLA) that Islamic banks can hold and the weights that should be assigned to Islamic deposits, which can be more volatile than conventional ones for various reasons, including the fact that they have relatively short maturities.
HQLA must have low correlation with risky assets, an active secondary market and low volatility. The highest level of HQLA includes sukuk (Islamic bonds) issued by sovereigns, multilateral development banks and the Malaysia-based Islamic Liquidity Management Corp.
Such HQLA should be accepted by central banks as collateral in their liquidity facilities, the guidance note says. The note could therefore encourage issuance of HQLA and local currency sukuk by sovereigns and their central banks, credit rating agency Standard & Poor's said in a research note.
"Based on the size of the Islamic finance industry, its composition, and its growth trajectory, we estimate the need for HQLA to reach about $100 billion in the next few years," S&P added.
The guidance note also details three arrangements that regulators can use to meet Basel III requirements in more undeveloped banking markets: central bank liquidity facilities, foreign currency HQLA that could be used to cover domestic currency liquidity needs, and expanded use of lower-level HQLA.
DEPOSIT INSURANCE
In the long term, the guidance note will also encourage regulators to develop Islamic deposit insurance schemes to reduce the need for HQLA, S&P said.
The note says such schemes could significantly lower the run-off rates, or weights, that are assigned to deposits. The riskier the funding source, the larger the amount of HQLAs needed to cover deposits.
For deposits classified as "stable", the IFSB guidance applies a 5 percent run-off factor, but this can be cut to 3 percent if a deposit insurance scheme is in place that is based on a prefunding system and is available quickly.
For less stable deposits, a minimum run-off rate of 10 percent is to be applied, the guidance note says.

The IFSB note classifies foreign currency-denominated retail accounts, which are large at some Islamic lenders, in the less stable category.
(Reuters / 20 April 2015)
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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Consultant-Speaker-Motivator: www.ahmad-sanusi-husain.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com

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