Likely to be rolled out early next year, this is a significant development, amd a first for a major Western central bank
FOR a secular regulator, the Bank of England (BoE) is pleasantly proactive in the faith-based financial services sector. Its contribution to the Islamic financial sector, for instance, is unassumingly important, yet has the potential to be a game changer in the global scheme of things.
The Old Lady of Threadneedle Street does have a tendency to live up to its sobriquet, combining a stoicism tempered with toughness and creativity, and a willingness to embrace new financial intermediation ideas and products, whether to facilitate public policy priorities under financial inclusion, or, simply, to promote the United Kingdom government’s Islamic banking proposition.
This is unlike its European Union and other G7 partners, which have been cynical, and sometimes hostile, about Islamic banking, despite paying lip service to its risk-sharing and asset-backed real economy attributes, which could play a role in inward investment and infrastructure financing requirements.
BoE last week published its latest consultation paper on “Syariah-compliant liquidity facilities: establishing a fund-based deposit facility”, paving the way for the launch of a central bank deposit facility based on a wakalah (agency) fund model — but slightly modified for the UK legal and regulatory environment. Such a facility would provide Islamic banks in the UK and any UK banks, which cannot engage in interest-based activity, with greater flexibility in meeting Basel III liquidity requirements.
This is a significant development, and a first for a major Western central bank. According to the International Monetary Fund (IMF), there are currently six key syariah-compliant liquidity management instruments offered by central banks for Islamic banks in their jurisdiction to access. These include interbank mudarabah placements; commodity murabahah; central bank wadiah (trust) certificate/deposit; central bank papers such as musharakah certificates and sukuk; other freely tradable government paper akin to domestic government securities; and Islamic repurchase agreements or sale and buy-back.
Many of the 56 Organisation of Islamic Cooperation (OIC) markets do not have such facilities in place, which impedes the development of Islamic banking in their jurisdictions.
Malaysia has the most comprehensive universe of local Islamic liquidity management instruments, even though local Islamic banks continue to complain about the dearth of such instruments in international currencies — the US dollar, pound sterling, euros and yen.
With successive UK governments keen on expanding London’s Islamic banking proposition to attract inward Islamic investment to fund UK infrastructure and urban regeneration, and, to boost trade with the OIC states, the UK Treasury and BoE have been keen to close liquidity management gaps by creating a level playing field for the six Islamic banks authorised in the UK and the 26 or so Islamic windows offering such products. Islamic banks have been at a serious disadvantage in this respect.
“The bank recognises that Islamic banks are currently unable to use the bank’s existing liquidity facilities. The Sterling Monetary Framework is the mechanism by which the bank sets interest rates, and interest-based facilities are not deemed syariah compliant,” explained BoE.
Since work on BoE’s strategy to broaden liquidity provisions to the market started in 2015, the motivation clearly is not linked to British exit from the EU (Brexit), albeit London, as a financial centre, will continue to be dominant in its offerings to the global Islamic finance industry. In this respect, initiatives such as BoE’s Islamic liquidity management mechanism could very well complement Brexit objectives of sustaining the city’s importance as a global financial hub. English law, similarly, is the preferred governing law for the majority of international Islamic finance transactions, especially sukuk and murabahah syndications.
What is revealing in terms of Islamic financial principles and market confidence is BoE choosing a central bank deposit facility based on a wakalah fund model as opposed to a commodity murabahah (tawarruq) structure. In its last consultation in February 2016, BoE consulted on both the fund based and commodity trading modes. While both models would be acceptable based on the feedback, BoE decided that a fund-based model with some adjustments would be the most feasible approach to establishing a deposit facility.
In the original wakalah model, says BoE, it was envisaged that the fund would be held as an asset on the bank’s own balance sheet. However, market feedback and further analysis indicated that it would be more appropriate to house the facility off balance sheet, in a UK incorporated special purpose vehicle (SPV). This will ensure effective segregation from the bank’s other activities. The SPV will be a wholly-owned subsidiary of the bank.
A key advantage of BoE’s syariah-compliant facility is that the funds held in the SPV can be treated as “Level 1” High Quality Liquid Assets (HQLA) for the Liquidity Coverage Ratio (LCR) standard under the Basel III liquidity management requirements. The major issue currently is the dearth of “Level 1” syariah-compliant HQLA — ideally AAA-rated sukuk.
To achieve this, BoE “will undertake to the participating Islamic banks to guarantee the funds they place in the facility, to establish a claim guaranteed by the central bank. This guarantee will be provided in line with the market standard for Islamic banks, i.e. it will grant the Islamic banks, as depositors, a discretionary right to a claim against the central bank for any loss of principal value”.
Assuming no material impediments arise, BoE will start work on the implementation of the syariah-compliant deposit facility fund in May, including integrating the facility into the bank’s systems, and to create a set of standardised terms and contractual documentation.
Typically, this could take up to a year, which means that the facility would most likely be rolled out after Spring 2018. How revealing in that it could turn out to be the most wholesome (tayyib) such liquidity management facility in the global market!
Mushtak Parker id a n independent London- based economist and writer. He can be reached via mushtakparker@yahoo.com