The UK’s Islamic banks are set to receive a welcomed boost as the Bank of England opened its Alternative Liquidity Facility this week and accepted deposits from participating banks for the first time.
LONDON: The much-awaited Alternative Liquidity Facility (ALF) is structured as a wakalah or fund-based facility and will enable participating banks to deposit funds. Participants’ deposits are backed by a fund of high-quality Sharia compliant securities (sukuk). The return from these instruments (minus hedging and operating costs) will be paid to depositors in lieu of interest.
The Bank of England (BoE), the country’s central bank, said that the fund purchased sukuk issued by the Islamic Development Bank (IsDB) in the first instance. The IsDB is a Sharia-compliant multilateral development bank and carries a triple AAA credit rating.
“This [the ALF opening] is a significant and positive advancement that further underlines UK government policy and support for Sharia compliant banking and financial services,” said Stella Cox, managing director of DDCAP Group.
Levelling the playing field
Like conventional banks, Islamic banks are subject to strict regulatory requirements. This includes holding a buffer of high-quality liquid assets (HQLA) to meet obligations as they fall due. Conventional banks are able to hold deposits at the central bank to help meet their buffer requirements but Islamic banks have been unable to do so before, because deposits were interest bearing.
As a result, British Islamic banks have faced challenges in managing their liquidity because the BoE’s existing facility is interest-based and there were no Sharia compliant liquidity facilities. Similarly, Islamic banks were also unable to invest in Gilts (UK government bonds) or interesting-bearing reserves accounts at the central bank.
At the same time, Islamic lenders had to fund their activities or products in expensive or inefficient ways, like holding large amounts of non-interest bearing cash or limiting their short-term deposits.
“There has been a shortage of UK-based liquidity management tools in British pound sterling (GBP) denomination,” said Omar Shaikh, a member of the UK Islamic Finance Council’s (UKIFC) advisory board. “To date efforts have been facilitated through interbank deposits, but normally this is the function of a central bank. Such facilities allow banks to manage their capital requirements and get some minimal return (in the current interest rate environment) on their liquidity.”
In a speech last year, Andrew Hauser, Executive Director for Markets at the BoE, highlighted that the ALF was an important step in providing a level playing field, and enabling greater flexibility in meeting regulatory requirements under Basel III prudential rules.
Good things come to those who wait
Last December, the BoE said that it was preparing to launch the ALF and planned to open it during the first quarter of this year.
The ALF has been in the pipeline for a while. In 2015, the central bank conducted a feasibility study of establishing a standalone non-interest-based facility. It followed up in 2016, with a public consultation, and then in 2017, when it sought to fine tune its approach.
“It has been a long time in development, there were challenges to be resolved to enable its implementation, but the BoE has been unwavering in its commitment to deliver the ALF throughout that extended period and it has achieved an industry first in becoming the first Western central bank to create such a facility,” said Cox.
Shaikh said that the fact the BoE has done this is beneficial to UK Islamic banks as they have an additional tool through which they can manage liquidity more effectively.
“It also demonstrates the UK's ongoing commitment to the Islamic banking sector,” he said. “This particular tool was promised some time ago and it has eventually come through, which is welcomed.”
The opening of the ALF follows the UK’s second sovereign sukuk which took place earlier this year. HM Treasury sold a five-year £500 million ($663 m) sukuk in March. The UK sold its maiden sovereign sukuk in 2014, which consisted of a £200 million ($265 m) issuance.
© SalaamGateway.com 2021 All Rights Reserved