Deposits held by Islamic banks in Pakistan have witnessed an impressive growth spurt in recent years. However, with the rapidly accelerating Islamic banking market, there comes a flush of surplus liquidity which harshly puts the brakes on the enthusiastic deposit mobilization drives of Islamic banks.
Islamic banks in Pakistan, with no access to SBP discount window facility, used to work with the constraint of only being able to place their surplus funds with other Islamic banks under inter-bank Musharakah and Waqalah agreement.
The treasury head of a renowned Islamic bank told BR-Research that inter-bank lending/borrowing didn’t turn out to be an efficient liquidity management tool as most of the Islamic banks faced excess liquidity. Hence, it’s not easy to find a party with a short (selling) position.
Due to limited investment avenues available in the face of a flare of Shariah compliant money, Islamic banks earn lower returns on their funds, which is a drag on their competitiveness.
Besides, conventional banks having Islamic windows don’t have a separate Islamic treasury department to manage Islamic liquidity flows in a Shariah compliant manner without mingling them with conventional funds.
To address the issue, Islamic sovereign bonds called Ijarah Sukuks were introduced by SBP. Although a welcome development, Ijarah Sukuks didn’t solve all of the issues. Industry insiders highlighted that because of the long-term nature of Ijarah Sukuks and short-term nature of deposits, Islamic banks suffer from massive asset/liability mismatch. This is besides the interest rate risk they face when they invest long at a fixed rate and have their liabilities frequently re-priced.
Market sources underpinned that although Sukuks can be traded, most are held to maturity, due to limited investment options available. Islamic banks can also manage their liquidity through equity placements as long as the equities are also Shariah compliant.
Industry insiders strongly urge the development of an active Islamic money market via short-term sovereign instruments and secondary market via Islamic repo agreements. Tri-party repos could be a solution to combat the prohibition of buy-back agreements in Islam.
Besides, lender of last resort facility is also imperative to enable them to manage their operations efficiently. SBP is also looking into the development of an Islamic Interbank Offered Rate (IIBOR) to act as a benchmark for pricing of various Islamic banking products.
Market participants are quite confident with the impending developments to improve the yields of Islamic instruments which would be a good omen for their profitability and a kick-start to their expansion plans.