National and Global Islamic Financial Architecture:
Problems and Possible Solutions for the OIC Member Countries
50
loans are prohibited by the Shariah, Islamic banks cannot borrow funds to meet liquidity
requirements. Furthermore, Islamic banks are prone to additional liquidity risks for various
reasons. In most jurisdictions there is no organized Islamic money market from which funds
can be sought in times of need. Second, as most assets of Islamic banks are predominantly
debt-based, they are illiquid due to Shariah restrictions on the sale of debt. Thus, raising funds
by selling debt-based assets is not an option that Islamic financial institutions can use.
Abdullah (2010) provides an overview of some of the liquidity management instruments used
in different countries. In the UAE, the central bank launched debt based commodity murabahah
(tawarruq ) Islamic certificates of deposits with maturities of one week to a year. To facilitate
the liquidity management of Islamic banks, the Central Bank of Bahrain started issuing short-
term salam based sukuk. As salam sukuk are debt based and not tradable, the central bank has
now moved on to issuing ijarah based ones which, being asset-based, are tradable. However, a
lack of active secondary markets for sukuk can hinder their sale at appropriate prices. Malaysia
is one of the few countries that has an Islamic Interbank Money Market (IIMM) in which
mudarabah based interbank investments can be used (Abdullah 2010). Similarly, Islamic banks
in Indonesia can either use the Domestic Interbank Shariah Financial Market operates using a
mudarabah based Interbank Investment certificate or place their excess liquidity with the
central bank under the Wadiah Certificate scheme.
3.4.2. Lender of the Last Resort (LOLR) Facilities
As indicated, when liquidity requirements of banks can be met at the private level, the central
bank can provide the required liquidity. One of the safety-nets available to banks in emergency
situations is to get emergency funds from the central bank which acts as the lender of last
resort (LLOR) to protect the banking sector in such situations. Islamic banks, however, can
face problems in using this facility as most of the existing LOLR facilities are interest based.
IFSB (2015: 77) identifies the preconditions for developing a Shariah compliant LOLR as
having a suitable legal framework for appropriate regulatory and remedial powers, coming up
with a Shariah compliant model of LLOR, and having in place a robust supervisory and Shariah
governance framework. A survey of IFSB of central banks of its 24 member countries carried
out in 2012 shows that only six had Shariah compliant LOLR facilities (IFSB 2013: 108). The
study also revealed that of the 20 countries surveyed only two had facilities of discount
windows that met Shariah requirements and five countries had Shariah compliant deposit
services for Islamic banks.
One of the issues related to the financial sector and economic crisis is the role of the LOLR at
the international level, particularly when the liquidity required is in foreign currencies. Note
that the role of LOLR at the international level is important when the whole financial sector of
a country is affected by a crisis, not when an individual financial institution is in distress. There
are suggestions that organizations such IMF can play the role of an international LOLR
(Giannini 1999). In fact, the IMF has, to some extent, played a role in providing liquidity to
countries in economic distress. However, unlike the domestic central bank, an international
LOLR may not have regulatory powers (Obstfeld 2009). Another option of dealing with a
liquidity crisis at the global level is to use a multilateral network of reciprocal swap
arrangements between central banks of different countries (Landau 2014, Obstfeld 2009).
Under this arrangement foreign currency can be swapped with domestic currency to meet to
meet liquidity needs. The swaps were used by central banks such as the Federal Reserve in the
aftermath of the recent GFC.