The International Islamic Rating Agency (IIRA), headquartered in Bahrain and set up two years ago by the Islamic Development Bank (IDB), has warned in its latest research report titled Liquidity Assessment of Islamic Banks that Islamic banks face challenges from declining liquidity in the markets.
This is partly reflected by the fact that many Islamic banks became net borrowers from the interbank market during 2008 from net providers of funds in 2007 indicating increased liquidity needs.
The subprime mortgage crisis, stressed the report, resulted in a loss of confidence among banks. As a consequence, many banks declined to participate in interbank markets. The result was diminished liquidity at a crucial time in the banking system.
Lack of liquidity,explained the report, means loss of depositors confidence and the resulting systemic risk which has caused runs on a number of banks. Since the origins of the crisis rest in the diminution of asset values, especially asset backed securities; the nature of Islamic banking with its prohibition on interest has served to protect Islamic banks to some extent. That is not to suggest they are entirely immune from the impact of declining real estate values and restricted real estate lending. However, Islamic banks are less likely than conventional institutions to suffer negative outcomes beyond their capacity to sustain core profitability and capital.
The report was based on the liquidity evaluation of eight banks for the period 2007-2008, which included AlBaraka Islamic Bank, Bahrain, Al-Salam Islamic Bank, Bahrain, Bahrain Islamic Bank, Dubai Islamic Bank, Jordan Islamic Bank, Khaleeji Commercial Bank, Kuwait Finance House Bahrain (KFH) and Meezan Bank Pakistan Ltd.
This is a disappointingly small evaluation sample and also pitches together commercial banks with investment banks, which is like evaluating apples with pears, because their business models and product offerings hence the risk and liquidity considerations would differ.
Albaraka, Al-Salam and KFH-Bahrain are effectively investment banks while the others are commercial banks. But the balance sheet of Dubai Islamic Bank is by far the largest compared to the others. As such the funding needs and exposure of the latter would far outweigh those of the others.
