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The subprime mortgage crisis resulted in a loss of confidence among banks. As a consequence, many banks declined to participate in interbank markets. The result was diminished liquidity in the banking system at a crucial time. A lack of liquidity means a loss of depositor’s 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.
In particular, IIRA has evaluated the liquidity of Islamic banks. We have selected a sample of key Islamic commercial banks based in a number of Islamic markets. The banks selected for this study are: Al Baraka Islamic Bank Bahrain, Al Salam Islamic Bank Bahrain, Bahrain Islamic Bank (BIsB), Dubai Islamic Bank (DIB), Jordan Islamic Bank (JIB), Khaleeji Commercial Bank (KCB), Kuwait Finance House Bahrain (KFH) and Meezan Bank Pakistan (MB).
Liquid assets to total liabilities in various banks
At year-end 2007, the Islamic banks’ liquidity position was strong. They were holding a large amount of liquid assets on their balance sheets. Reflecting the constraints in the deployment of funds imposed by Shari'ah guidelines and the competition from conventional banks, liquid assets constituted an average 46.9 per cent in 2007 for the banks in the study.
The most liquid banks are Al Salam and Khaleeji Commercial Bank which were new start-ups in 2007. Excluding these, the average drops to 32.5 per cent of liquid assets in 2007, indicating strong liquidity irrespective of jurisdictions.
IIRA defines liquid assets as cash or cash equivalents, short-term placements to banks or financial institutions and liquid-quoted investments such as government paper and quoted Sukuk.
Short-term liabilities include deposits and borrowings. The least amount of liquid assets were held by KFH Bahrain at 9.9 per cent and the most liquid was Jordan Islamic Bank at 45 per cent.
On average, excluding the ratios of start-up banks (KCB and Salam as mentioned above), liquid assets declined to 26 per cent of total assets during 2008 from 32.5 per cent in 2007. This shows that on average during 2008 the impact of the global crisis on liquid assets has remained limited as reflected in a modest downward adjustment of the ratio. This decrease should be seen in the context of an increase in the loans to core funding ratio which indicates that some of the liquid assets are now transferred to loans and advances.
The chart above clearly shows how liquid assets in Islamic financial Institutions have declined relative to liabilities. Quite noticeable among them are BIsB and Dubai Islamic Bank. A few exceptions are also present, such as AlBaraka and Meezan, which increased their liquid assets during the year.
Core funding
Loans to core funding is a measure that captures the resource utilisation of a bank. Core funding is the amount of funds available from customers’ deployment of resources. The two principal components of core funding are the stable portions of customer deposits and unencumbered capital (capital after deducting mandatory reserves, investments in fixed assets, branches and subsidiaries).
As a result of the need to book only Shari’ah-compliant assets, this ratio has historically been low for Islamic banks representing an under-utilisation of resources.
This however proved to be an advantage for Islamic banks as the conservative posture of their balance sheet helped them to cope with the repercussions during the crisis situation. Depending on its market, business model and risk positioning, a bank often keeps 75-95 per cent of its core funds in customer assets.
The remainder is kept in liquid assets and the investment portfolio in order to provide liquidity and enable the bank to earn a small spread. In the universe under discussion we see most of the banks registering a healthy increase in their utilisation ratio and also keeping it below 100 per cent at the same time. Only Al Baraka and Meezan have reduced their loans as a percentage of core funding which was also evident in their increased liquid assets ratio.
Interbank funding
The interbank ratio is to assess if the bank is a net taker of funds or a net contributor of funds to the interbank market. A net provider status means that lendings to financial institutions are higher than borrowings.
Many Islamic banks who were net providers of funds to the interbank market in 2007 became net borrowers during 2008. Unlike 2007, when all Islamic banks except Albaraka Islamic were net lenders, the money market 2008 has seen a reversal in trend.
Banks like KFH Bahrain, Dubai Islamic Bank, Bahrain Islamic Bank, and Al Baraka Islamic Bank became net borrowers, indicating their increasing liquidity needs. They registered interbank ratios of 0.21, 052, 0.19 and 0.06 respectively. This shows that they have increased their reliance on professional sources (interbank and brokered deposits) of funds to cover the increased deployment in the business.
Three-month maturity gap to total assets
An additional significant measure to assess the liquidity position is the maturity profile of assets and liabilities of the Islamic bank, which is commonly known as a gap analysis. A gap analysis gives an indication of how well the bank is expected to meet its maturating obligations with the help of inflows from maturing assets. The deficit needs to be covered with the help of external borrowings.
Evident from the gap analysis is that the above two banks are facing challenges with respect to their liquidity positions. Large maturities in shorter tenures indicate a reliance on borrowings and the use of short-term sources to advance longer tenure customer assets such as loans and advances.
A bank is considered to have positioned itself adequately in terms of maturities of assets and liabilities as long as the negative gap in up to three months doesn’t exceed 10 per cent of total assets. Excluding the above two, the rest of the institutions are adequately covering the maturing liabilities from maturing assets. Dubai Islamic Bank has not reported maturing assets and liabilities in their published accounts.
Link: http://www.cpifinancial.net/v2/fa.aspx?v=0&aid=270&sec=Islamic%20Finance
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