E.P.L. In Islamic Finance– LIQUIDITY–Where Is It?

Post by: David (Daud) Vicary (Abdullah)

This is the final part of a three part series on EPLand focuses on Liquidity (part 1 and part 2 are here).

Anyone who has ever run a business will know that Liquidity is the lifeblood of that business.  The same is true of a Financial Institution; you only need to look at what happened at Lehman Brothers to understand that. Indeed, I am sure that many readers with some experience under their belts will have witnessed at first hand the frightening experience of a run on a bank.

So the importance of Liquidity, I hope, is established.  It is equally important in the world of Islamic Finance.  Perhaps even more so.

Here is why.

The availability of liquidity in a market is vital, but, so too, is the ability to transfer excess liquidity to other markets to ensure that the excess is used effectively.  I go back here to my Elevator Speech on Islamic Finance.  When asked what Islamic Finance is I usually respond along the lines of “ The effective and economic distribution of capital for the benefit of the real economy and the community”.

Here the key is distribution.  If you are not able to move the surplus, cross border or access it when you are in deficit, there is a problem, and this has been a problem for Islamic Finance which has, to all intents and purposes, been a constraint on growth.

Enter the IILM Co in October 2010.

IILM Co stands for the International Islamic Liquidity Management Corporation, which has been established by the Central Banks of 12 countries  and 2 multilateral Development Banks.  The idea is to establish globally accepted instruments that are tradable and available for managing short term liquidity requirements of Financial Institutions.

The origins of this organization came from the deliberations of the IFSB (Islamic Finance Services Board) while driving the Global Islamic Financial Stability Forum.  Plans to implement and execute the establishment of the IILM Co are underway, with the focus on providing three things:-

  1. Globally acceptable Shariah compliant short term liquidity instruments
  2. Rules of membership.  Basically who can join and on what basis
  3. Settlement and trading procedures

We are advised that all of this should be in place during 2011.

The theory is that this platform will enhance Global Financial Stability and also ensure that Liquidity surplus can be transferred to areas of Liquidity deficit both easily and at a competitive price.  This will then allow for further expansion of Islamic Finance globally and the better management of short term liquidity risk.

Understanding Liquidity and its management requires further Education at all levels as well as changing some perceptions with regard to the usage of Shari’ah compliant instruments. We are, however, on the way to the next level.

There is much to do and not a moment to lose.