The facility will allow for the 1st time UK Islamic banks to hold pound deposits at BoE
By HABHAJAN SINGH / Pic By BLOOMBERG
Britain saw a significant development for Islamic finance (IF) late last month when the Bank of England (BoE) pushed forward liquidity support measures that would help level the playing field for Islamic banks.
On Sept 28, BoE deputy governor Dave Ramsden announced that the bank will establish a subsidiary to house a Shariah-compliant facility (SCF).
The SCF, once launched, will allow UK Islamic banks to hold pound deposits at the BoE for the first time, BoE said in a statement.
Conventional banks can already hold reserves accounts at the BoE. Hence, the SCF is an important development in enabling Islamic banks to do the same, providing them with greater flexibility to meet the Basel III liquidity rules, the statement added.
Ramsden, who oversees markets and banking at the UK’s central bank, announced the move in a speech at the Society of Professional Economists Annual Conference in London, presenting the move as one of the two latest innovations at BoE.
“One of the lessons of the crisis and the ensuing 10 years was that we need to continuously challenge ourselves to ensure that we are prepared for the future. The bank has taken that to heart,” he told the gathering.
In the first innovation, he said BoE has recently supplemented the ability to provide liquidity to its expanded set of members by ensuring that it is operationally capable of accepting equity collateral, should the need ever arise.
“And, second, in pursuit of a more diverse and resilient financial landscape in the UK, we have been progressing work to enable Islamic banks to hold BoE reserves to meet their regulatory requirements for holdings of high-quality liquid assets (HQLAs) in a way consistent with Islamic commercial jurisprudence.
“And as a result, today I can announce that we will shortly be establishing a new subsidiary of the bank to house the SCF; this will be a special-purpose vehicle (SPV), called the Bank of England Alternative Liquidity Facility (BEALF).
“This will also be the first non-interest-based liquidity facility to be offered by a major Western central bank, providing important structural support to the UK’s IF sector, and further strengthening the UK’s position as an international financial centre,” he said.
It is a welcome additional regulatory block for Islamic banks. The move is a culmination of a journey that included the publishing of a 19-page consultation paper, “Establishing Shariah-Compliant Central Bank Liquidity Facilities” in February 2016.
The document set out to assess the feasibility of establishing deposit and liquidity insurance facilities on
a Shariah-compliant basis.
The BoE paper presented the preliminary findings in which it had identified two models that may provide a suitable basis for establishing a Shariah-compliant central bank deposit facility, and two possible models for providing liquidity insurance to Islamic banks.
On the approach taken, the document noted that the UK regulatory regime “accommodates IF within a flexible — but secular — unitary framework”.
“This means that the UK authorities apply a non-discriminatory approach, endeavouring to ensure a level playing field for all financial firms.
“It also means that, as the authorities are financial rather than religious regulators, the development
of Shariah compliance standards in the UK must be market-led. But, the application of Shariah compliance standards must also be transparent to customers, as product disclosure rules apply to all firms,” it said.
Basel III liquidity rules, which are implemented in the European Union under the capital requirements regulation, require banks to hold a liquid asset buffer (LAB) of unencumbered and HQLAs at all times, the document noted.
The assets in the buffer should be readily accessible and easy to convert into cash in private markets to meet any sudden demands for liquidity the firm may face, especially during periods of firm specific stress or more general market disruption.
All banks, including standalone Islamic banks, have to comply with the LAB requirements. However, the document noted that Islamic banks were unable to hold assets that earn interest, or were based on activities which were otherwise prohibited under the Shariah principles. This had put them in a bit of a tight spot.
“The pool of assets that are both suitable for use by Islamic banks and of sufficiently high quality is limited: One such asset, the UK government’s 2014 £200 million (RM1.09 billion) sovereign sukuk, was heavily oversubscribed on issue,” it said.
The document noted that Basel III recognises the challenge for Islamic banks in meeting their LAB requirements, with the rule allowing them to use a wider range of assets for their buffer, which are subject to haircutting to avoid favourable treatment over conventional firms.
“To satisfy the HQLA requirement, an alternative to holding qualifying sukuk for the LAB is to hold a deposit at the central bank, providing it is immediately callable. In the UK, conventional banks can already use
the deposits they hold in reserves accounts with the (BoE) to contribute towards their LAB,” it added.
In its latest statement, BoE said that at its September meeting, the bank’s Court of Directors agreed that the subsidiary will take the form of an SPV, called the BEALF.
BEALF will be formally incorporated shortly, and will be a wholly owned subsidiary of the bank, with the bank’s senior management appointed as its directors.
“Establishing BEALF demonstrates the bank’s commitment to delivering a non-interest-based liquidity facility in the UK. As well as helping to level the playing field for the IF sector, this will be a first for a major Western central bank,” said Andrew Hauser, BoE’s ED for markets and sponsor of the SCF project.
The BoE statement also noted that it is working to establish an SCF which will allow Islamic banks in the UK to hold pound deposits guaranteed by the central bank, in a manner which does not involve paying or receiving interest.
The SCF will provide Islamic banks with greater flexibility in meeting the Basel III liquidity requirements, putting them on a more level playing field with conventional banks, which can already place deposits at the central bank, it added.