Bank of England (BoE)’s long-awaited Shariah compliant non-interest-based deposit facility, an instrument years in the making, will be operational in the first quarter of 2021, Andrew Hauser, the executive director of markets at BoE, announced at IFN UK OnAir Forum 2020. VINEETA TAN breaks the story.
The instrument, known as the Alternative Liquidity Facility (ALF), will be the first Shariah compliant liquidity management tool from a western central bank. It is the BoE’s solution to level the playing field for Islamic banks in liquidity management, an exercise of extreme challenge for Islamic financial institutions due to the dearth of non-interest high-quality liquidity assets (HQLAs) in the market.
This leaves UK Islamic banks at a disadvantage against their conventional peers which have access to a wide range of HQLAs including cash, central bank reserves, government and corporate debts and commercial papers. Shariah banks in the country had to resort to structuring their business in narrow or inefficient manners to avoid Riba such as holding large stocks of non-interest-bearing cash or limiting their offerings of short-term deposits.
“Initially, we had hoped that Islamic banks would be able to use our normal reserve accounts by agreeing to forgo any interest paid as many observant Muslim customers do on their retail bank account. But upon further investigation, this solution proved unworkable. Reserve accounts were intimately bound up with the concept of interest given their core role in implementing monetary policies and the disparity in return offered to Islamic and non-Islamic banks when rates were to be higher would have left a decidedly uneven playing field,” Hauser said in his keynote address at the third day of IFN UK OnAir Forum 2020.
Work commenced in 2015 to study the feasibility of a Shariah compliant deposit facility, with the help of central banks of Bahrain, Malaysia and the UAE. The BoE engaged with the industry in 2016 and 2017 to gather input on a potential facility, which has been decided will be of a Wakalah structure.
Under ALF, participant deposits will be backed by a fund of assets, the return of which — net of hedging and operational costs — will be passed back to depositors in lieu of interest.
“The new facility will provide UK Islamic banks, and indeed any other UK banks with formal restrictions on engaging in interest-based economic activities, with greater flexibility to meet HQLA requirements, enabling them to hold a reserve-like asset in a non-interest environment,” explained Hauser.
It is learned that over the next few months, BoE will finalize legal documentation pertaining to the ALF, complete operational testing and begin the onboarding process for interested applicants. Firms can expect to commence this work from January 2021 onward.
This was first reported on the 2nd December 2020.