The Bank says the facility, in which deposits from Islamic banks will be backed by a return-generating fund of high quality Shariah compliant assets, "will further strengthen the United Kingdom’s role as the leading international financial centre for Islamic finance outside the Muslim world".
Islamic finance had assets totalling $2.4 trillion in 2019, 11% higher than a year earlier and a third bigger than in 2015.
In a speech given during UK Islamic Finance Week, the Bank of England's Andrew Hauser said that key aspects of Islamic finance "make it particularly well suited to financing the post-Covid recovery".
Hauser said these aspects include prioritising equity-like risk-sharing over debt, factoring ethical and environmental considerations into investment decisions, and embracing innovative financial solutions beyond traditional banking.
However, he noted that Islamic banks have long challenges in efficiently managing their liquidity, stating the Bank of England’s new non-interest based central bank deposit facility "is designed to help level the playing field".
Conventional banks hold a range of high-quality liquid assets to meet those obligations, including cash and central bank reserves; government and corporate debt; and asset backed securities and commercial paper. They can also borrow in secured and unsecured money markets and, as a backstop, from central banks. But Islamic banks’ prohibition on the payment or receipt of interest means they can’t access many of these tools.
Hauser explained that Islamic banks found it hard to adjust to the post-crisis ‘Basel 3’ liquidity rules, "which gave centre stage to the very instruments they were prohibited from holding", including government bonds, such as UK gilts and US Treasuries, and remunerated central bank reserves accounts.
The Bank of England's new Alternative Liquidity Facility will provide UK Islamic banks with greater flexibility in meeting high-quality liquid assets (HQLA) requirements, enabling them to hold a reserves-like asset in a non-interest based environment.
The ALF will be structured as a wakalah or fund-based facility, a commonly used model in Islamic finance. Participant deposits will be backed by a fund of assets, the return from which, net of hedging and operational costs, will be passed back to depositors in lieu of interest.
Andrew Hauser said: "The strengths of this model include its relative simplicity – conceptually and practically – and its flexibility to accommodate future changes in what is a still fast-developing market. The ALF will grow as the UK Islamic bank sector grows. And it will be well placed to exploit the growing diversification of available HQLA-eligible sukuk assets. Over the coming months, we will finalise legal documentation, complete our operational testing and begin the onboarding process for eligible applicants."
The Facility will be open for business from the first quarter of 2021.
Once operational, Hauser says the ALF should "help put the UK Islamic finance sector on a more level footing with the rest of the market, giving firms here greater flexibility in meeting their liquidity requirements, and helping them to compete with conventional peers while staying true to their founding principles".
