Qatar Central Bank directive and monetary policy

The other part of the Qatar's central bank I wanted to comment on (refer to my last post for the bulk of my comments) was its discussion of the monetary policy implications of the closure of Islamic windows:

"In view of the evident difference between the bases and the methodologies pertaining to the conventional and the Islamic banking activities, since for instance, the impact of each type differs from the other in the ability to create money and increase money supply, the use of monetary policy instruments available to Qatar Central Bank faces significant challenges due to the current overlap between non- Islamic and Islamic activities of conventional banks operating within the State. This overlap hinders the optimal use of those tools, negatively impacting on the monetary policy performance and efficiency, and impeding the creation of new tools, which enhance the monetary policy effectiveness. At the same time, the segregation of the conventional and Islamic banking activities will enable Qatar Central Bank to have a systematic framework of liquidity management and improve the efficiency of open market operations. On the other hand, this will also open new prospects for the monetary policy to develop new instruments targeted at these two types of banking activities according to the size and relative weight in the market, in addition to the degree of influence thereof on money supply. The monetary policy instruments will then have a faster and more efficient impact on the operational, intermediate and ultimate objectives."

The main takeaway from this part is that the central bank plans (or is planning to) engage in monetary policy differently for Islamic and conventional banks. It also plans to address the liquidity management issues facing Islamic banks (which I neglected to mention in my earlier post on a hypothetical Islamic window). This is important, but it is a long-term plan implemented with a short-term, almost hasty decision to separate Islamic and conventional banks completely within the regulatory framework.

The most basic form of policy mentioned in the press release is the potential for additional liquidity management tools that Islamic banks need and are substituting with inter-bank commodity murabaha or wakala agreements. As I have discussed earlier, this is an unstable solution should their be another crisis where banks lose access to loans based on fears of insolvency that are widespread across the global financial sector. These could be in the form of securities issued by the central bank akin to the Central Bank of Bahrain's sukuk al-salam and sukuk al-ijara, which have met with substantial demand in that country. However, this would not require that Islamic banks be completely separate from conventional banks. Bahrain has both wholly Islamic banks as well as Islamic windows at conventional banks and doesn't plan on changing that.

The press release hints at further moves, including separate monetary policy for conventional and Islamic banks. That would be unique in the world if it were accomplished. From what I understand, the change would allow the central bank to set different benchmark rates for Islamic banks and conventional banks through separate open market operations and they do not want there to be any overlap between the two sectors (which of course leads to arbitrage that would make the two policies identical if the market became efficient). It would also lead to a more feasible outcome of the central bank being able to support the Islamic banks without providing stimulus to conventional banks at the same time. If the banking sector were a greater size relative to the economy (like in Bahrain), this could make sense, but it is still would be difficult to accomplish in practice.

In the end, the section on "monetary policy" in the press release does not leave me with much additional explanation for the directive and its sudden and non-transparent release. It is far more likely that the main reason for the new complete separation is the difficulty of the regulators in overseeing Islamic windows at conventional banks within the current regulatory framework. The potential black-eye for the regulators if an Islamic window were operationally separate and saw its capital depleted without the regulators being aware and involved is a much better explanation. The methodology of the directive--requiring the units be closed or sold--is likely a reflection of the central bank wanting to strengthen the domestic Islamic banks, even at the expense of some conventional domestic banks.