The International Islamic Liquidity Management Corporation (IILM) has delayed its first sukuk issuance according to Zeti Akhtar Aziz, the chairwoman of the IILM and head of Malaysia's central bank. She said that the first issuance would come in the next six months, while previous statements had said issuance would occur before the end of 2011. However, progress is being made with a rating forthcoming. The first issuance would be small, with follow-on issuance in the range of $2-$3 billion per issue in several currencies to meet demand, although in the past the IILM has stated that issuance would begin in US dollars and be followed by Euro issues with other currencies added as they were demanded by Islamic financial institutions.
The key function that the IILM provides is short-term sukuk, issued by a body with a high credit rating to meet the liquidity needs of Islamic banks. Banks generally take in short-term deposits and use those funds to lend long-term. To remain in business, they need to have sufficient liquidity (i.e. cash) on hand to meet withdrawals by depositors. The rating on the short-term assets they hold is important for meeting their minimum capital requirements under Basel and local regulations. The short-term sukuk provide an investment option that will generate some yield without exposing the banks to the counterparty risk that would emerge from inter-bank murabaha, for example.
There is also the potential, particularly if the IILM extends the maturities of sukuk it sells, for these sukuk to form the backbone for repurchase agreements (repos). A repo is a secured short-term (often overnight) loan between banks and in the conventional world operates using high quality bonds as collateral like US Treasuries. In the Islamic form of repos in use today in the UAE, the collateral is commodity murabaha-based certificates of deposit issued to banks by the UAE central bank, of which I have been critical. The International Islamic Financial Market (IIFM) has laid out other alternatives, none of which are optimal, for Islamic repos, which I described in an earlier post.
The next piece of information that will be interesting will be the assets that are used to back the issuance, and Zeti said they are working to "get the allocation of high-quality underlying assets". The most likely structure will be istithmaar or ijara, both of which would probably be done using an asset-based structure. The assets would likely be contributed by IILM members, most of which are central banks from OIC countries, although the Central Bank of Luxembourg is a member. The central banks are not likely to risk that their assets could be taken by sukuk holders should the IILM default or otherwise fall apart.
It is good to see the IILM move towards beginning operations, however late its development is. The biggest need it can fill is to provide a source of short-term assets for Islamic banks that do not have the risks associated with lending their surplus funds to other Islamic banks. When an Islamic bank lends its funds to another bank--even for a short period--it subjects itself to the risk that the funds would be lost or tied up if that bank failed. For the Islamic banking system as a whole, this provides a powerful mechanism for contagion, where the fears about an Islamic bank's solvency could be transmitted to other institutions which have lent money to it.