May 14, 2015 / 6:32 AM / 2 years ago

IDB delays short-term sukuk as sector looks for liqudity tools

May 14 (Reuters) - The Jeddah-based Islamic Development Bank has no immediate plans to issue short-term sukuk (Islamic bonds), leaving it to domestic and regional issuers to meet growing demand for liquidity management tools in the sector.

A lack of sharia-compliant paper has been a major constraint for the development of Islamic finance, with the tools needed to help Islamic banks meet tough Basel III regulatory standards being phased in very gradually.

Last year, the IDB said it aimed to issue its first short-term sukuk in 2014, adding to wider efforts to develop high-quality liquid assets (HQLAs) for Islamic banks to use, but at this stage such a programme is not planned.

"IDB in principle supports the establishment of the short-term sukuk programme but for the time being we are not considering any issuance," IDB President Ahmad Mohamed Ali told Reuters late on Wednesday.

The AAA-rated IDB priced a $1 billion five-year sukuk in February and Ali said that next year's issue would be similar, as the IDB focuses on infrastructure financing.

In the meantime, domestic regulators including Bahrain and the United Arab Emirates have expanded their Islamic liquidity tools in recent months.

The Malaysia-based International Islamic Liquidity Management Corp (IILM), backed by nine central banks and monetary agencies as well as the IDB, has also tried to fill the gap with issuance of three-month and six-month sukuk.

But there are concerns that such tools could be insufficient in times of market stress, when they are needed most.

"A key issue is the absence of secondary markets that provide a proven record of being a reliable source of liquidity at all times", Kuwait central bank governor Mohammad al-Hashel said at an IILM seminar in April.

The IILM has built a track record of regular issuance since 2013, but it has limits. IILM sukuk are not explicitly backed by member central banks and there is no clear indication by IILM whether these would be taken back and cashed in through repo-style transactions, al-Hashel said.

"Based on this, and other considerations, it appears that IILM sukuk are likely to be treated as corporate rather than sovereigns."

The Basel III capital standard gives regulators some leeway in defining the types of HQLA that banks can hold, but these need to have low correlation with risky assets, an active secondary market, and low volatility - features that most Islamic securities lack. (Reporting by Maja Zuvela and Bernardo Vizcaino; Editing by Eric Meijer)

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