Regulation of Islamic Financial Institutions 319
Liquidity
The current fi nancial crisis has been called the “perfect liquidity surprise.”
Liquidity problems associated with the crisis have forced regulators to get
tough on this issue. Basel III incorporates the introduction of minimum
liquidity standards and the monitoring of the liquidity coverage ratio (LCR)
of fi nancial institutions. The LCR is designed to ensure that the fi rm has
enough liquid assets to cover a short - term crisis based on a predetermined
set of cash infl ows and outfl ows established by the BCBS. Such liquidity
issues have serious implications for IFIs for several reasons. First, Islamic
fi nancial institutions do not have access to short - term liquidity through
markets. One of the biggest impediments for IFIs is to develop liquid mar-
kets where securities can be traded effi ciently at minimal transaction cost.
Second, given the heavy concentration of trade or commodity fi nance, the
assets of Islamic banks are illiquid; that is murabahah - based assets cannot
be traded in the secondary market. Third, whereas conventional banks have
access to liquidity provided by a lender of last resort, Islamic banks cannot
benefi t from such a facility as the lending is interest - based. This means that
although an Islamic bank may be in good fi nancial health, it could still face
additional capital requirements because of low liquidity which could ham-
per its growth or effi ciency.
Quality of Information
For markets, policymakers and fi nancial authorities, and multilaterals (IMF
and World Bank) appropriate coverage and quality of information is becom-
ing increasingly critical for their capacity to assess risks and vulnerabilities.
Regulators are looking for better information on a range of activities such
as off - balance - sheet risks (involving better consolidated supervision), and
the risks of fi nancial inter - linkages. The new regulatory and supervisory
environment will be information - focused and fi nancial institutions will be
required to enhance the collection and disclosure of information as required
by the regulators.^6
This means that the fi nancial institutions will have to improve, enhance,
and upgrade the overall fl ow and quality of information in their institutions.
They will need to be very focused on satisfying the reporting and disclo-
sure requirements for the regulators and supervisors. They should expect to
address this issue across all business lines and functional areas, from front
to back offi ce. For some institutions, it will require an upgrade of their risk -
reporting systems or the development of new risk measures.
The general level of transparency and disclosure in the Islamic fi nancial
services industry is low. The impact of the new quality - of - information
requirements could come from two directions. At the institutional level, the
demand for the fl ow and quality of information within the institution to
be enhanced could entail the automation of manual monitoring processes, the
upgrading of information systems, and improving the transparency of data