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Islamic Liquidity Management Gaining Momentum, But market Fragmentation Persist: Fitch
Fitch Ratings building at Canary Wharf - LONDON/ENGLAND FEBRUARY 23, 2016
Islamic liquidity management instruments (ILMI) are gradually evolving across key Islamic finance markets including the GCC and Malaysia, but regulatory inconsistencies and divergent sharia interpretations continue to hinder their development, according to Fitch Ratings' Islamic Finance Survey 2025.
The survey, which included responses from over 220 market participants, identified liquidity management and funding constraints as the most pressing challenges facing Islamic financial institutions (IFIs). While efforts to strengthen the ILMI ecosystem are underway, fragmentation between even the most advanced Islamic finance jurisdictions remains a core issue.
Growing Regulatory Initiatives Show Promise
Fitch highlights a number of recent regulatory initiatives that are improving the ILMI landscape: Bank Negara Malaysia (BNM) introduced the Islamic Collateralised Funding Policy Document in 2024, which spurred a threefold rise in Islamic interbank repo transactions to approximately USD10 billion.
in 2024, which spurred a threefold rise in Islamic interbank repo transactions to approximately USD10 billion. In the United Arab Emirates, the central bank launched an overnight murabaha liquidity facility and is developing Sustainable Islamic M-Bills that could act as eligible collateral.
The Central Bank of Bahrain launched a sharia-compliant commodity murabaha facility in 2024.
Despite these gains, the Islamic interbank and repo markets remain shallow compared to their conventional counterparts.
Shortage of Sukuk a Key Concern
Government sukuk issuance plays a crucial role in helping Islamic banks park surplus funds in high-quality liquid assets (HQLA). However, 68% of respondents cited a lack of sukuk availability or variety as a key investment concern, while 59% pointed to liquidity challenges as a constraint.
Several countries with active Islamic finance sectors — including Bangladesh, Nigeria, Egypt, Maldives, and Iraq — either do not issue sukuk or do so irregularly. In Kuwait, however, new legislation allowing government borrowing could pave the way for sovereign sukuk issuance for the first time since 2017.
To address the scarcity of short-term sukuk, the International Islamic Liquidity Management Corporation (IILM) increased its sukuk issuance programme to USD6 billion in 2024, up from USD4 billion, in response to rising demand. These instruments are rated 'F1sf', offering a secure avenue for short-term liquidity management.
Sharia Divergence and Regulatory Limits
One of the primary barriers to ILMI standardisation is divergent sharia interpretations across jurisdictions. Fitch notes that in some cases, Islamic banks within the GCC cannot transact with each other due to sharia compliance conflicts, and even less so with conventional banks.
For example: In Malaysia, BNM's Shariah Advisory Council (SAC) in 2024 barred Islamic financial institutions from transferring funds to conventional banks unless it is certain the funds will not be used in non-sharia-compliant activities.
Omani regulations similarly prevent Islamic banks from placing funds with conventional institutions.
Moreover, GCC-based Islamic banks often avoid investing in Malaysian government sukuk due to concerns over murabaha-based tradability restrictions and currency risk. In response, BNM's SAC approved the use of wakalah-based contracts in 2024 to address these concerns and broaden investor appeal.
Digital Technologies Hold Potential but Adoption Is Nascent
Fitch also sees potential in the digitalisation of liquidity management, with technologies such as tokenisation, blockchain-based repos, smart contracts, and AI-driven operations offering the promise of real-time settlement, enhanced transparency, and fractional ownership.
However, adoption across Islamic banks remains at an early stage, and substantial investment and collaboration are required to bring these technologies to scale.
Stable Outlook for Fitch-Rated Islamic Banks
Despite the liquidity management challenges, most Fitch-rated Islamic banks remain investment-grade, particularly in the GCC. In many cases, their Issuer Default Ratings are supported by sovereign backing, contributing to stable liquidity profiles.
While Islamic liquidity management is making notable strides, especially in Malaysia and the UAE, the lack of market standardisation, sharia fragmentation, and limited sukuk supply continue to restrain sector-wide advancement. Enhanced regulatory coordination, innovation in short-term instruments, and digital adoption will be key to unlocking the full potential of Islamic liquidity markets in the years ahead. Related
