Short-Term Liquidity Management Mechanisms in the Absence of Islamic Interbank Loan Markets

Abstract

The Islamic finance model is sufficiently well specified at the “bank-to-client” level, but does not regulate the “central bank-to-bank” and “bank-to-bank” relationships. This chapter proposes a concrete Shari’ah-compatible mechanism for setting up an Islamic interbank loan (In the Islamic finance industry, the word “loan” is usually avoided because of associations with interest-based funding. However we use it in this chapter, as the term “interbank loan market” is well established and the substitution of the word “loan” with the word “funding” may lead to misunderstandings) market and managing Islamic bank liquidity, which allows a segregation of Islamic and non-Islamic finance. Islamic banks should as a minimum, delink from LIBOR and other traditional reference rates and come up with their own financial benchmarks.