Durmuş Yilmaz: Managing liquidity in the Islamic financial services
industry
Speech by Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey, at
the conference on "Managing liquidity in the Islamic financial services industry", organised by
the Islamic Financial Services Board (IFSB), Istanbul, 6 April 2011.
* * *
Distinguished Participants, Esteemed Guests and Valued Members of the Press,
Welcome to the Conference on Managing Liquidity in the Islamic Financial Services Industry
organized by Islamic Financial Services Board (IFSB). As the Central Bank of Turkey, we are
very pleased to host this special event. I would like to extend my appreciation to the IFSB for
organizing this timely conference in this beautiful city. I believe that this conference will be a
productive platform for fruitful discussions on Islamic liquidity management practices.
In this opening speech, I will share my thoughts regarding managing liquidity in Islamic
finance and the challenges ahead.
Distinguished Participants,
As you all know, unconventional polices and extraordinary measures have been put in place
by central banks and fiscal authorities during and after the financial crisis. As liquidity
concerns played a major role in the deepening of the crisis, intense discussions on a new
structure in global liquidity management have dominated the global arena. In this context,
liquidity management issues in the Islamic Financial Services deserve a special attention.
Successful implementation of a solid liquidity management system can be the key for
sustaining the rapid growth of the industry.
The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of
usury. Simply put, interest is prohibited, but profit sharing is not.
The distinctive elements of Islamic finance could be listed as:

Its ethical element (the prohibition of usury and exploitation of the borrower),
 The preference for trading in real assets (rather than synthetic products),

Partnership between the investor and investee,

and its governance structure (requiring a Shariah council).
Although their interest-free business model makes participation banks more stable compared
to conventional banks by protecting them from interest rate risk, it actually makes their
liquidity risk management more difficult. Liquidity risk is directly related to the ability of a bank
to maintain sufficient funds to meet its commitments, which may, in turn, be related to its
ability to attract deposits or sell its assets. As institutions engaged in many kinds of banking
activities, Islamic banks also have to meet their liquidity needs and obligations to ensure the
smooth running of their business. However, the very nature of these banks with their
objective of avoiding interest in any form makes it difficult and costly for them to meet their
liquidity needs due to conventional mechanisms of liquidity management.
As a new and improving banking model, Islamic banking has some shortages in comparison
with their conventional counterparts. In the conventional banking system with a
welldeveloped interbank money market, a variety of instruments are available for the banks.
Access to interbank money markets for short-term borrowings gives considerable flexibility to
banks to adjust their short-term cash flows. Existence of secondary markets for financial
instruments is also an important source of liquidity. However, this conventional mechanism of
liquidity management including interbank market, secondary market financial instruments
and facilities from the central bank as the lender of last resort are all based on interest and
therefore, not acceptable for Islamic financial institutions.
In addition to the challenges regarding the liquidity management, there are also supervisory
and regulatory issues to be considered. In order to resolve the differences in country level
regulations regarding appropriate Shari'ah-compliant instruments, working on globally
accepted liquidity management regulations and infrastructure could be a viable option.
Establishment of a carefully designed and structured Global Shariah Supervisory Board
could be a step in the right direction.
In this context, we also appreciate the excellent and productive work of Bank Negara
Malaysia, the Gulf central banks and other parties. As a major effort, the International Islamic
Liquidity Management Corporation (IILM) has been established to assist institutions offering
Islamic financial services in addressing their liquidity management issues in an efficient and
effective manner. This institution addresses one of the fundamental problems of Islamic
financial institutions: the provision of adequate liquidity in times of stress. Once there is an
international lender-of-last-resort facility (to complement and not to replace existing national
facilities), the provision of Islamic financial services will be carried out with an increased
confidence.
The IILM is expected to issue high quality, liquid, tradable and low risk Shari'ah-compliant
financial instruments at both the national level and across borders to enhance the soundness
and stability of the Islamic financial markets. The instruments of the IILM will be utilized in
liquidity management as eligible collateral for interbank transactions and central bank
financing, or through trading of IILM instruments (either within the same country or
crossborder) in the secondary market. As the IILM is intended to facilitate cross-border liquidity
management, its instruments shall be denominated in major reserve currencies. This is to
ensure access to a large pool of global investors and broaden the range of its holders,
thereby enhancing the prospects for active secondary market.
There is not an available mechanism through which the Central Bank of Turkey can provide
liquidity to the interest-free banking sector, or the so-called participation banks. However, the
Central Bank of Turkey has become a founding member of the IILM and contributed
10 million USD to its equity.
As additional efforts by the institutions in Turkey to facilitate participation banks' liquidity
management, the Undersecretariat of Treasury has started the issuance of Revenue Indexed
Bonds, which are purchased by the participation banks. As it is known, another kind of
interest-free security, which could be useful for participation banks especially in their liquidity
management, is a specially designed financial certificate, called "Sukuk". There is a
regulation of the Capital Markets Board of Turkey dated 1 April 2010 that permits the
issuance of rent certificate, which are very similar to asset-backed securities.
We believe that such interest-free securities, which could also be traded in secondary
markets, is very beneficial for the participation banks in their liquidity management
operations.
Distinguished Participants,
The vital issue of liquidity management has the potential to reshape the future trends in the
monetary policy framework. The path to resolution involves not only revisiting economic
policies, but also economic and institutional infrastructure that surrounds them. In this sense,
the Islamic finance has a good way to go in order to maintain well-structured liquidity
management system. I hope that this conference will lead to new ideas that help authorities
in their efforts to design a solid Islamic liquidity management structure.
Thank you for your attention.