Why Islamic finance has an important role to play in
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supporting the recovery from Covid and how the Bank of
England's new Alternative Liquidity Facility can help
Speech given by
Andrew Hauser, Executive Director, Markets
UK Islamic Finance Week 2020
2 December 2020
I am grateful to Arshadur Rahman for his help in writing this speech, and to Sarah Hall,
Maggie Illingworth, Rhys Phillips and Chris Worthington for their comments and guidance.
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All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice
Introduction
It's a privilege to be with you today to talk about the Bank of England's work on Islamic finance -
date for our new Shari'ah compliant
and to announce the launch non-interest based deposit facility,
the first such account from a Western central bank.
The facility, in which deposits from Islamic banks will be backed by a return-generating fund of high
quality Shari'ah compliant assets, will further strengthen the United Kingdom's role as
the leading
international financial centre for Islamic finance outside the Muslim world.
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But it also goes deeper because the core principles1 of Islamic finance are strikingly well suited
to responding to some of the biggest challenges we will all face in rebuilding our economy once
Covid has passed. Prioritising equity-like risk-sharing over debt. Factoring ethical and
environmental considerations into investment decisions. And embracing innovative financial
solutions beyond traditional banking.
And that lies four square within the Bank of England's mission
to promote the good of the people of
the United Kingdom, Muslim and non-Muslim alike.
Global growth in Islamic Finance
Islamic finance is a global success story, with assets of $2.4 trillion in 2019 (Table 1). That's 11%
higher than a year earlier, and fully a third bigger than in 2015.
Table 1: Size and composition of Islamic Finance Services Industry ($bn, 2019)
*
*Gulf Co-operation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates).
Source: Islamic Financial Services Industry Stability Report 20202
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Three quarters of those Islamic finance assets are held by banks and are large enough to play a
systemic role in thirteen countries.3 There's also a nascent Islamic insurance industry (takaful) -
and a much larger capital market, anchored around the growing stock of sukuk4 issued by
companies and governments (Chart 1), and over 1,500 Shari'ah compliant investment funds.
Chart 1: Global sukuk issuance and stock outstanding
Source: Islamic Financial Services Industry Stability Report 20202
The role of the UK and the Bank of England in supporting Islamic Finance
So far, so impressive. But what, you might ask, does all this have to do with the UK or the Bank of
England, when the centre of gravity for Islamic finance lies in the Middle East, North Africa, South
and South East Asia?
the
Well, the fact is that, outside those regions, the UK is pre-eminent centre for Islamic finance.
And that reflects its significant, well-established domestic Muslim population; its strong
relationships with the wider Muslim world; and its deep expertise in financial market origination and
distribution, embedded in a mature legal and regulatory framework.5
Indeed, Islamic finance in the UK goes back many decades (Table 2): from commodity-based short
term liquidity management and trade finance in the 1970s, to the first UK Islamic bank, investment
funds and takaful in the early 1980s.6
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Table 2: Islamic finance in the UK selected timeline
1970's London market brokers offer wholesale liquidity management using commodities
1982 Swiss-based Dar al Mal al Islami opens London office offering investment management
services
1983 Establishment of first Islamic bank, Albaraka Bank (ceased 1993)
Establishment of first UK Islamic insurance (takaful) company, Takaful UK Ltd
1996 Islamic mortgages offered in the UK by United Bank of Kuwait (now Ahli United Bank)
2003 HSBC Amanah launches Islamic mortgages and bank accounts in the UK
2004 Authorisation of Al Rayan Bank Plc (formerly Islamic Bank of Britain)
Court case of Beximco vs. Shamil Bank of Bahrain establishes principle that secular authorities
cannot opine on Shari'ah compliance
Bank ABC offers Islamic mortgages under Al Buraq brand
2005 Children's Mutual launches Shari'ah compliant Child Trust Fund
Lloyds TSB offers Shari'ah compliant current account
2006 Authorisation of European Islamic Investment Bank Plc (ceased in 2018)
First sukuk listed on the London Stock Exchange (Tabreed, $200m)
2007 Authorisation of Bank of London and the Middle East Plc
Authorisation of investment firm Amiri Capital (ceased 2018)
FSA outlines regulatory approach to Islamic finance in: "Islamic finance in the UK: regulation
and challenges"
2008 Authorisation of QIB (UK) Ltd (formerly European Finance House)
Authorisation of Gatehouse Bank Plc
Authorisation of British Islamic Insurance Holdings/Principle Insurance (ceased 2013)
Consultation paper CP08/22 establishes liquid asset buffer requirement for all UK banks
2012 Authorisation of ADIB (UK) Ltd (ceased 2020)
HSBC Amanah exits UK market
2013 Authorisation of Cobalt Underwriting
London hosts the World Islamic Economic Forum, the first time outside the Muslim world
2014 UK Government issues its first sovereign sukuk
Authorisation of Investment firm Arabesque Asset Management
TAM Asset Management launches Shari'ah compliant investment funds
2015 Islamic Insurance Association of London established
Bank of England commences Shari'ah compliant facilities (SCF) project
2017 Authorisation of Shari'ah compliant crowd funding firm Yielders
Columbia Threadneedle Investments launches Shari'ah compliant global equity fund
Authorisation of Shari'ah compliant home finance firm Strideup Homes
2018 Al Rayan Bank issues first sterling denominated residential mortgage backed sukuk
2019 Registration of PrimaDollar Factoring, Shari'ah compliant trade finance firm
2020 Authorisation of Investment firm Wahed Invest
Registration of several Shari'ah compliant e-money and payment services firms and agents,
including: Niyah, Moneemint, Rizq
2021 Planned launch of the Bank of England's Alternative Liquidity Facility (ALF)
Sources: Bank internal analysis and FCA Register
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I am proud to say that the Bank of England has been involved throughout those developments.
A key moment, which some of you will recall first-hand, came in 2003 when our then Governor, the
late Sir Edward George, delivered a speech in which he talked about being touched by the plight of
Muslim neighbours who had had to use a conventional interest-bearing mortgage to purchase their
home, reluctantly and against their principles. He reflected on how sad and unnecessary this
financial system's capacity for
seemed, given the UK innovation in meeting the needs of different
parts of society.7
To put that right, the Bank asked a senior working group drawn from the public and the private
sectors to identify the changes needed to legal, tax and regulatory arrangements. Those changes
formed the foundations of the system we have today. They were subsequently reinforced by a
2007 FSA paper articulating how Islamic finance could be fairly and consistently supervised within
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a secular regulatory framework.8 Thirteen years later, one of the co-authors of that paper
Arshadur ('Ash') Rahman, known to many attending Islamic Finance Week -
is the driving force
behind our new facility.
The regulatory approach set out by Ash and his co-authors still applies today. A preference for
principles over excessively rigid rules, able to respond to diverse and evolving markets, and reduce
the scope for regulatory arbitrage. Avoiding unnecessary regulatory obstacles to Islamic finance,
while giving no special favours. And recognising we are secular, not religious, regulators, who
cannot opine on Shari'ah
compliance,9 and equally cannot disapply regulations either.10 To
deepen our international engagement further, the Bank of England joined the Islamic Finance
Stability Board as an Associate Member in 2015.11
That approach has paid off. Today, the UK is home to four exclusively Islamic banks with assets of
more than a dozen conventional banks offering Shari'ah compliant services, a host of
over £5bn,
investment firms, and a thriving advisory sector.
Islamic finance and Covid
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Of course there have been many challenges over the years but none perhaps quite as serious as
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the Covid pandemic. The human cost has been enormous as has the economic impact,
particularly in parts of the Muslim world. I know that some worry that Covid might slow the pace of
growth in Islamic finance, as economic activity declines, and market participants revert to more
conventional tools to meet the daunting financing needs of the crisis.
But that needn't be so -
because key aspects of Islamic finance make it particularly well suited to
financing the post-Covid recovery:

First, the philosophical focus on equity-like sharing of risk and reward will become
increasingly relevant as market participants get to grips with the scale of debt accumulated
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in response to Covid. The attractions of debt are obvious when interest rates are so low
particularly for those able to lock in long-term fixed rates in local currencies. But those
borrowing at floating rates, at short maturities, or in foreign currencies, face sharp negative
income shocks when rates rise, debt rolls over, or local currencies depreciate. Risk-sharing
contracts, including those promoted by Islamic finance, pose materially lower medium-term
risks to stability.12 The Bank of England has long advocated the risk-sharing merits of
GDP-linked instruments, which could be packaged in sukuk form.13 And, together with HM
Treasury and the FCA, we have recently announced a high-level working group to consider
ways to foster a longer-term financial markets culture to support productive investment.14

Second, Islamic finance seeks to avoid investing in socially detrimental activities. In fact, it
'green sukuk' has
was pro-ESG before the term was ever invented! Issuance of so-called
risen sharply in the past three years (Chart 2) - and the Islamic Development Bank issued
an innovative $1.5bn sustainability sukuk in June.15 But these are still quite modest
numbers relative to the vast sums of money now looking to invest in credible ESG assets.16
So there's plenty of scope for further growth.

Third, the prohibition on many forms of traditional banking in Islamic finance should
There's great interest
naturally spur exploration of more innovative forms of intermediation.
in exploring the scope for Islamic fintech like Shari'ah compliant
e-money platforms and
peer-to-peer lenders, to tackle a range of issues, including financial inclusion.17 The UK is
a world leader in this sector (Chart 3).
Chart 3 Number of Islamic finance fintech
Chart 2 Green sukuk issuance
firms by country
Source: Islamic Financial Services Industry Stability Report
20202
Source: data from https://ifnfintech.com/landscape/, and Bank
calculations.
The challenges of managing liquidity in Islamic finance banks
As well as supporting the safe development of new types of Islamic finance, we also recognise
some of the challenges facing more established parts of the sector.
Islamic banks, for instance, have long faced profound challenges in efficiently managing their
liquidity, and it's here that the Bank of England's new
non-interest based central bank deposit
facility is designed to help level the playing field.
All banks need to manage expected and unexpected outflows, eg as depositors make payments
and withdrawals. Conventional banks hold a range of high-quality liquid assets to meet those
obligations, including cash and central bank reserves; government and corporate debt; and asset
backed securities and commercial paper. They can also borrow in secured and unsecured money
markets and, as a backstop, from central banks.
But Islamic banks' prohibition on the payment or receipt of interest means they can't access many
of these tools. To avoid being caught short, they have historically had to structure their business in
inherently narrow or inefficient ways, for example by holding large stocks of non-interest bearing
cash, or limiting their offerings of short-term deposits.
Ironically this left them relatively well placed to weather the Global Financial Crisis of 2008-09: in
aggregate UK Islamic banks remained liquid, in a market where liquidity was otherwise very
'Basel 3' liquidity rules, which gave
scarce. But they found it harder to adjust to the post-crisis
centre stage to the very instruments they were prohibited from holding, including government
bonds, such as UK gilts and US Treasuries, and remunerated central bank reserves accounts.
To meet this challenge, the Basel liquidity rules give national supervisors discretion to treat sukuk
as High Quality Liquid Assets (HQLA), subject to haircuts or other conditions. The consequent
increase in demand for sukuk from banks was one factor boosting issuance in recent years. But
the proportion of sukuk classed as eligible for regulatory buffers remains relatively modest
compared to demand. As a result, while sukuk can provide a reliable medium-term store of value,
the relative scarcity of HQLA-eligible stock can give rise to uncertain price movements, especially
in stressed markets, reducing the value that is readily realisable, and making it harder for banks to
increase their holdings quickly when required.
All of this means that Islamic banks can face a somewhat uneven playing field relative to
conventional banks when it comes to liquidity management. Unable to use liquid gilts or interest-
bearing reserves accounts at the Bank of England to meet short-term outgoings, they have tended
to hold inefficiently high stocks of cash at zero return, or higher-yielding but somewhat less liquid
sukuk.
and launch of the Bank of England's
The design Alternative Liquidity Facility
That's where our new Alternative Liquidity Facility (or 'ALF') should make a real difference.
Initially we had hoped Islamic banks might be able to use our normal reserves accounts, by
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agreeing to forgo any interest paid as many observant Muslim customers do on their retail bank
deposits. But on further investigation this proved unworkable: reserves accounts were too
intimately bound up with the concept of interest, given their core role in implementing monetary
policy. And the disparity in return offered to Islamic and non-Islamic banks at higher levels of Bank
Rate would have left a decidedly uneven playing field.
Work therefore commenced in 2015 to assess the feasibility of establishing a standalone non-
the limits of the Bank's knowledge
interest based facility. Recognising of Islamic finance, we drew
on the expertise of fellow central bankers across the Middle East and Asia, including those from
Bahrain, Malaysia and the UAE.
In light of that research, we triaged a number of potential models to gauge which might fit best with
the specificities of the UK market, legal and regulatory environment. We consulted publically on
those options in 2016, and again in 2017 to fine tune our intended approach.18
Today, after a long and comprehensive process,
I'm pleased to announce that the Alternative
Liquidity Facility will be open for business from the first quarter of 2021. The new facility will
provide UK Islamic banks (and indeed any other UK banks with formal restrictions on engaging in
interest-based activity) with greater flexibility in meeting HQLA requirements, enabling them to hold
a reserves-like asset in a non-interest based environment.
The ALF will be structured as a wakalah or fund-based facility: a commonly used model in Islamic
finance (Chart 4). In simple terms, that means that participant deposits will be backed by a fund of
assets, the return from which, net of hedging and operational costs, will be passed back to
depositors in lieu of interest.
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The strengths of this model include its relative simplicity conceptually and practically and its
flexibility to accommodate future changes in what is a still fast-developing market. The ALF will
grow as the UK Islamic bank sector grows. And it will be well placed to exploit the growing
diversification of available HQLA-eligible sukuk assets.
Over the coming months, we will finalise legal documentation, complete our operational testing and
begin the onboarding process for eligible applicants. Firms should expect to commence this work
from January 2021.
Once operational, the ALF should help put the UK Islamic finance sector on a more level footing
with the rest of the market, giving firms here greater flexibility in meeting their liquidity
requirements, and helping them to compete with conventional peers while staying true to their
founding principles.
Chart 4 How the ALF will work19
We've Eddie George's
come a long way since speech almost 20 years ago. But one thing that
remains more important to us than ever is working with you. The liquidity facility I've described
here today is in no small part a product of close and committed co-operation between the Bank,
a real step forward, but it's only one step. Through
industry bodies and the private sector. It's
continued engagement and focused effort, together we can build a more innovative, diverse and
inclusive marketplace: one which really can meet the needs of every part of our society.
Thank you
19
In the first instance, (1) the Bank prefunds the ALF with an interest-free loan, which is used (2) to purchase eligible sukuk and (3) any
hedges required to insulate the fund from FX risk. Islamic banks then (4) place deposits in the ALF, the principal value of which is (5)
guaranteed by the Bank to ensure the facility is HQLA-compliant. In the event the aggregate value of participating bank deposits do not
reach the aggregate value of the fund, the Bank will step in as co-depositor for the residual amount. The rate of return on the deposit
(6) is based on the rate of return on the portfolio backing it, net of hedging and other operational costs; and on maturity the return from
the fund is paid over to participating banks, and the principal amount is returned or rolled over.
10
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