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5.9 Maintaining a High-Quality Liquidity Buffer

C 33/2015 STA Effective from 3/1/2022
  1. a.IBs must maintain a liquidity buffer as the first line of defense in the event of a liquidity disruption. A liquidity buffer consists of cash and other highly liquid, unencumbered, Shari’ah-compliant assets and is an important tool in disruptive market conditions when an IB may need to generate liquidity in a short span of time and normal funding sources become dry or are unable to provide liquidity. The availability of this excess liquidity precludes the need for an IB to take extraordinary measures during initial periods of stress.
  2. b.IBs must calibrate the magnitude of its liquidity buffer on the basis of its funding gap and stress testing exercise over specific time horizons. The calibration of a liquidity buffer is highly dependent on assumptions used for defining the stress conditions. These assumptions incorporate the factors such as net and cumulative funding requirements in various time buckets, as well as encompassing both contractual and non-contractual cash flows. Assumptions must also include factors such as the length and severity of stress, the withdrawal of funding by investment accounts and depositors, and the non-availability of funding on an unsecured basis (including interbank Mudarabah, and Wakalah) as well as on a secured basis (using Shari’ah-compliant alternatives structure to a repurchase agreement) from modestly liquid assets.
  3. c.The IB liquidity buffer must comprise cash and highly liquid assets which can be sold or used as collateral for a Shari’ah-compliant alternative to a repurchase agreement in disruptive market conditions.

    In addition to the highly liquid instruments, other instruments which may need a relatively longer time in liquidation may be considered, provided the IB can demonstrate the ability to generate the liquidity from such instruments in an agreed timeframe. The core component of this buffer must be eligible as collateral for generating liquidity from the Central Bank on a Shari’ah-compliant basis.

  4. d.The IB can also include statutory reserves with the Central Bank in its calculation of a liquidity buffer provided it can demonstrate that such reserves can be withdrawn in case of need without any regulatory repercussions. The criteria for specifying an instrument’s eligibility as a liquidity buffer include its issuer, size, maturity, depth of the market, currency, tradability from a Shari’ah perspective, and the range of investors holding such an instrument.
  5. e.IBs must ensure that its liquidity buffer is reasonably diversified, and that there are no constraints – whether legal, regulatory or operational – on the utilisation of these assets. The IB must also consider maintaining buffers of highly liquid assets in other major currencies, especially in cases where the local currency is non-convertible.
  6. f.An IB must also test and be active in each market in which it keeps Shari’ah compliant assets as liquidity buffers. This will provide an assurance to the IB about the liquidity of such instruments in various market conditions and will provide an opportunity to test its assumptions.