Islamic banks' liquidity toolkit widens, but conventional gap persists

July 28, 2026 (MLN): Islamic banks have seen a marked expansion in liquidity-management instruments across major markets over the past decade, helping them meet funding needs and deploy surplus liquidity more effectively.

Fitch Ratings highlighted this while noting that a gap with conventional banks remains, particularly in jurisdictions where Islamic banking is still a niche or emerging segment, adding that the Iran war has further emphasized the need for robust Islamic liquidity management.

Fitch said several GCC Islamic banks have broadened their funding base through certificates of deposit, Islamic syndications and private placements, while Islamic repurchase agreements are picking up pace in a number of markets, aided by growing Islamic bank holdings of sovereign sukuk  now more widely available across the GCC and ASEAN  which qualify as eligible repo collateral.

Standardization, however, continues to pose a challenge.

The International Islamic Financial Market and the International Capital Market Association are working on unified Islamic repo documentation that could lower operational costs and ease sharia-related complications, the agency noted, while also pointing to Saudi Awwal Bank's execution of the first blockchain-based Islamic repo transaction as a notable market development.

Central bank Islamic liquidity facilities are now available across most core markets including the GCC, Malaysia, Turkiye, Indonesia, Pakistan, Bangladesh and Tunisia and some GCC central banks have rolled out stimulus packages and loan-deferral programmes for Islamic banks since the war began.

Fitch flagged that such sharia-compliant support mechanisms remain absent in markets like Morocco, Egypt and Kazakhstan, leaving them more exposed to a potential liquidity crunch.

The report also pointed to shallower Islamic interbank markets compared with conventional ones, especially where Islamic banks are few in number.

Divergent sharia contract standards add further friction: Indonesian regulators, for instance, do not permit tawarruq-based contracts, restricting local banks' interbank dealings with GCC peers that rely on tawarruq structures, while Omani rules bar Islamic banks from placing funds with conventional banks, narrowing their counterparty options.

Bangladesh's central bank, Fitch said, is planning a dedicated Islamic interbank money market to address such gaps.

On sukuk, Fitch noted that broader sovereign issuance is giving Islamic banks more avenues to park excess liquidity in high-quality liquid assets.

Sukuk made up 42% of outstanding debt capital market instruments in the GCC, 59% in Malaysia, 18% in Indonesia and 8% in Turkiye as of the first half of 2026, while Egypt, Bangladesh and Algeria have also begun issuing sukuk.

Pakistan's adoption of a hybrid-sukuk structure in 2026 could further widen supply, the agency added.

Short-term sukuk, however, remain scarce across most GCC countries, Jordan, Nigeria and other markets, limiting liquidity-management flexibility even as medium-term issuance grows more accessible.

Fitch said only 3% of its rated sukuk carry tenors of up to one year, with the bulk concentrated in International Islamic Liquidity Management 2 SA's asset-backed commercial paper programme, rated F1sf.

The agency further noted that Islamic banks in some markets, such as Jordan, earn no return on balances held with the central bank, while the Bank of England expanded its Alternative Liquidity Facility in 2025 to support UK Islamic banks' liquidity management.

Fitch's Islamic Finance Survey 2026 ranked liquidity and funding constraints as the most pressing challenge facing Islamic financial institutions a position the issue has held for several years.

Weak liquidity access stemming from shallow markets or restrictive regulation is likely to weigh negatively on Fitch's funding and liquidity assessments and Viability Ratings for Islamic banks, whereas deep, liquid repo markets including official-sector support could bolster credit profiles.

Around 62% of Fitch-rated Islamic banks were investment-grade as of the first half of 2026, with roughly 85% carrying Stable Outlooks, excluding national ratings.

Fitch added that GCC Islamic banks remain well-buffered should the Iran war stay contained, citing sound financial metrics heading into the conflict along with ample capital and liquidity buffers and healthy asset quality.

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