Islamic Finance: The New Regulatory Challenge, 2nd Edition

Chapter 18

The Role of Capital Markets in Providing Shari’ah-Compliant Liquidity

Prasanna Seshachellam

The effectiveness of any capital market, including Islamic capital markets, depends to a large extent on its depth and liquidity and the extent to which it can provide liquidity to the constituents of the financial services sector in its economy. Liquidity is the vital lubricant to ensure safe, sound, and efficient operations and sustainable growth of various participants in the Islamic finance industry. Islamic financial institutions are not very different from the conventional financial institutions in this respect, as they share similar obligations towards their clients and counterparties and hence a similar need to manage their risk profiles.

1. LIQUIDITY AND ITS IMPORTANCE TO THE ISLAMIC FINANCIAL SYSTEM

The critical importance of liquidity to sound and efficient functioning of the Islamic finance sector is better appreciated now than in the past, given the lessons learnt from the global financial crisis. Although the Islamic finance sector was not affected to the same extent as the conventional financial system by the global financial crisis, the lessons learnt by the conventional finance industry have highlighted the critical role of adequate liquidity in the overall safety and growth of various constituents of the Islamic finance sector. The need to develop a robust liquidity supply infrastructure has been widely accepted among the leading thinkers of the Islamic finance ...