Lower retail deposits amid the small branch networks Islamic banks run in key Asian markets are putting pressure on their liquidity coverage ratios (LCR).

LCR of Islamic banks in the region are weaker compared traditional banks, in part, due to weaker retail deposits, according to Moody’s Investor Service.

That has driven some banks to rely on corporate deposits and unsecured wholesale funding that lead to higher net cash outflows and more pressure on LCRs, the rating agency says. However, banks with a greater proportion of retail deposits – considered more “sticky” – typically display solid liquidity coverage.

“In Asia, the retail funding of Islamic banks is constrained by their small branch networks, which results in weaker LCRs when compared to their conventional peers,” the rating agency says.

By contrast, retail customers in GCC tend to be more Shariah aware, providing Islamic banks with a large base of low-cost retail savings deposits, hence supporting their stronger LCRs. However, lower oil prices are reducing overall domestic liquidity in GCC countries, pushing up their reliance on wholesale funding. This development could lead to a gradual weakening of the LCR metrics for both Islamic and conventional banks.

Moody’s reported that in a comparison of Islamic banks’ LCRs with conventional peers across countries, those Islamic banks with a strong retail focus typically have strong LCRs, but they also face a shortage of Shariah-compliant high-quality liquid assets (HQLAs), putting them at a disadvantage relative to conventional banks.

On the bright side, the Malaysian, Indonesian and Qatari governments have been frequent sovereign issuers of sukuk in recent years, providing a solid stock of Shariah-compliant HQLAs for Islamic banks. By contrast, the scarcity of Shariah-compliant HQLAs in Saudi Arabia and Kuwait, because of a lack of domestic sovereign sukuk issuance, is pushing Islamic banks to hold large balances of cash and low-yielding Treasury bills.

Looking ahead, liquidity for Islamic banks will continue to benefit from the expansion of their retail businesses, while the development of domestic sukuk markets will improve their access to HQLAs, further bolstering their LCRs.