Monetary Policy in the Presence of Islamic Banking

IMF Working Papers, March 18, 2016

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Paper discusses key issues related to the conduct of monetary policy in countries that have Islamic banks.
Describes the macrofinancial background and monetary policy frameworks where Islamic banks typically operate.
Analyzes the monetary transmission mechanism in economies where Islamic and conventional banking coexist.
Notes that most economies with Islamic banks also have conventional banks, calling for a comprehensive approach to monetary policy.
Argues that a dual approach to monetary policy should be considered whenever the Islamic segment of the financial system is not as developed as the conventional one.
Explores potential spillovers between conventional and Islamic financial systems.
Proposes specific recommendations on the design of Islamic monetary policy operations and for facilitating monetary transmission through the Islamic financial system.

Coexistence of Islamic and conventional banks affects monetary transmission channels and policy design.
The relative development of the Islamic segment matters: less-developed Islamic segments may warrant a distinct (dual) policy approach.
Spillovers between conventional and Islamic financial systems are important for overall financial stability and policy effectiveness.
Liquidity management, interbank markets, and the availability of Islamic-compliant instruments (e.g., Sukuk markets) are central to transmission via Islamic banks.

Design Islamic monetary policy operations tailored to the characteristics of Islamic banks and Islamic-compliant instruments.
Facilitate monetary transmission through the Islamic financial system by improving liquidity management tools available to Islamic banks.
Consider the degree of development of the Islamic financial segment when choosing between comprehensive and dual monetary policy frameworks.
Address interbank market functioning and market infrastructure to reduce frictions between conventional and Islamic segments.
Enhance availability and depth of government securities and Sukuk markets to support market-based monetary operations for Islamic banks.
Account for implications for lender-of-last-resort arrangements and crisis management in dual financial systems.

Subjects: Asset and liability management, Credit, Financial markets, Financial services, Interbank markets, Islamic banking, Islamic finance, Liquidity, Liquidity management, Monetary policy, Monetary policy frameworks
Keywords: bank, bank lending channel, banks competition, dual financial systems, exchange rate, financial system, funding cost, Global, government securities market, Interbank markets, Islamic banking, Islamic banks, lender of last resort, Liquidity, Liquidity management, market, monetary operations, monetary policy, monetary policy framework, Monetary policy frameworks, monetary policy transmission, monetary transmission mechanism, Sukuk markets, transmission mechanism, WP