Malaysia's central bank is introducing an Islamic overnight funding facility which could encourage commercial banks from the Gulf to trade more in the country's sharia-compliant money market.

The collateralised murabaha facility, announced last week, 'will add diversity to the existing liquidity management tools and further promote greater liquidity in the Islamic financial market,' the bank said.

The new facility will allow Islamic banks to obtain funds from the central bank by pledging high investment grade sukuk as collateral, a Malaysian-based Islamic banker said.

Currently, Islamic banks can obtain funds from the central bank through a deferred-payment sale agreement, but this structure is not considered permissible by some sharia scholars outside Malaysia so banks from the Gulf have been reluctant to use it.

Because it involves murabaha, a common cost-plus financing structure in Islamic finance, and collateral, the new facility is likely to be more acceptable to banks from the Gulf, the banker said, adding it may be more cost-effective.

Last June the UAE central bank introduced a similar facility to provide liquidity to banks: a collateralised murabaha facility in which banks can use Islamic certificates of deposit as collateral.

Al Rajhi Bank, Kuwait Finance House, Bank Alkhair and Elaf Bank are among the Middle Eastern institutions active in the Malaysian market.

The facility is in line with increasing allocations of funds into sukuk by Islamic banks, Bahrain-based Al Salam Bank assistant vice-president Srinivasan Gopalakrishnan said.-Reuters