The lack of appropriate financial instruments is leading to excess liquidity and to an uneven playing field for Islamic banks, the IMF said in a report on the sector.
Islamic banks have become a significant part of GCC's banking systems, the report said.
While in the Middle East and North Africa (MENA) region Islamic banking assets represent 14% of total banking assets, in the GCC the market share is over the 25% threshold, "which suggests that Islamic banks have become systemically important in these countries", the IMF said.
GCC Islamic banking assets reached $490 billion at end-June 2013, with Saudi Arabia dominating the region with a 49% share, followed by the United Arab Emirates on 19%, Kuwait on 16%, Qatar at 11% and Bahrain with 5%, while the segment is "still nascent" in Oman, the IMF said.
With total Islamic banking assets of $564bn as of the first half of 2014, the GCC region accounted for 38.2 per cent of global Islamic banking assets, the report said.
However, liquidity management has become a concern as there is a general lack of Sharia'a-compliant instruments that can serve as high-quality short-term liquid assets.
"The inadequate availability of Sharia'a-compliant financial instruments seems to have forced Islamic banks to hold a significant amount of cash reserves, limiting the flexibility of the central bank's monetary operations with Islamic financial institutions. Therefore, a key challenge is to broaden the range of Sharia'a-compliant instruments and build liquid markets", the report said.
A "partial" response would be to support efforts to build Islamic liquid interbank and money markets, which are crucial for monetary policy transmission through the Islamic financial system, the IMF said. "This can be achieved, to a large extent, by deepening Islamic government securities and developing Shari’ah-compliant money market instruments," it said.
Despite significant progress in the GCC Islamic banking infrastructure, access to market financing, particularly to securities and other placement opportunities, remains limited for Islamic banks compared with their conventional counterparts, the IMF said. For the GCC overall, holdings of securities in terms of assets were higher, at 18.4%, for conventional banks compared to Islamic banks at 14.6 per cent.
"In most countries, efficient money and interbank markets for Sharia'a-compliant instruments have not yet been developed, partly because of the limited availability of the necessary instruments," the report said.
GCC countries have made some efforts to issue Sharia'a-compliant financial instruments, it said.
The IMF added that efforts should continue to develop the sovereign sukuk market, which will help to develop the Islamic interbank market.