The move comes as part of a broader push to promote London as a top centre for Islamic finance
The Bank of England is studying ways to increase the number of sharia-compliant assets that Islamic financial institutions can use in their liquidity buffers, a step towards reducing concentration risks in the sector.
The move comes as part of a broader push to promote London as a top centre for Islamic finance, in the face of growing competition from other centres such as Dubai and Kuala Lumpur.
Currently, sukuk (Islamic bonds) issued by the AAA-rated Islamic Development Bank are the only assets that meet the central bank's criteria for use in the liquidity buffers of the 22 Islamic financial institutions operating in Britain.
These include six full-fledged Islamic banks such as the European Islamic Investment Bank, Bank of Londonand the Middle East and Gatehouse Bank.
In addition to reducing risks, expanding the eligible list could improve growth prospects for the industry and remove a potential entry barrier to the sector, a consultation paper released by the central bank said.
"Recognising only one asset also potentially limits the growth of existing sharia-compliant firms and creates barriers to entry for new sharia-compliant firms due to the difficulties that can be experienced obtaining the asset."
Islamic finance follows religious principles such as bans on interest and pure monetary speculation; this limits the types of financial tools that banks can use to manage their short-term funding needs.
The Bank of England's proposal is in line with the approach of Basel III global banking regulations, which allow sukuk issued by high-rated sovereigns to be included in the liquid assets buffer without a haircut.
This would allow Britain's proposed 200 million pound ($330 million) sovereign sukuk issue to be used, as well as other high-investment grade instruments such as sukuk issued by the Malaysia-based International Islamic Liquidity Management Corp.
Sukuk issued by sovereigns with lower credit ratings and other non-financial issuers could also be eligible, subject to haircuts and caps, the consultation paper said. The consultation will end on April 15 but no date was given for the proposed reform.
Britain first announced plans for a sovereign sukuk issue six years ago but that issue never materialised as the country's Debt Management Office decided the structure was too expensive.
The new proposal is less than a fifth of the size of the original, and is designed to boost London's status rather than to diversify Britain's investor base to a significant degree.