Gulf institutions plan to spur development of the Islamic finance industry by setting up a bank that would boost liquidity in sharia-compliant markets.

But the mandate of the bank is so wide that it may struggle to have an impact early on, says a Reuters report.

The Islamic Development Bank (IDB), a Jeddah-based multilateral institution, signed a memorandum of understanding with the Qatari government and Saudi Arabia's Dallah Albaraka Group on Tuesday to launch an Islamic bank based in Doha.

The bank will aim to facilitate Islamic interbank trade, develop liquidity-management solutions and launch an Islamic securities market, IDB president Ahmad Mohamed Ali said in a statement.

It will address "the dearth of senior financiers" and "the absence of market liquidity between Islamic banks", he said without giving a timeline for the bank's launch. The bank would also become involved in infrastructure projects and standardising Islamic financial products.

The bank's ambitions address some of the main weaknesses of the Islamic finance industry. Liquidity is a major issue.

Last month, for example, the Bahrain-based International Islamic Financial Market and the International Swaps and Derivatives Association launched a contract template for Islamic profit rate swaps, to help Islamic financial institutions better hedge risk. But banks will find it hard to use the swaps without a liquid market; by becoming a major player in swaps, the new bank could accelerate growth of the market.

But the breadth of the bank's mandate means it may struggle, initially at least, to focus effectively on a single area. Interbank trading, infrastructure financing, product design and standard-setting are different skills which the bank will need to build from scratch - possibly setting off a bidding war for some of the top Islamic finance talent in the Gulf.

It is unclear if the bank's resources will be sufficient for the tasks. The three founders said the bank would have $1 billion of capital - not a massive amount for a bank - and that they had agreed to provide $500 million of that amount. They did not specify where the rest of the capital would be obtained.

There has been market talk in the past that institutions might be set up elsewhere to help develop the Islamic finance industry, for example in Bahrain. One such plan which has come to fruition is the Malaysia-based International Islamic Liquidity Management Corp, established in November to issue short-term instruments compliant with Islamic law. Its mandate is narrower than that of the IDB's proposed bank. - Reuters