The Bank for International Settlements published two important consultation documents in December which can be viewed on its website. The consultation period ends in April, but if the proposals are accepted, which seems likely, it is too early to ascertain how long implementation will take. The Islamic Financial Services Board (IFSB) will have to consider the implications for Islamic banks. The major changes concern capital adequacy. There will be no significant changes to Tier 1, comprising paid up capital. Tier 2 is to comprise only subordinated debt, the issue for Islamic banks being whether Sukuk can be included in subordinated debt. The subordination means that the debt can absorb losses, with other creditors, such as Mudarabah depositors, having their claims settled first in the event of a bank failure. As Sukuk are asset-backed, one issue is whether this would affect the pecking order for claims in the event of bankruptcy, with Sukuk holders having a prior claim over designated assets. If this is indeed the case, Sukuk may not qualify as subordinated debt. There are also issues about acceptable liquidity, which poses potential problems for Islamic banks, as commodity Mudarabah assets are unlikely to qualify. Clearly, the IFSB will have to consider carefully the liquidity proposals of the Basel Committee, and indeed the wider issue of whether new Shariah compliant instruments can be developed for liquidity management.
PROFESSOR RODNEY WILSON
Basel 3 is a band aid for western problems. In some markets, Islamic banks already exceed the expected standards. But we have two problems: what will come of securitization, and is anybody worried about liquidity? ABDULKADER THOMAS CEO and President, SHAPE ─ Financial Corp
The consultation paper issued by the Basel Committee of Banking Supervision (BCBS), entitled “Strengthening the Resilience of the Banking Sector” and commonly dubbed as “Basel 3”, attempts to strengthen global capital and liquidity regulations. The issues addressed are the raising of the quality and quantity of Tier 1 capital, enhancing the risk management framework and introducing a leverage ratio. These measures are aimed at promoting the build-up of capital buffers in the good years that can be drawn upon in bad years. The challenge that faces any bank is associated with the fact that Tier 1 capital will be redefined to only include pure equity and no longer subordinated debt that was originally issued to meet capital requirements. The announcement by Deutsche Bank in early 2009 not to refinance its subordinated debt but instead pay an additional cost to servicing it, supports the notion that subordinated debt should not be considered as part of capital, but instead as operational funds. This will either result in an increase in pure equity capital or a change in the lending strategies of banks. Reduction in high risk lending or a flight to low risk lending only may be the result. For Islamic banks, the challenge is in principle fairly similar, even though the use of subordinated debt is at present minimal. The larger challenge for Islamic banks is not necessarily posed by the redefinition of Tier 1 capital under the proposed new guidelines, but has more to do with the following two points: Given that the consultation period on the BCBS paper does not close until the 16th April 2010, now is probably a good time for Islamic banks to discuss these issues with their regulators. DR NATALIE SCHOON Head of product research, Bank of London and the Middle East
It is almost lost in the discussion of standardization and standards setting bodies that the key to the success of any effort is buy-in from the Islamic financial institutions (IFIs) involved. If IFIs ignore or cherry pick the standards established to guide the industry, then their implementation should be judged a failure. Right now, there is enough acceptance of standards like those of AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) that it is still in the grey area between success and failure. Certainly, the work of AAOIFI is respected globally and several countries have made the adoption of AAOIFI standards mandatory. However, there is much more that needs to be done to make the standards even more relevant. Standards setting bodies like IFSB and AAOIFI need to continue to engage national regulatory bodies to either make the standards mandatory or be strongly encouraged for IFIs. This may be difficult in jurisdictions where IFIs are regulated identically to conventional financial institutions and there is no separate regulatory framework for IFIs. Once this point is reached where countries without separate regulations for IFIs are the only ones where AAOIFI or IFSB standards are not required, then IFIs should work to pressure the acceptance of the standards as a marketing tool that sets the standards-abiding institutions apart from those that choose not to adopt the standards in full. BLAKE GOUD Principal, SharingRisk.org
|