Basel lll, on track to be implemented globally over the coming year, intends on enhancing the banking regulatory framework by strengthening bank capital requirements. Overall, Islamic banks appear to be capable of withstanding the regulatory realignments, yet they will need to address particularities within the new standards as they may cause adverse effects on their deposit bases.
Clear, simple asset management procedures undertaken by Islamic financial institutions will see a smooth transition to meet Basel III’s minimum capital standards with confidence. However, Sharia compliant financial procedures employed by Islamic banks may prove problematic as interest payments are not favoured. Alternatively, deposits are garnered through Profit-Sharing Investment Accounts (PSIAs), which tend to be more challenging than standard deposit practices. New regulations will need to come into play to ensure risk is eliminated. Although obtaining High-Quality Liquid Assets (HQLAs) may appear beneficial, they are not generally adapted to Sharia principles due to Islamic securities markets not being as substantial as other markets. Not inclusive of Bahrain and Malaysia, Arabic central banks do not commonly issue instruments which are certified HQLAs, and they generally have a short cycle.
Following a study by Thomson Reuters, it was established that Islamic commercial banks asset’s amounted to about $1.2 trillion at the end of 2013. This includes approximately a quarter of Gulf Arab Countries’ deposits, and over a fifth of Malaysia’s. Basel III’s reformations require banks to maintain a sizeable amount of HQLAs, over and above the net cash outflows for 30 days under a high-stress scenario. Outflows are determined through allocating a variety of weights to funding sources such as PSIAs. A larger amount of HQLAs are needed to compensate for the predicted repercussions involved in riskier funding sources, leading to them having shorter cycles and require additional reporting.
Full visibility into this matter will be obtained once Basel III begins to be implemented globally, as leading regulators will then begin to assign “run-off rates” to PSIAs. Regulators are aware of the Islamic banking sector’s potential, and will continue to proceed accordingly. Their evaluation will be determined by a series of factors and procedures intended on indicating the Islamic banking industry of each country, not limited to the issue of handling of losses onto deposit holders under their contracts. The Malaysian Islamic Financial Services Board (IFSB) will also converge early of next year in order to asses this matter, providing the national regulators with guidance and insight.
The Central bank of Kuwait has begun to assimilate its regulatory standards with Basel lll in anticipation of its global implementation. This is intended to strengthen the Central Bank of Kuwait, as Basel lll is predicted to reduce risks arising from financial and economic stress. This is designed to promote the stability and development of the nation’s businesses and markets.
Malaysia’s Central Bank has yet to announce run-off rates or HQLA requirements for PSIAs. Commercial banks have predicted that these may be declared early next year following IFSB. They have, however, issued that PSIAS will be categorised into one of two types; general PSIAs which are comparable to standard retail deposits, and specific PSIAs which are equivalent to managed investment accounts. Islamic banks have been given a reasonable two-year period to create an internal regulatory system of distinguishing between the two deposit types. It has been suggested that global regulators may declare run-off rates of 3-10%, depending on the stability of the deposits. Perhaps, Islamic banks may follow suit, meaning the number of HQLAs needed may vary greatly within the percentage bracket.
Basel lll’s functionality is twofold; it is positioned to strengthen the industry on both a microprudential and macroprudential level, increasing the durability of banking systems directly against industry-wide risks. The Islamic banking sector’s Basel lll implementation will mark the reformation of the banking industry, as the regulatory framework is wholly aimed at stabilising the global economy through maximising on the international and regional potential of the banking and financial systems.
