Basel lll capital rules may help Islamic banks to develop quality assets
The revised capital requirements for Basel lll will strengthen the Islamic finance industry and may lead to improve the quality of their liquid assets to comply with liquidity coverage ratio and net stable funding ratio, experts say.
The banking and financial analysts, however, say the regulators should join hands to develop more Islamically acceptable liquid instruments for enhanced asset allocation and liquid management.
“The revision of capital requirements for Basel III should encourage the Islamic banks to allocate more funds towards quality assets, which will diversify the risk and strengthen their balance sheets,” Kazim Ali, head of corporate banking at Noor Bank, told Khaleej Times.
According to an estimate, global Islamic banking assets are ranging from $1.8 trillion to $2 trillion as the Shariah-compliant banking is gaining momentum across the world with an impressive annual growth rate of 15 per cent to 20 per cent. However, the Islamic finance industry is yet to become a global force due to various issues, which need to be addressed to pose a serious challenge to conventional banking.
Ali said introduction of LCR by the Islamic Financial Services Board (IFSB) is expected to address the issues such as the lack of high quality assets provided the regulators come up with a relatively comprehensive list of high quality liquid asset (HQLA) keeping in mind the Islamic banks’ Shariah-imposed investment restrictions.
“Restricting to purely government sukuks or other instruments which do not have sufficient market depth may cause an adverse impact, Ali said.
Ashruff Jamall, partner — Global Islamic Finance Leader of PwC, echoed similar views and said the requirements to comply with LCR and NSFR will require Islamic financial institutions to improve the quality of their liquid assets, which is likely to be challenging in view of the lack of breadth of the equivalent of an Islamic money market as well as Islamically acceptable liquid instruments.
“Regulatory and supervisory authorities may need to use national discretion in order to account for specific economic conditions and the business models of Islamic financial institutions in their respective jurisdictions,” Jamall told Khaleej Times.
“Regulators in the UAE and the wider GCC and the market must work together to enhance the number of Islamically acceptable liquid instruments in order to allow for enhanced asset allocation and liquidity management. PwC is a key contributor and works closely with regulators and the industry on related standards and regulations,” he added.
To a question about IFSB revised capital requirements for Basel III standard, he said those elements of the Basel III framework, which are relevant to the Islamic financial services industry, would certainly have a positive impact in strengthening the capital and liquidity of Islamic financial institutions.
“The requirements relating to enhanced risk management, governance, liquidity, such as LCR and NSFR, maintenance of higher capital buffers such as the counter cyclical buffers and tighter rules around composition of capital will all contribute to boosting the capital requirements of Islamic financial institutions.
“Islamic financial institutions that foresee the need for an increase in their capital should start taking proactive steps to comply with the applicable elements of Basel III, which is being phased in over a number of years through to 2019,” Jamall said.
The IFSB is likely to release its guidance note on the parameters and calculation of the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) in early 2015.
Credit rating agency Standard & Poor’s, which believes that the IFSB revised capital requirements for Basel III could help to strengthen the Islamic finance industry, said in a recent report that the introduction of a LCR might address some of the industry’s long-standing weaknesses, particularly the lack of HQLA.
“Our base-case scenario assumes that there will be no major changes in Islamic banks’ quality of capital, which we see as strong on average. At the same time, we believe that raising capital requirements through the introduction of new capital buffers will help to make the industry more resilient,” said Standard & Poor’s credit analyst Mohamed Damak.
These buffers will ultimately help Islamic banks to cope better with the cyclical nature of the economies of the countries in which they operate and major business activities. Most of the Islamic financial institutions that we rate operate in emerging economies and also tend to have fairly significant exposure to the real estate sector.
“While we continue to view the liquidity of the Islamic financial institutions that we rate as adequate on average, we think that Basel III implementation creates an opportunity for the industry to develop a new range of HQLA to address the chronic lack of such instruments.”
Over the past few years, the Central Bank of Malaysia has tackled the lack of HQLA by becoming the largest issuer of short-term sukuk, providing Malaysian Islamic banks with much needed liquidity management instruments.
Other central banks, the International Islamic Liquidity Management Corporates (IILM), and the Islamic Development Bank (IDB) may follow suit, providing the industry with new liquidity management instruments. Basel III implementation may also encourage highly-rated sovereigns and corporates to list their sukuk on developed and liquid markets to make them eligible for HQLA inclusion - By Muzaffar Rizvi© Copyright - Khaleej Times