Written by Shama shoukat

Q3. A critical evaluation of The Guidance Notes and Standards of the IFSB (Islamic Financial Services Board) on Capital Adequacy for Islamic Financial Institutions designed to address the Basel III requirements. With the tremendous growth in the Islamic financial industry, it is attracting the market participants across the world. It has become more important in the different regions and being a flourishing baking segment over the time. IFSB (Islamic Financial Service board) is providing the guidelines time to time to resolve the issues that the Islamic financial industry encountering due to weaknesses in its framework.The Third Basel Accord is the set of framework to address the weakness of the Islamic financing to improve the liquidity management and leverage and funding ratios to improve the capital adequacy. The guideline provided by the IFSB to address the requirements of the Basel III help the Islamic financial service providers to improve the liquidity and risk related issues, capital adequacy ratio and many other stress factors.

The Islamic banks mostly financed by the Tier 1 capital consisting of the common stock and Tier 2 consist of impairment and allowances to limited extent. (Annadif, 2013). The Basel III requires that the Islamic financial institutions must be financed by the equity with the lower percentage and other risky assets by higher percentages. But this capital must have a high liquidity coverage ratio and low leverage ratio. (BIS, 2015)

The guideline provided by the board helps the Islamic service providers to implement the liquidity coverage ratio to eliminate the weaknesses of the financial industry. The IFSB-GN-6 defines the three main features that the quality liquid asset must have. (GULF BANKING, 2015)

Low correlation with risky assets Active and sizeable market Low volatility

The Islamic financial institutions and banks are having the assets that are generating low profits consisting solely of the bank deposits. According to the board, the adequate capital consisting of the cash, high quality liquid assets and Sukuk can enhance the liquidity and lower leverage ratios generating high profits for the institutions. The balance issuance of the sukuk and other financial instruments can lead the financial institutions toward the high profitability (Saudi Gazette, 2015)The board also focused on the capital loss absorption that enables the conversion of the capital instruments into the common stock of the bank terms and condition are proved impractical and non-viable. The capital instruments can also be written off. This clause removes the barriers and let the private sectors to contribute in this Islamic financing. (BIS, 2015)There are few challenges that the financial institution are facing with respect to the third Basel Accord. All the Islamic banks are well financed by the Tier 1 and Tier 2. To calculate the adequacy capital ratio the capital introduced must me identified using the alpha factor. This alpha factor varies with respect to jurisdiction. With the increase in the financial instruments, for example Sukuk it is tough to identify that with which tier the instrument belongs. (Kammer, 2015)

The principles and guideline given by the board can reduce the financial crisis across the globe and can enhance the tremendous growth of the Islamic financial institutions as well as industry. The third Basel Accord will provide the opportunity to deal with the Shariah-compliant and the central banks and other financial institutions can help in the issuance of the sukuk to resolve the weakness of the Islamic financial institutions. It will improve the risk management, transparency of the bank with the disclosure requirements and will tackle the economic stress that the banks are facing for the last few years.

ReferencesAnnadif, C. R. a. A. A., 2013. Islamic Banking and Capital Requirements. [Online] Available at: http://www.riskdynamics.eu/blog/bid/325781/Islamic-Banking-and-Capital-Requirements-Part-2[Accessed 19 June 2015].BIS, 2015. Basel III phase-in arrangements. [Online] Available at: www.bis.org/bcbs/basel3/basel3_phase_in_arrangements.pdf[Accessed 19 June 2015].GULF BANKING, 2015. Basel III requirements to strengthen Islamic banks liquidity. [Online] Available at: http://gulfnews.com/business/sectors/banking/basel-iii-requirements-to-strengthen-islamic-banks-liquidity-1.1486048[Accessed 19 June 2015].Kammer, A., 2015. Islamic Finance: Opportunities, Challenges, and Policy Options. [Online] Available at: http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CB4QFjAA&url=http%3A%2F%2Fwww.imf.org%2Fexternal%2Fpubs%2Fft%2Fsdn%2F2015%2Fsdn1505.pdf&ei=OEKDVbfIEM2JuATFxrzwCw&usg=AFQjCNFYu2WZJAeEX0ZxpRO3tnYIqIoRJw&sig2=p4dIl3ZGAYQV0SDhHEY76g&bvm=bv[Accessed 19 June 2015].Saudi Gazette, 2015. Basel III requirements to strengthen Islamic banks liquidity management. [Online] Available at: http://www.saudigazette.com.sa/index.cfm?method=home.regcon&contentid=20150401238900[Accessed 19 June 2015].