INSTRUMENTS FOR MEETING CAPITAL ADEQUACY REQUIREMENTS UNDER BASEL III: A SHARĪʿAH PERSPECTIVE

The Basel III regulatory framework has set out new capital and liquidity standards for banking institutions. In particular, Basel III has increased the minimum capital levels to be maintained by banks and redefined the criteria for qualifying regulatory capital instruments to be included under Tier-1 (T1) and Tier-2 (T2) capital. The overall objectives of the reforms are to enhance the banking sector’s ability to absorb shocks arising from financial and economic stress and reduce the risk of spillover from the financial sector to the real economy (BCBS, 2011: 1).

The revised definition of regulatory capital by Basel III has in turn raised some key questions concerning the capital raising exercise of Islamic banking institutions (IBIs). It is asked whether the Basel III capital instruments can be issued by IBIs without raising Shari’ah concerns and thus meet the objective of strengthening the resilience of IBIs in the event of economic and financial stress. Accordingly, regulatory bodies such as Bank Negara Malaysia (BNM) and standard setting bodies such as the Islamic Financial Services Board (IFSB) have issued guidelines for IBIs on the maintenance of regulatory capital in compliance with Basel III regulations. The Capital Adequacy Framework issued by BNM (2012) is applicable to IBIs in Malaysia; while Exposure Draft-15 issued by IFSB (2012) which is still going through the process of revision based on public consultation and is expected to be finalized by the end of 2013-provides initial guidance to regulators and IBIs worldwide on the maintenance of high-quality regulatory capital components which comply with Shari’ah rules and principles.

This research will compare the qualifying Additional Tier-1 (ATI) and Tier 2 capital instruments under Basel III. In particular, the research will examine the Shari’ah issues, especially related to subordination, arising in both equity-based and exchange-based contracts when used for structuring ATI and T2 capital instruments. It will also discuss the current subordinated sukük issued by IBIs worldwide for meeting regulatory capital requirements. In the light of the discussion, the most appropriate Shari ah contracts relevant for structuring ATI and T2 capital instruments will be proposed.