Challenges in implementing capital adequacy guidelines to Islamic banks
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Challenges in implementing capital adequacy guidelines to Islamic banks Rima Turk Ariss and Yolla Sarieddine
Department of Finance, Business School, Lebanese American University, Beirut, Lebanon. Tel: +961 1 786456 1644; Fax: +961 1 786456 1627; e-mail: [email protected]
Rima Turk Ariss holds a PhD from the University of Wales, Cardiff Business School, United Kingdom, July 2004. She is currently employed at the Lebanese American University as an Assistant Professor of Finance in the School of Business. She teaches undergraduate and graduate courses in finance. Her research interests include the impact of financial liberalisation on bank efficiency; cost efficiency and productivity change; banking concentration and competition; market structure and financial stability; Islamic banking and finance; and law and finance. Yolla Sarieddine holds a Masters Degree in Business Administration from the Lebanese American University (2006). She is currently employed as the manager of the credit department at Kafalat (Guarantees for Loans for Small and Medium Enterprises). ABSTRACT
Throughout the past 30 years or so, the practice of Islamic banking has proved to be a viable alternative and is growing at an estimated annual rate of 15 per cent. Many challenges still lie ahead, however, for Islamic banks to be able to comply with international standards and guidelines. A key issue relates to the implementation of Pillar 1 of the Basel II Accord, or capital adequacy requirements that were originally set to capture different types of risks faced by conventional banks, and that do not cater to the risk specificities of Islamic banks. The objective of this paper is to overview the recent guidelines for risk management and capital adequacy in Islamic banking and to study the implications of applying Pillar 1 to a
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major Islamic bank. We specifically raise serious issues related to the nature of risks arising from the uses of funds of Islamic financial institutions and their implication on the banking book of the Islamic financial institution. Still other challenges lie ahead of international regulatory bodies in order to cater to other types of risks that are unique to Islamic financial institutions. Journal of Banking Regulation (2007) 9, 46–59. doi:10.1057/palgrave.jbr.2350059
INTRODUCTION In three decades of evolution of the Islamic banking industry, a number of Islamic banks were established under heterogeneous social and economic environments. What started as a small rural banking experiment in a remote village in Egypt has now reached a level where both local and international banks are committed to offering a wide range of Islamic banking products and services. The practice of Islamic banking spreads from East to West all the way from Indonesia and Malaysia towards Europe and the Americas. The successful operations of these institutions and their growth have established that Islamic banking is a viable and robust alternative to commercial banking practices. Islamic finance gained additional momentum when multinatio
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