CAPITAL ADEQUACY & IMPLEME TATIO OF BASEL III IN ISLAMIC BANKS

Over the years there is increasing emphasis on the important of capital adequacy. The recentspates of financial crisis worldwide have raised greater awareness of the importance forcapital adequacy. Banks has to strike a balance between the risks they are exposed and thecapital to support that risks. The trade offs of matching too much capital to a risk, is a lessattractive returns to its shareholders. The opportunity costs of doing the opposite would beperilous to the banks. Hence, banks are devoting significant resources towards risk andcapital management, using sophisticated tools and calculations. The complexity of thisminimum capital adequacy model (Basel 2) is a better reflection of their actual risks – withthe inclusion of operational, functional, reputation, traded market, interest rates risks – ascompared to the use of credit risk only (Basel Accord) in the past. This paper firstly reviewsthe role of capital adequacy in conventional banking and Islamic banking and argues that auniform application of the Basle capital adequacy norms to both conventional and Islamicfinancial institutions may be discriminatory and defeat the very purpose of the regulations,that of ensuring a level playing field for banks across the globe. The business of Islamicbanking is different. Islamic interbank money market is also likely to be influenced byliquidity standards of Basel III accord. The papers argues that it would be a very difficulttask for Islamic banking system to fully prepare the implementation of new liquidity standardunder current scheme. The paper discusses some unique characteristics of assets andliabilities of Islamic banks. The nature and magnitude of relevant risk factors for Islamicbanks are observed to be quite different as compared to conventional riba-based banks.