Impacts of Basel III on Islamic Finance

Abstract

The Basel Committee on Banking Supervision (BCBS) has introduced Basel III which was initiated after the recent global financial crisis in an effort to strengthen the regulatory regime of the banking sector. Basel III has introduced several modifications such as added liquidity requirement ratios in addition to strengthening capital requirements. This paper examines the impact of Basel III regulatory framework on Islamic Finance from a theoretical point of view. Using content analysis, this study finds that the impact of Basel III on Islamic Finance is relatively smaller than conventional finance since their model does not support short selling and non-Shari’ah complaint derivatives and thus they are having this competitive advantage over their conventional counterpart. However, it is important to highlight that deep examination of Islamic Banks’ nature, specifications, and the way they conduct business is required to identify issues not considered by the Basel III framework. As Islamic Banks will not be able to fully adopt Basel III framework without any modifications that are in line with their specifications and nature. Thus, recommending IFSB to adapt these new requirements and issue new standards by considering Islamic finance industry when doing so. There is also a need for a robust infrastructure for Islamic financial institutions for their sound liquidity and smooth functioning, which will include development of Islamic money market and securities market. In addition, there is need for innovating new Shari’ah compliant products for Islamic financial institutions instead of just mimicking conventional products.