Capital Adequacy Norms For Islamic Financial Institutions

This paper argues that a uniform application of the Basle capital adequacy norms to both conventional and Islamic financial 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 Islamic banking is different. The paper discusses some unique characteristics of assets and liabilities of Islamic banks. The nature and magnitude of relevant risk factors for Islamic banks are observed to be quite different as compared to conventional riba-based banks. Further, Islamic banks can “pass on” asset risk to investment account holders unlike their conventional counterparts. Given the possibility of such risk absorption, the paper questions the relevance of the Basle norms in their present form and discusses certain modifications and alternative ways to compute capital adequacy measures for Islamic financial institutions.