Improving Banking Supervisory Mechanisms
In the OIC Member Countries
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5.7 Capital Conservation Buffer and Countercyclical Buffer in Islamic Banks
There are also two additional buffers set up by the Basel committee: a countercyclical buffer
and a capital conservation buffer in order to prevent a financial collapse.
- Capital Conservation Buffer
An important part of the capital conservation buffer should be composed of common equity
(Tier 1) assets. If the banks have not enough capital for this buffer, Basel 3 restricts the
distribution of dividends, share buybacks or bonus payments until the ratio of 7% is respected
(4.5% + 2.5%). Constraints on a bank’s discretionary distributions will be imposed when
banks fall into the buffer range.
- Countercyclical buffer
When banking authorities judge that credit growth is resulting in an unacceptable buildup of
systematic risk, an additional capital buffer will be required.
In these two requirements, Islamic banks neither have a competitive advantage nor
disadvantage against conventional banks. Therefore, the impact of capital conservation and
countercyclical buffer is neutral on Islamic banking.
5.8 What are the Core Principles Effective in Banking Supervision in Islamic
Banking?
As we discussed before, there are 29 core principles for effective banking supervision for
conventional banking. The adaptation of the revisions of Pillar 3 on market discipline with
respect to disclosure requirements (for securitization exposures, sponsorship of off-balance
sheet vehicles, and the components of regulatory capital) should not be a significant problem
in Islamic finance. However, a more fundamental systemic issue related to market behavior
became apparent during recent months when emerging markets experienced substantial
capital outflows and exchange-rate pressures – namely, a vulnerability of Islamic finance that
emanates from volatile Sukuk markets with the potential to “infect” Islamic banks and thus
spread throughout the whole IFSI.
A particular stability concern results from the quantitative asymmetry between the global
conventional industry and the Islamic finance industry: movements that are minor on the
global conventional finance scale can have major destabilizing effects for the much smaller
Islamic finance industry. Recent market turbulence that resulted in capital outflows and
pressures on the exchange rates of some IFSB member countries are powerful reminders of
the importance of macro-prudential oversight for the timely identification and assessment of
systemic risks and for appropriate policy measures whenever necessary. The quantitative
asymmetry suggests that macro-prudential supervision is of greater importance for the Islamic
segment of the financial system.
Along with the most important micro-prudential regulations issued for the banking sector, the
market turbulence of 2013 suggests the need to intensify or initiate more work on cross-sector
regulations and macro-surveillance. With the BCBS as the main strategic partner of the IFSB
for micro-prudential issues, the cooperation between the IFSB and the IMF could help to link
the latter’s macro-prudential initiatives with the work of the IFSB, hence contributing to the
IFSI’s greater stability and resilience.