Capital Standards
In general, Basel III contains various measures aimed at improving the quality of the capital with the ultimate aim of improving the loss absorption capacity in both going concern and liquidation scenarios. Under Basel III, common equity will form the predominant part of Tier 1 capital. Tier 2 capital will be simplified and Tier 3 will be phased out completely. The committee also has stricter definitions for what counts as capital. There are no changes in standardized approach for risk weighting assets.
Most of the Gulf based banks are comfortably placed with respect to these changes. Tier 1 capital has been the predominant form of bank capitalization in the region, although a few banks have issued Tier 2 subordinated debt.
One question that was debated was what constitutes an adequate level of capital adequacy. Most Gulf Countries have a minimum CAR of between 10% to 12% which is way above the Basel standards of 8%. Adding the counter cyclical buffer would raise the minimum level to 14.5%. Participants felt that this level could adversely affect growth.
Qatars Central Bank has said in January 2011 said that Islamic Banks are likely to be governed by a set of rules that are different from those applied to the conventional Banks. Participants were interested in knowing how different these would be from the Basel III regulations.
Liquidity Standards
Basel III Liquidity Ratios will concentrate on improving both the short term and long term liquidity profiles of banks. The Liquidity Coverage Ratio, measures a bank's ability to convert assets into cash within a 30-day window, and would need to be a minimum of 100%. In addition, banks are required to better match the tenors of their liabilities with their assets using a Net Stable Funding Ratio. This would be calculated as available amount of stable funding divided by the required amount of stable funding, and would need to be a minimum of 100%.
Both regulators and participants felt that the extreme stress scenario used for the Liquidity Coverage Ratio, combined with the definition of high quality liquid assets, may prove problematic for Gulf based banks, as many of the markets were intrinsically small.
It was pointed that in January 2011, Qatar’s Central Bank issued specific directives to the conventional banks that have Islamic branches, directing them to stop opening new Islamic branches, accepting Islamic deposits and dispensing new Islamic finance operations.
These directives also affect the liquidity management of the Islamic banks in two ways. Firstly, the lack of a developed Islamic money market, and especially an Islamic interbank market, of the kind seen in conventional finance affects the short term liquidity management of the Islamic banks. Secondly, the shortage of short term, liquid Islamic investment instruments with limited capital risk and predictable returns also hampers the development of liquidity management as required under Basel III.
Conclusions
Improved capital standards under Basel III are not likely to impose too much of a burden on Gulf based Banks. It is quite likely that Gulf regulators would fast track these changes ahead of their counterparts in the western markets where Banks are likely to go through a capital raising process. Readers will recall that Kuwait was one of the earliest jurisdictions in the world to implement Basel II capital standards in 2005.
However, Liquidity Standards do pose a challenge in terms of implementation especially for Islamic Banks. Given the current state of development, Islamic finance is a still a relatively small part of the total financial services industry in many Gulf markets; and therefore it may be difficult to create a local Islamic liquidity market of worthwhile size.
Therefore it has been proposed that the implementation of the liquidity proposals needs to be progressive and in line with the development of Shariah compliant money /capital market in that jurisdiction.
Tailpiece: One of the speakers gave an insight on the working of BCBS’s Liquidity sub group in Basel – she was meeting the officials from time to time in Switzerland. Her take is that the members hardly understood liquidity. The feedback with BCBS is that retail commercial banks - which in no way contributed to the crisis – were being made to pay for through the NSFR – also known colloquially as the Northern Gate ratio!
