Basel III liquidity requirement ratios and Islamic banking

Abstract

Basel III was initiated after the recent global financial crisis to strengthen the regulatory regime for the banking sector. As liquidity problems faced by banks were a key feature of the crisis, Basel III has added liquidity requirement ratios in addition to reinforcing the capital requirements. Specifically, the Liquidity Coverage Ratio (LCR) has been introduced to ensure liquidity in banks in the short term, and a Net Stable Funding Ratio (NSFR) is proposed to promote medium- and long-term resilience against liquidity shocks. Islamic banking has been growing rapidly in different parts of the world and forms a significant part of the financial sector in many countries. This article examines the implications of the new Basel III liquidity requirement ratios for Islamic banks. Given the short history of its development and the restrictions imposed by Shari’ah principles, the Islamic banking sector faces several restrictions that will constrain its adoption of the Basel III liquidity requirements. After presenting the basic principles of Islamic finance, the article identifies the challenges that Islamic banks will face in meeting their liquidity needs and outlines certain practices in which these are being resolved.