BASLE FRAMEWORKBASLE FRAMEWORKAND THE ISSUES OFAND THE ISSUES OF

REGULATION, SUPERVISION AND REGULATION, SUPERVISION AND CORPORATE GOVERNANCECORPORATE GOVERNANCE

IN ISLAMIC BANKINGIN ISLAMIC BANKING

DR. M. UMER CHAPRADR. M. UMER CHAPRARESEARCH ADVISERRESEARCH ADVISER

IRTI/IDB, JEDDAHIRTI/IDB, JEDDAH

22

THE NEED FOR INTERNATIONAL FINANCIAL REFORMTHE NEED FOR INTERNATIONAL FINANCIAL REFORM

INTERNATIONAL FINANCIAL CRISESINTERNATIONAL FINANCIAL CRISES

HOW TO PREVENT SUCH CRISES FROM TAKING PLACE IN HOW TO PREVENT SUCH CRISES FROM TAKING PLACE IN

THE FUTURE?THE FUTURE?

CALL FOR A “NEW ARCHITECTURE” FOR THE FINANCIAL CALL FOR A “NEW ARCHITECTURE” FOR THE FINANCIAL

SYSTEMSYSTEM

BASLE COMMITTEE ON BANKING SUPERVISION (BCBS)BASLE COMMITTEE ON BANKING SUPERVISION (BCBS)

33

THE 1988 BASLE CAPITAL ACCORDTHE 1988 BASLE CAPITAL ACCORD

BCBS, INTERNATIONAL CONVERGENCE OF CAPITAL BCBS, INTERNATIONAL CONVERGENCE OF CAPITAL

MEASUREMENT AND CAPITAL STANDARDS (1988)MEASUREMENT AND CAPITAL STANDARDS (1988)

A SIMPLE STANDARDIZED APPROACH FOR ESTABLISHING A SIMPLE STANDARDIZED APPROACH FOR ESTABLISHING

MINIMUM CAPITAL REQUIREMENTS – BANKS TO MAINTAIN MINIMUM CAPITAL REQUIREMENTS – BANKS TO MAINTAIN

CAPITAL ON THE BASIS OF FIVE CLASSES OF BORROWERS CAPITAL ON THE BASIS OF FIVE CLASSES OF BORROWERS

(0%, 10%, 20%, 50% AND 100%)(0%, 10%, 20%, 50% AND 100%)

DID NOT DISTINGUISH BETWEEN THE RELATIVE DEGREES OF DID NOT DISTINGUISH BETWEEN THE RELATIVE DEGREES OF

CREDITWORTHINESS AMONG INDIVIDUAL BORROWERS CREDITWORTHINESS AMONG INDIVIDUAL BORROWERS

APPLIED INITIALLY TO INTERNATIONALLY ACTIVE BANKS IN APPLIED INITIALLY TO INTERNATIONALLY ACTIVE BANKS IN

THE G10 COUNTRIESTHE G10 COUNTRIES

44

BASLE II - 1996BASLE II - 1996

GREATER FOCUS ON RISK MEASUREMENT AND GREATER FOCUS ON RISK MEASUREMENT AND

CONTROLCONTROL

THE “THREE PILLARS”THE “THREE PILLARS”

55

BASLE II (1)BASLE II (1)

““PILLAR 1”: CAPITAL ADEQUACYPILLAR 1”: CAPITAL ADEQUACY

RISK ADJUSTED CAPITAL REQUIREMENTSRISK ADJUSTED CAPITAL REQUIREMENTS

THREE OPTIONSTHREE OPTIONS

EXTERNAL-RATINGS BASEDEXTERNAL-RATINGS BASED

INTERNAL-RATINGS BASEDINTERNAL-RATINGS BASED

MODELS-BASEDMODELS-BASED

66

BASLE II (2)BASLE II (2)

““PILLAR 2”: SUPERVISORY REVIEW PILLAR 2”: SUPERVISORY REVIEW

TO EVALUATE THE RISK PROFILES OF INDIVIDUAL TO EVALUATE THE RISK PROFILES OF INDIVIDUAL

BANKSBANKS

SPECIFY THE NEED FOR REMEDIAL MEASURESSPECIFY THE NEED FOR REMEDIAL MEASURES

77

BASLE II (3)BASLE II (3)

““PILLAR 3”: MARKET DISCIPLINEPILLAR 3”: MARKET DISCIPLINE ENHANCING THE DEGREE OF TRANSPARENCY IN ENHANCING THE DEGREE OF TRANSPARENCY IN

BANKS’ PUBLIC REPORTING AND THE DISCLOSURES BANKS’ PUBLIC REPORTING AND THE DISCLOSURES

THEY MUST MAKE TO LEND GREATER INSIGHT INTO THE THEY MUST MAKE TO LEND GREATER INSIGHT INTO THE

ADEQUACY OF THEIR CAPITALIZATIONADEQUACY OF THEIR CAPITALIZATION

88

THE CORE PRINCIPLES (1997)THE CORE PRINCIPLES (1997)

BCBS, BCBS, CORE PRINCIPLES FOR EFFECTIVE CORE PRINCIPLES FOR EFFECTIVE

BANKING SUPERVISION (1997)BANKING SUPERVISION (1997)

SETS OUT 25 BASIC PRINCIPLES THAT ARE SETS OUT 25 BASIC PRINCIPLES THAT ARE

REQUIRED FOR AN EFFECTIVE SUPERVISORY REQUIRED FOR AN EFFECTIVE SUPERVISORY

SYSTEMSYSTEM

99

THE CORE PRINCIPLES (1)THE CORE PRINCIPLES (1)

PRINCIPLES 1-5 : LICENSING AND STRUCTUREPRINCIPLES 1-5 : LICENSING AND STRUCTURE

PRINCIPLES 6-15: PRUDENTIAL REGULATIONS PRINCIPLES 6-15: PRUDENTIAL REGULATIONS

AND REQUIREMENTSAND REQUIREMENTS

PRINCIPLES 16-20: METHODS OF ONGOING PRINCIPLES 16-20: METHODS OF ONGOING

BANKING SUPERVISIONBANKING SUPERVISION

1010

THE CORE PRINCIPLES (2)THE CORE PRINCIPLES (2)

PRINCIPLE 21: INFORMATION REQUIREMENTSPRINCIPLE 21: INFORMATION REQUIREMENTS

PRINCIPLE 22: FORMAL POWERS OF PRINCIPLE 22: FORMAL POWERS OF

SUPERVISIONSUPERVISION

PRINCIPLES 23-25: CROSS-BORDER BANKINGPRINCIPLES 23-25: CROSS-BORDER BANKING

1111

REGULATION AND SUPERVISION OF ISLAMIC FINANCIAL REGULATION AND SUPERVISION OF ISLAMIC FINANCIAL INSTITUTIONS (1)INSTITUTIONS (1)

TWO RESPONSIBILITIESTWO RESPONSIBILITIES:: TO APPLY THE INTERNATIONAL STANDARDS TO APPLY THE INTERNATIONAL STANDARDS

TO COMPLY WITH THE SHARI‘AH TO COMPLY WITH THE SHARI‘AH

1212

ISSUES INVOLVED (1)ISSUES INVOLVED (1)

CAPITAL ADEQUACYCAPITAL ADEQUACY

EVALUATION AND CONTROL OF RISKS IN THE DIFFERENT EVALUATION AND CONTROL OF RISKS IN THE DIFFERENT

ISLAMIC MODES OF FINANCE: ISLAMIC MODES OF FINANCE:

CREDIT RISK, MARKET RISK, LIQUIDITY RISK, INTEREST CREDIT RISK, MARKET RISK, LIQUIDITY RISK, INTEREST

RATE RISK AND OPERATIONAL RISKRATE RISK AND OPERATIONAL RISK

MUDARABAH, MUSHARAKAH, MURABAHAH, SALAM, MUDARABAH, MUSHARAKAH, MURABAHAH, SALAM,

IJARAH, IJARAH, ANDAND ISTISNA ISTISNA‘‘

1313

ISSUES INVOLVED (2)ISSUES INVOLVED (2)

ACCOUNTING STANDARDSACCOUNTING STANDARDS

INTERNAL CONTROLS AND EXTERNAL AUDITINTERNAL CONTROLS AND EXTERNAL AUDIT

GREATER TRANSPARENCYGREATER TRANSPARENCY

DEPOSIT INSURANCEDEPOSIT INSURANCE

SHARI‘AH AUDITSHARI‘AH AUDIT

1414

CORPORATE GOVERNANCECORPORATE GOVERNANCE

WHAT IS CORPORATE GOVERNANCE? WHAT IS CORPORATE GOVERNANCE?

PROTECT THE INTERESTS OF ALL STAKEHOLDERS BY PROTECT THE INTERESTS OF ALL STAKEHOLDERS BY

ENSURING FAIRNESS, TRANSPARENCY AND ACCOUNTABILITYENSURING FAIRNESS, TRANSPARENCY AND ACCOUNTABILITY

WHY CORPORATE GOVERNANCE?WHY CORPORATE GOVERNANCE?

PRINCIPAL/AGENT CONFLICT OF INTERESTSPRINCIPAL/AGENT CONFLICT OF INTERESTS

1515

DIFFERENT MODELS OF CORPORATE DIFFERENT MODELS OF CORPORATE

GOVERNANCEGOVERNANCE

ANGLO-AMERICAN MODELANGLO-AMERICAN MODEL

FRANCO-GERMAN MODELFRANCO-GERMAN MODEL

THE ISLAMIC MODEL: THE CONCEPT OF JUSTICE IN THE ISLAMIC MODEL: THE CONCEPT OF JUSTICE IN

ISLAMISLAM

1616

MECHANISMS FOR CORPORATE GOVERNANCEMECHANISMS FOR CORPORATE GOVERNANCE

BOARD OF DIRECTORSBOARD OF DIRECTORS

SENIOR MANAGEMENTSENIOR MANAGEMENT

SHAREHOLDERSSHAREHOLDERS

DEPOSITORSDEPOSITORS

1717

TOOLS FOR CORPORATE GOVERNANCETOOLS FOR CORPORATE GOVERNANCE

INTERNAL CONTROLS SYSTEMINTERNAL CONTROLS SYSTEM

RISK MANAGEMENT CULTURERISK MANAGEMENT CULTURE

CREDIT RISK, MARKET RISK, LIQUIDITY RISK, INTEREST RATE CREDIT RISK, MARKET RISK, LIQUIDITY RISK, INTEREST RATE

RISK AND OPERATIONAL RISKRISK AND OPERATIONAL RISK

ENHANCING TRANSPARENCYENHANCING TRANSPARENCY

LOAN ACCOUNTING AND DISCLOSURELOAN ACCOUNTING AND DISCLOSURE

EXTERNAL AUDITEXTERNAL AUDIT

SHARI‘AH CLEARANCE AND SHARI‘AH AUDITSHARI‘AH CLEARANCE AND SHARI‘AH AUDIT

1818

THE NEED FOR INSTITUTIONAL INFRASTRUCTURETHE NEED FOR INSTITUTIONAL INFRASTRUCTURE

FACTORS THAT ENABLED THE ISLAMIC SYSTEM TO FACTORS THAT ENABLED THE ISLAMIC SYSTEM TO

WORK EFFECTIVELY IN THE CLASSICAL PERIODWORK EFFECTIVELY IN THE CLASSICAL PERIOD

CAN WE MAKE THE SYSTEM SUCCESSFUL NOW? CAN WE MAKE THE SYSTEM SUCCESSFUL NOW?

THE NEED FOR INSTITUTIONAL INFRASTRUCTURETHE NEED FOR INSTITUTIONAL INFRASTRUCTURE

1919

INSTITUTIONAL INFRASTRUCTURE (1)INSTITUTIONAL INFRASTRUCTURE (1)

CREDIT RATING AGENCIESCREDIT RATING AGENCIES

CENTRALIZED SHARI‘AH BOARDCENTRALIZED SHARI‘AH BOARD

CHARTERED SHARI‘AH AUDITORSCHARTERED SHARI‘AH AUDITORS

SHARI‘AH COURTS AND BANKING TRIBUNALSSHARI‘AH COURTS AND BANKING TRIBUNALS

2020

INSTITUTIONAL INFRASTRUCTURE (2)INSTITUTIONAL INFRASTRUCTURE (2)

AUDIT ORGANIZATIONAUDIT ORGANIZATION

ISLAMIC FINANCIAL MARKETISLAMIC FINANCIAL MARKET

LENDER OF LAST RESORTLENDER OF LAST RESORT

TRAINING INSTITUTES FOR ISLAMIC BANKINGTRAINING INSTITUTES FOR ISLAMIC BANKING

2121

CONCLUSIONCONCLUSION