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The Important Role of Sukuk In The Basel III Era

Updated: Jumat 5 Desember 2014 - 11:14 Kategori: Ekonomi Syariah Posted by: Ricky Dwi Apriyono

This article has been published in Thomson Reuters Sukuk Perceptions and Forecast 2015, Page 60.

The implementation of Basel III rules has created several challenges to Islamic financial institutions (IFIs) especially with regards to capital adequacy and liquidity requirements. Basel III primarily requires all banks, including Islamic banks, to strengthen their capital and liquidity positions by holding higher quality capital, which would enable banks to absorb financial shocks, and maintain higher level of liquidity, which enables banks to reduce their dependency on money market instruments.

Basel III requires all banks to maintain the minimum ratio of 4.5% for Tier 1 common equity capital, an increase from 2% required by Basel II. Basel III also changed the minimum requirement for additional Tier 1 capital and Tier 2 capital to 1.5% and 2%, respectively, from 2% and 4% previously required by Basel II. In addition, Basel III requires banks to maintain 2.5% capital preservation buffer and 0-2.5% countercyclical capital buffer.

In addition, Basel III also redefines the meaning of capital. According to Basel III, the components of Tier 1 capital consist of common equity as core capital, and preferred stock and hybrid securities as additional capital. Subordinated bonds and loans are counted as Tier 2 capital.

Given the uniqueness of Islamic banks’ products and operations, the implementation of Basel III rules for Islamic banks and other IFIs requires more clarification. The Islamic Financial Services Board (IFSB) released IFSB-15 in December 2013 with the purpose of introducing a framework for capital adequacy and liquidity requirements to suit the uniqueness of IFIs.


The IFSB-15 is an amended and improved version of two previous IFSB standards on capital adequacy, namely IFSB-2 and IFSB-7. IFSB-2 focused on capital adequacy standards for IFIs while IFSB-7 focused on capital adequacy requirements for sukūk, securitisations and real estate investments. IFSB-15 also provides guidelines for the components of regulatory capital (Tier 1 and Tier 2). Like Basel III, IFSB-15 also defines common equity as the Tier 1 core capital and preferred stock as the additional Tier 1 capital. However, it is important to note that preferred stock is only considered a Shariah-compliant instrument in some jurisdictions such as Malaysia.

In addition, perpetual musharakah sukuk is also counted as additional Tier 1 capital, while mudarabah and wakalah sukuk with maturity of five years or more are counted by IFSB-15 as components of IFIs’ Tier 2 capital. However, in practice, other types of sukuk may also be classified as either additional Tier 1 or the component of Tier 2 capital as long as the sukuk fulfill IFSB-15 requirements for each category of capital. In summary, the IFSB-15 has stressed the important role of sukuk in the Basel III era.  

BASEL III-Compliant Sukuk

From the above explanation, it is clear that the implementation of Basel III and IFSB-15 has opened the way for sukuk to be used by Islamic banks and other IFIs as the alternative  instrument to comply with regulatory requirements. Certainly, the adoption of Basel III will boost the number of sukuk issuance and their transactions value.

Basel III has already created a new trend in the sukuk market with the birth of so-called "Basel III-compliant sukuk". There have been nine issuances of such instruments since Basel III's initial implementation which kicked off in January 2013 with total deals worth more than $4.93 billion, according to Zamya Sukuk Monitor.

The first issuance of Basel III-compliant sukuk came from Abu Dhabi Islamic Bank (ADIB) in November 2012, even before the initial implementation of the accord. ADIB issued perpetual mudarabah sukuk with the purpose of raising its additional Tier 1 capital. Following ADIB's success, Dubai Islamic Bank (DIB) issued the second Basel III-compliant sukuk in March 2013 for the same purpose. At the end of 2013 and at the beginning of 2014, three issuances of such sukuk occured in Saudi Arabia, from Saudi Hollandi Bank (SHB), Saudi British Bank (SAAB) and National Commercial Bank (NCB). Unlike the Emirati banks, the Saudi bank issued the sukuk to increase their Tier 2 capitals.

The successful experience in the GCC has been followed by Islamic banks in Southeast Asia especially in Malaysia with the issuances of Basel III-compliant sukuk by AmIslamic Bank, Maybank Islamic, RHB Islamic and Public Islamic (using the murabahah structure) which aim to boost the banks' Tier 2 capital. Many more issuances of such sukuk are expected in the years to come.


The implementation of Basel III also poses challenges to the liquidity position of Islamic banks. For example, Basel III and IFSB-15 demand Islamic banks manage their liquidity through holding highly-rated sovereign and corporate sukuk (investment grade). This should be done in order to comply with the Liquidity Coverage Ratio (LCR) introduced by Basel III. However, currently there is only limmited number of these sukuk available in the market. Investment grade sukuk are much more liquid than junk or unrated sukuk, and they can only be issued by highly-rated governments and companies (which are lacking across Muslim-majority countries).

As the demand for these sukuk increases due to Basel III requirements, the opportunity opens up for highly-rated governments and companies to issue sukuk. In fact, this is already becoming a trend. The UK government issued £200 million of sovereign sukuk in June 2014, which, among other reasons, aimed to capture the strong demand for highly-rated sukuk. The issuance was oversubscribed. The latest AAA-rated non-Muslim government which issued sovereign sukuk was Hong Kong.

Issued in September 2014, the sukuk was oversubsribed 4.7 times, indicating very strong demand for the security. The Sukuk from these countries are very important for IFI's liquidity management and will be a driver for global sukuk market growth.

The strong demand for highly liquid sukuk by IFIs in order to comply with Basel III requirements has also pushed the International Islamic Liqudity Management (IILM) to issue its first $490 million worth of three-month sukuk in August 2013 (the sale was oversubscribed). About a year later, the IILM issued its second 2400 million worth of six-month sukuk in order to accomodate market need and preference; the issue was again oversubsribed.

However, despite this encouraging trend, more effort is needed to develop more highly-rated liquidity management instruments to help Islamic banks and other IFIs fulfill their liquidity regulatory requirements. With more issuances of sukuk expected in the years to come, the cost of sukuk issuance is also expected to fall. One factor contributing to this drop in cost is that more countries are expected to amend their regulatory and tax laws to ensure sukuk have the same advantages as conventional bonds.

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