The Role of Capital Adequacy Standard of the Islamic Financial Service Board (IFSB) in Minimizing the Financial Crisis Impact for Financial Institutions.

Abstract

Purpose – This research has been designed to examine the role of Islamic Finance through its proposed Capital Adequacy standard of Islamic Financial Service Board in minimizing the impact of the World Financial Crisis. Research Problem– the problem of this research steamed from the idea that during the financial crisis there was a diversification in the performance of the two types of financial systems (Islamic and conventional). And since each system is using its own tools of risk mitigations, the question to be raised is could this have an impact on the performance of each system during the time of crisis?

Research Hypothesis – this research was designed to examine four hypothesis, these are: 1-Financial institutions that implementing capital adequacy standard of Basel II-adapted by the IFSB can secure an appropriate quality and adequate level of the total capital resources compared to those who do not implement it during the crisis time. 2-The minimum capital adequacy requirement proposed by ISBF for IIFS to be a CAR can be more efficient in achieving the supervision goals of Financial Institutions than that proposed by Basel II for risk weight structure. 3-The guiding principles on conduct of business offered by IFSB creates a regulatory and supervisory environment that better helps improve banking sector performance than those who do not implement it. 4-The implementation of capital adequacy standard of Basel II-adapted by the IFSB can help protecting financial institutions from a liquidity shortfall caused by the overvaluation of assets compared to those not implemented it during the crisis time. Objectives– some of the objectives of this research are: 1.Explaining the Characteristics & Mechanism of the IFSB Capital adequacy standard and examining its role on minimizing Financial Crisis impact for Financial Institutions and its impact on Six Middle East based Banks. 2.Shedding a light on the role of Islamic Finance in providing a satisfactory service for those been affected by the downturn of the Conventional financial system. Design/methodology/approach – This research has adopted multiple research techniques such as the Comparative analysis technique and Ratio analysis technique (as Capital ratios are considered as a reliable source in predicting potential bankruptcies)were used to measure the profitability, efficiency, and liquidity of Islamic and conventional banks and to compare the Capital Ratio (CAR), Efficiency ratio (CTI), Profitability ratio (ROAA), (ROAE), Liquidity ratio (LA/TA), Leverage ratio and Gearing. Data were computerized using EXCEL 2003. Data were analyzed to test statistical significant using SPSS11 for Windows. Student t-test was used to test the differences between the means of Islamic and conventional banks of all the ratios. One way analysis of variance was used to test differences between the means of ratios of individuals banks included in the study. SAMPLE/ SELECTION CRITERIA/ SOURCE OF DATA– In this research a sample of six banks has been selected which are operating in four different countries in the Middle East three of them are conventional and other three are Islamic banks. The selection criteria was based on the similarity in size, activity of the market where the bank is operating, suitability of the bank for the study and availability of the required data and similarity of the market as well. This data was collected from the following sources: Annual and quarterly financial statements of the six banks, database of IMF, World Bank and Asian Development Bank (as all of these banks are operating in Asian Countries), database of Islamic Development Bank, Jeddah, Saudi Arabia, different Research Journals and Books on Islamic Banking and Finance.

Findings & Recommendations – this research reached many conclusions, ones most important are: 1-Financial institutions that implementing capital adequacy standard of Basel II-adapted by the IFSB can secure an appropriate quality and adequate level of the total capital resources compared to those who do not implement it during the crisis time. 2-The minimum capital adequacy requirement proposed by IFSB for IIFS to be a CAR can be more efficient in achieving the supervision goals of Financial Institutions than that proposed by Basel II for risk weight structure. This research has made many recommendations, some of these are: 1-Financial institutions are encouraged to adopt implementing capital adequacy standard of IFSB because it can secure an appropriate quality and adequate level of the total capital resources. 2-Financial institutions are advised to adopt IFSB (CAR) as the minimum capital adequacy required by IFSB for IIFS can be more efficient in achieving their supervision goals. Research limitations/implications – One of the important limitations of this research was the small size of the sample. Only six banks were included in the analysis of which three were conventional and the other three were Islamic. Another limitation is the short period on which data were collected. Data of only two years (2008-2009) was analyzed. However, this was justified as the study was seeking the most accurate figures regarding the Capital Adequacy Ratio components which were not disclosed in many other Banks than those included in the sample. With respect to the period of data, it was made on purpose because the intention of this study was to address the issue of the World Financial Crisis which took place and reached its peak at the above mentioned years and that any extension above those two years will negatively affect the accuracy of the result. In addition, all the previous studies that addressed the World Financial Crisis take the same bath and concentrate only on the years of the Crisis. Originality/value –If majority of the literature has found Islamic banks, performed well most of the times, then it should reflect the same during the crisis.1 Although many previous studies have addressed the issue of performance and efficiency of conventional and Islamic banks, not many of them addressed the issue of Capital Adequacy standard of IFSB and the effect of the adapted standard on the world financial crisis. This research is an addition to the growing body of literature that compares the Islamic and conventional banks during the financial crisis depending on real data as some studies call.