Islamic Finance: The New Regulatory Challenge, 2nd Edition

Chapter 1

Supervision of Islamic Banks: The Regulatory Challenge—Basel II and Basel III

Simon Archer and Rifaat Ahmed Abdel Karim

1. INTRODUCTION

The documents of the Basel Committee for Banking Supervision (BCBS)—International Convergence of Capital Measurement and Capital Standards: A Revised Framework (generally known as Basel II) and the recently introduced new major set of reforms to Basel II, which are aimed at addressing global capital regulatory framework in light of the prevailing global crisis (and are generally known as Basel III)—present a real challenge to banking regulators and supervisors. This challenge is, of course, first and foremost in respect of the application of both documents to conventional banks. Basel II was issued in June 2004 (with some revisions in November 2005) to supersede the original 1988 Capital Accord (Basel I), while Basel III was issued in December 2010, with a revised version in June 2011.

The main innovations introduced in Basel II were, first, a significantly more comprehensive and sophisticated approach to measuring credit risk and, second, a capital requirement for operational risk. With respect to market risk, Basel II did not supersede the 1996 Amendment of Basel I, which had introduced a capital treatment for this category of risk not specifically covered in the original Capital Accord. The two approaches to market risk under Basel II, the Standardised Approach and the Internal Models Approach, are continued under Basel III.1 However, ...