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(ICAAP), which is prepared by banks and reviewed by supervisors. In
addition, specific review visits are part of this process. The supervisor can
request additional regulatory capital for any issues not covered under pillar
one, such as interest raterisk in the banking book andconcentration risk.
Pillar three: market discipline
The majority of disclosures are recommended and not mandatory. The
intention is to reduce potential overlap with other disclosure standards such
as International Financial Reporting Standards (IFRS) and International
Accounting Standards (IAS). As a result, additional disclosures are only
mandatory in relation to the implementation of particular methodologies or
instruments.
The general expectation is that large banks withsophisticated risk
management systems will benefit from the new regulation, and the same
assets will see their regulatory capital level reduced. However, this will
strongly depend on overall counterparty credit quality and robustness of
internal control processes and procedures. For the industry as a whole, the
required capital is expected to remain as it is, or potentially even increase.
Impact on Islamic banks
The impact of the changed regulation on banks in general is quite significant.
Substantial investments have been, and continue to be, made in enhanced
technology. To date, the exact impact on regulatory capital is still unknown.
The impact on Islamic banks is largely the same as for the conventional
banking industry. However, there are a few issues specific to Islamic banks.
Balance sheet size
Although the Islamic financial industry has grown substantially over the
past decade, it remains relatively small when compared to the overall
financial sector. Undeniably, the size of an individual Islamic bank is
typically not large enough to justify theinvestmentrequiredfortheadvanced
risk measurement approaches. As mentioned earlier, this is not restricted
to Islamic banks, but the smallness of the Islamic financial industry makes
it generally more difficult to lobby for changes in regulatory policy, such as
Basel II.
The absence of significant amounts of loss data is one of the problems that
hinder smaller sized banks that need to comply with Basel II. Islamic banks
- most of which have only recently been established and which have not
seen a complete economic cycle yet – do not have a long enough history and
hence cannot meet the Basel II requirement for seven years of loss data.
