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The most significant recent reform in international bank regulation has been in the area of capital adequacy, first instigated by the BASLE Committee and formally introduced in 1988. These reforms have had, and continue to have, significant economic consequences. However, the concept of capital adequacy and its usefulness in bank regulation has attracted a significant amount of criticism from the academic community. This raises the question as to why it was that capital adequacy was adopted as a tool for international bank regulation, despite major concerns with its rationale and effectiveness. Although the topic of capital adequacy has attracted an increasing body of research, the reasons behind the adoption and implementation of capital adequacy by international bank regulators have remained unexamined in the literature. This paper investigates the rationale for capital adequacy, citing documentary and interview evidence surrounding the key decisions, and in the process traces the dynamics of international bank regulation. The principal finding is that regulatory reform was influenced by tradition, convenience and likely acceptability rather than by any serious considerations of regulatory objectives and potential effectiveness of the capital adequacy reforms. This corresponds to findings about the origin and dynamics of regulation in the political economy literature.

This paper aims to provide a methodology for designing and conducting solvency stress tests, under the standardised approach as per IFSB-15, including the establishment of macro-financial links, running scenarios with variation of assumptions and stress scenario parameters; apply and illustrate this methodology by providing a stylised numerical example through a tractable Excel-based framework, through which Islamic Commercial Banks (ICBs) can introduce additional regulatory requirements and show that they would remain in compliance with all capital requirements after a moderate to severe shock; and identify the potential remedial actions that can be envisaged by an ICB.

The paper uses the data of the one of the groups to which certain amendments and related assumptions are applied to develop a stylised numerical example for solvency stress-testing purposes. The example uses a Stress Testing Matrix (STeM; a step-by-step approach) to illustrate the stress-testing process. The methodology of the paper uses a two-stage process. The first stage consists of calculating the capital adequacy ratio (CAR) of the ICB using the IFSB formulae, depending on how the profit sharing investment account (PSIA) are treated in the respective jurisdiction. The second stage is the application of the stress scenarios and shocks.

Taking into account the specificities of ICBs such as their use of PSIA, the results highlighted the sensitivity of the CAR of an ICB with respect to the changes in the values of alpha and the proportion of unrestricted PSIA on the funding side. The simulation also indicated that an ICB operating above the minimum CAR could be vulnerable to shocks of various degrees of gravity, thus bringing the CAR below the minimum regulatory requirement and necessitating appropriate remedial actions.

The paper highlights various implications and relationships arising out of stress testing for ICBs, including the vulnerability of an ICB under defined scenarios, demanding appropriate immediate remedial actions on future capital resources and capital needs. The findings of the paper provide a preliminary discussion on developing a comprehensive toolkit for the ICBs similar to what is developed by the International Monetary Fund Financial Sector Assessment Programme.

This paper focuses on the gap with respect to the stress testing of capital adequacy. The main contribution of the paper is twofold. The first is the development of an STeM – a step-by-step approach, which provides a method for simulating solvency (i.e. capital adequacy) stress tests for ICBs; the second is the demonstration of the potentially crucial impact of profit-sharing investment accounts and the way they are managed by ICBs (notably the smoothing of profit payouts) in assessing the capital adequacy of the ICBs.

The need for international regulation of financial markets became apparent in the mid‐1970s in response to the post‐Bretton Woods liberalisation of financial markets. The elimination of the fixed exchange rate parity with gold resulted in the privatisation of financial risk, which created pressure to eliminate controls on cross‐border capital movements and the further deregulation of financial markets. It became necessary for national regulatory authorities to promote safe and sound banking systems through the effective management of systemic risk in national markets. Similarly, the need for international standards of prudential supervision was also recognised, to prevent solvent banking institutions in one jurisdiction from losing business to less respectable institutions operating in other jurisdictions whose laws permitted cut‐rate financial services and other risky financial practices. The privatisation of financial risk also created the need for financial institutions to spread their risks over many assets and activities, which led, in turn, to a significant increase in short‐term cross‐border portfolio investment that has, in many instances, exposed capital‐importing countries to increased systemic risk due to the volatility of such investments.

This paper examines the need for international regulation of financial markets and suggests the possible role that a global financial supervisor might play in providing effective regulation of international financial markets. The first part discusses the nature of systemic risk in the international financial system and the necessity for international Minimum Standards of prudential supervision for banking institutions. The second part examines the efforts of the Basel Committee on Banking Supervision to devise non‐binding international standards for managing systemic risk in financial markets. Recent financial crises in Asia, Russia and Latin America suggest, however, that informal efforts by international bodies such as the Basel Committee are inadequate to address the risk of systemic failure in financial systems. The third part therefore argues that efficient international financial regulation requires certain regulatory functions to be performed by a global supervisor acting in conjunction with national regulatory authorities. These functions should involve the authorisation of financial institutions, generation of rules and standards of regulatory practice, surveillance of financial markets, and coordination with national authorities in implementing and enforcing such standards.

The aims of this paper are: first, to draw attention to the issues of displaced commercial risk (DCR) which arise as a result of the risk characteristics of profit‐sharing investment accounts (PSIA), the main source of funding of Islamic banks in most jurisdictions; and, second, to present a value‐at‐risk approach to the estimation of DCR and the associated adjustments in capital requirements.

The paper is based on empirical research into the characteristics of PSIA in practice, which vary to a greater or lesser extent from what one would expect them to be in principle, on an analysis of the capital adequacy and risk management implications that flow from this, and on an econometric formulation whereby the extent of DCR in Islamic banks may be estimated.

The findings are, first, that the characteristics of PSIA can vary from being a deposit like product (fixed return, capital certain, all risks borne by shareholders) to an investment product (variable return, bearing the risk of losses in underlying investments), depending upon the extent to which the balance sheet risks get shifted (“displaced”) from investment account holders to shareholders through various techniques available to Islamic banks' management. Second, the paper finds that this DCR has a major impact on Islamic bank's economic and regulatory capital requirements, asset‐liability management, and product pricing. Finally, it proposes an econometric approach to estimating DCR but report that individual Islamic banks generally lack the data needed to apply this approach, in the absence of which panel data for a population of Islamic banks may be used to estimate DCR for that population.

Empirically, the paper is thus limited by the lack of data just mentioned. Furthermore, the application of the proposed panel data approach has been left for future research.

The analysis of the issues and the development of the econometric model represent in themselves an original research contribution of some significance.

Purpose – This research analyses the stability of a number of banks operating in Malaysia by using descriptive statistical analysis based on internal variables. These include the characteristics of the bank, capital adequacy ratio, ratio of profitability, liquidity ratio and the ratio of bank operations.

Methodology/approach – Each bank’s stability is studied using z-score analysis. Data are sourced from the balance sheets and income statements of the banks from 2000 to 2011.

Findings – The results indicate that characteristics of a bank do influence a bank’s performance. There are significant differences in financial ratios between Islamic and conventional banking. Islamic banks provide a lower loan loss of capital to cover impaired loans than conventional banks. This provides high capital based on the mean value obtained. The capital ratio allows both sets of banks to meet the capital adequacy ratio set by the Central Bank of Malaysia. Meanwhile, in profitability ratios, conventional banks have higher returns on higher assets, whereas Islamic Banking has higher returns on higher equity. Only 8 Islamic banks and 11 conventional banks are highly stable banking institutions in Malaysia.

Originality/value – Islamic and conventional banking systems in Malaysia need further improvement to deal with unexpected economics crises and increased competition between the two. Hence, Islamic banking must be refined, especially for improving their stability to attract more investments for further development and performance.

As financial markets across the world become more integrated, the potential for financial shocks to be transmitted both from one jurisdiction to another and from one financial sector to another increases. At the same time differences in national regulatory arrangements can be the source of important competitive distortions between financial institutions. Against this background national authorities have been seeking to coordinate the regulation of securities firms and of batiks undertaking securities business. This paper, which is published in two parts, aims to clarify some of the policy issues arising from recent convergence initiatives by examining the US capital adequacy rules for US investment firms and contrasting the US approach with European securities regulation as formulated in the Capital Adequacy Directive. The first part of this paper was published in the previous issue of Journal of Financial Regulation and Compliance.

As financial markets across the world become more integrated, the potential for financial shocks to be transmitted both from one jurisdiction to another and from one financial sector to another increases. At the same time differences in national regulatory arrangements can be the source of important competitive distortions between financial institutions. Against this background national authorities have been seeking to coordinate the regulation of securities firms and of banks undertaking securities business. This paper, which is published in two parts, aims to clarify some of the policy issues arising from recent convergence initiatives by examining the US capital adequacy rules for US investment firms and contrasting the US approach with European securities regulation as formulated in the Capital Adequacy Directive. The second part of this paper will be published in the next issue of Journal of Financial Regulation & Compliance.

The introduction of Basel capital adequacy standards (I, II and III) has provoked a large body of empirical and theoretical literature that aimed to detect the consequences of risk-based capital rules on bank lending behaviour and credit availability (and the possible emergence of the credit crunch phenomenon), and came up with divergent conclusions. This study aims at participating in this continuous debate but detecting the applicability of the credit crunch theory in the MENA region, taking into consideration the impact of the institutional environment, which may play a role in mitigating the supply-side credit crunch.

This study exploits the Fixed Effects method on a dataset of 210 banks from 14 MENA countries over the period 1999–2016. The paper exploits the percentage change in bank credit as a dependent variable, capital requirements and three institutional quality variables as explanatory variables, in addition to a set of micro- and macro-economic variables.

The study finds that the implementation of higher capitalisation ratios does participate in a significant decline in bank credit supply. Additionally, by testing the impact of institutional factors on bank lending, it reveals that good governance and political stability encourage banks to extend credit and soften the credit crunch, while higher level of financial freedom discourages banks from expanding loan supply and even magnifies the decline of credit following tightening capital requirements.

This paper provides very important insight for MENA policymakers and bank regulators by highlighting the importance of the institutional environment factors in amplifying or softening the effect of higher capital requirements in their economies.

In addition to examining an understudied sample of countries, this paper's originality and value added are represented mainly by testing the impact of institutional environment and governance level on bank lending behaviour.

The purpose of this paper is to assess key issues in measurement and management of operational risk in Malaysian Islamic banks.

Descriptive, analytical, and comparative analyses are used to discuss the issues of operational risk in Islamic bank through the implications associated with the Islamic banks' operational risk as well as the implications on risk measurement, risk management, and capital adequacy.

Discussion on operational risk in Islamic banks is significant and becoming more complicated compared with conventional banking because of the unique contractual features and general legal environment. While basic Basel II core principles of effective banking supervision apply equally well and ideally suit the Islamic banking institutions, risk measurement, and risk management practices still need specific adaptations to Islamic banks' operational characteristics. These particularities highlight the unique characteristics of Islamic banks and raise serious concerns regarding the applicability of the Basel II methodology for Islamic banks.

This study has important implications for the understanding of operational risk, particularly the specific issues of the Islamic banks' operational risk that arise from the different nature of the financing and investment activities of the banks. With regard to measuring operational risk capital charge, the banks have to choose the right and effective method to ensure the operational risk capital charge will be more in line with the banks' actual risk profile and thus will provide the adequate capital and an improved buffer once the losses are announced.

The paper will fill the gap to the existing literature of operational risk in banking institutions especially Islamic banks, by showing the needs of specific adaption of operational risk measurement and risk management practices due to the nature of Islamic banks.