By Dadang Muljawan research Economist, Bank Indonesia Humayon A. Dar Lecturer, Department of Economics, Loughborough University, Loughborough, UK Maximilian J.B. Hall Professor, Department of Economics, Loughborough University, Loughborough, UK
Corresponding motive: Maximilian J. B. Hall Department of Economics, Loughborough University Loughborough LE11 3RG, United Kingdom Phone: +44 (1509) 222714 Fax : +44 (1509) 223910 E-mail : M.J.Hall1@lboro.ac.uk
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A Capital Adequacy Framework for Islamic Banks: The Need to Reconcile Depositors Risk Aversion With Managers Risk Taking
Abstract
Conceptually, an Islamic bank has an equity-based capital structure, dominated by shareholders equity and investment deposits based on profit and leaving sharing [PLS]. There is no need for capital sufficiency regulations if the Islamic banks are structured as pure PLS-based organizations. However, due(p) to informational asymmetry and risk aversion by investors, there shortly exist fixed claim liabilities on the Islamic banking ratio sheets.
This necessitates the imposition of capital adequacy requirements, which aim at maintaining general stability by achieving two fundamental objectives. First, capital regulations should value risk-averse (assumed unsophisticated) depositors. This requires a minimum equity capital cushion and an optimum assets-liabilities composition. Second, capital regulations should give the right incentives to shareholders to promote prudent behavior by the banks. This requires analysis of the effect of financial participation by shareholders on Pareto optimality, and analysis of potential behaviour by shareholders when facing financial uncertainty. This paper combines modern banking theory and principal-agent analysis to break a framework for an optimal capital structure for Islamic banks. The proposed capital regulation...If you want to get a full essay, fiat it on our website: Orderessay
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