Islamic banking: a challenge for the Basel Capital Accord

Islamic intermediation, based on profit-sharing contracts, seems difficult to tie in with the fundamental and the objectives of the Basel prudential regulatory framework, grounded on risk-sensitive capital requirements. For stabiility purposes, the greater is the risk transformation performed by a financial intermediary, the more relevant is capital. If the regulation forces on the shareholders a financial burden that grows with the intermediation risk, it not only limits the moral hazard relating to the coexistence of the explicit and implicit deposit insurance and of the lending of last resort, it also limits the conflict of interest among depositors and shareholders typical of banking characterised by opaque assets and high leverage.We may then ask what could possibly be the prudential role of capital for an Islamic bank, and, more in general, if it is justified to limit its financing function since the bank, funding its assets with profit-sharing contracts, does not perform a portfolio risk ransformation function, with the result that the investment account holders and shareholders jointly bear the credit and market risks.