Sukuk : a tool in proposed additional tier-1 capital under Basel iii

                                                                                                     
Basel III has introduced important capital reforms for strengthening tier-1 capital, especially by introducing a new category of capital with the name of 'additional tier 1 capital'. Additional     tier 1 capital is a perpetual financial instrument. It is not guaranteed, it has no redemption features, and it is junior to depositors and other creditors of the bank. Bangladesh has started preparations to implement the Basel-III framework for bank companies from 2014. So, the banking companies of the country will also required to rise this type of capital. Mudarabah perpetual sukuk may become a tool in proposed additional tier-1 capital under Basel iii for Islamic banks in Bangladesh as rest of the world already started to use sukuk for the purpose.
For example, on the 19th November 2012, Abu Dhabi Islamic Bank (ADIB), one of the world’s leading Islamic banks, successfully issued US$1 billion-worth of additional Tier 1 capital certificates. This is the world’s first Basel III compliant Tier 1 Sukuk issuance. Qatar Islamic Bank issued US$750 million in Sukuk and Saudi Hollandi Bank with its US$373 million domestically-placed Sukuk.  AmIslamic Bank is to issue Malaysia’s first Basel III-compliant Sukuk in the first quarter of 2014. For the purpose the bank has attained necessary regulatory approvals from Bank Negara Malaysia (BNM) and Securities Commission Malaysia. This is the first Malaysian Sukuk that is Basel III-compliant.
Let us shade some light on what is sukuk. Sukuk, an Arabic word meaning financial certificates, refers to the Shariah-compliant equivalent of interest-bearing fixed-income instruments            or bond. Due to its inherent beauty, the emergence of Sukuk has been one of the most significant developments in Islamic capital markets in recent years. Sukuk have become one of the fastest-growing areas of Islamic finance as Issuers and investors look to meet their requirements while ensuring compliance with their principles and values.
Financial sector of Bangladesh is dominated by banking sector putting remarkable contribution in GDP and sustainable development of the Country. Islamic banking industry has been playing a vital part in this input. After the inception in Bangladesh in 1983 the Islamic banking industry experienced a steady growth and at present in Bangladesh there are eight fully fledged Islamic banks. In addition, 15 other regular commercial banks and two foreign banks are offering Islamic products through their Islamic banking branches/windows.  Currently, the combined market share of Islamic banks accounts around 25 per cent of the total banking market of Bangladesh. Thus, Islamic part of banking sector contributing greatly in the development of national economy.
But a very significant weakness of Islamic financial market of Bangladesh is lacking of Islamic capital market instruments like Sukuk. Sukuk has been proved to be very vital financial instrument throughout the world and playing role for the socio-economic development. As rest of the world experiencing Sukuk as a very successful financial instrument we must not be left behind.  Hopefully it will be introduced in the country in nearest future as it is a well-discussed issue at intellectual level of Islamic finance and has much prospect in Bangladesh.  
But the market of Bangladesh is not unfamiliar with this kind of Sukuk as this type of skulk is already being issued on the Bangladesh stock markets since 2007. Islami Bank Bangladesh Limited (IBBL) raised fund of Tk.3, 000.00 million in the year 2007 by issuing Mudaraba Perpetual Bond (MPB). This is the pioneer and so far the only sukuk in Bangladesh. Islami Bank Bangladesh Limited issued this sukuk for capital raising purpose. Mudarabah Perpetual Bond of Islami Bank Bangladesh Limited (IBBL) has the priority over shareholders but subordinated to the depositors and befitting also for proposed additional tier-1 capital under Basel iii.
The principal amount of funds of Mudarabah and profit rates cannot be guaranteed and the contract is fundamentally a profit sharing arrangement between the two parties. A Mudarabah Perpetual sukuk is a Mudarabah equity share in an Islamic bank to be traded in the stock markets. The Mudarabah Perpetual sukuk is fully conforms to the fundamental Shariah requirements of the Mudarabah partnership contract. In addition, it will be perpetual, non-redeemable, and junior to all forms of deposits of the Islamic bank but will be treated as senior to Musharakah equity shares whether held privately or publically. Thus the Mudarabah Perpetual sukuk will meet the conditions of Basel III for fulfilling the additional tier-1 capital criteria.
The central focus of Basel III is on strengthening the stable sources of funding and liquidity. To be a stable source of funding the Sukuk should be free of the structural risks. The Mudarabah Perpetual Sukuk is based on a pure Mudarabah contract, it is driven by asset price risk, it is perpetual and non-redeeming, it is junior to deposits and hence it will be fully compliant with the Basel III additional tier-1 capital criteria. Being based on Mudarabah the Mudarabah Perpetual sukuk is free of structure risk as there would only asset price risk and no credit risk and rate of return risks will exist in its design.  
The Mudarabah Perpetual sukuk holders are entitled to cash dividends, stock dividends and rights issues. It has no redemption facility & pre-determined interest rates. It will share income derived from investment activities and also get an additional rate of profit equivalent to 10% of the rate of dividend. Mudarabah Perpetual Bond will be issued to meet the requirement of proposed additional tier-1 capital under Basel iii of the Bank. It will be perpetual has no maturity. As a Mudaraba instrument it will get priority over the shareholders in respect of getting profit and also refund of principal in case of liquidation of the bank. It will, however, be junior to the Depositors in respect of the payment of both profit and refund of principal. Will be listed with bourses of the country and will remain freely transferable depending on the market demand.
It is evident, from the rash of banks across the world coming to the Islamic capital market that capital raising exercises are ramping up as part of the agenda to fulfill Basel III requirements. The main reason banks issue Sukuk for capital rising leaving other sources is to gain a certain profile; and they are usually looking to signal something to the market such as the ability to obtain liquidity from that specific market. The Malaysian market is generally more active in terms of trading sukuk compared to the Middle East markets in which investors usually hold the paper for dividend. Experts involve in Islamic financial markets also think that Dhaka has much potential to become one of the important international canters for Islamic finance like Dubai, Bahrain and Malaysia with the right kind of support from the authority.

M. A. Hamid is a banker working with ICB Islamic Bank Limited. Email:  mahamid@icbislamic-bd.com