This thesis makes a theoretical contribution to the design of the capital adequacy
assessment framework for Islamic banks. The proposed capital regulation is aimed at
enhancing the Islamic banks' operational sustainability.
The first analytical section in the thesis discusses the nature of sharing contracts. The
analysis helps to explain the current reluctance to use sharing contracts by the players in
the Islamic banking system. Each individual will always try to optimise his utility,
monetarily as well as religiously, as a form of compliance with religious rules.
However, in an adverse condition, religious and risk-averse customers will compromise
the two utility objectives (i.e. adopting hybrid types of contract that, to some extent,
deliver his minimum required financial return besides also complying with religious
The second analytical section in the thesis discusses possible improvements to the
capital regulation of Islamic banks. This includes the possibility of enhancing the
fiduciary as well as the agency roles performed by the Islamic banks. The analysis
produces a number of propositions. The first proposition is to require the banks to have
prudent assets-liabilities (capital) structures and to have adequate financial cushions.
The second proposition is to require the shareholders of Islamic banks to observe a
minimum level of financial participation; and to require the banks to disclose crucial
financial information to investors. Theoretically, the higher the level of financial
participation and the higher the quality of information provided, the better the quality of
the contract entered into by the banks and 'their customers.
The last part of the discussion, embracing empirical analysis, shows the important role
played by capital in absorbing temporary financial shocks (especially when debt-based
deposits are dominant). The discussion also covers the possibility of using statistical
techniques for assessing the soundness of Islamic banks' operational activities.
A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.