5.1. Introduction

(1) The Basel III capital adequacy framework contains 2 additional measures for conserving Capital through the Capital Conservation Buffer and the Counter-Cyclical Capital Buffer.

(2) The Capital Conservation Buffer promotes the conservation of Capital and the build-up of a buffer above the minimum in times of economic growth and credit expansion leading to profitability, so that the buffer can be drawn down in periods of stress. It imposes an obligation to restrict a firm’s distributions when Capital falls below the Capital conservation buffer minimum.

(3) The rules requirements relating to application of Capital Conservation Buffer are set out in this Chapter.

5.2. Capital Conservation Buffer

(1) An Islamic Bank whose Risk-based Capital requirement is higher than its Base Capital Requirement must maintain a minimum Capital Conservation Buffer of:

• (a) 2.5% of its total RWA; or
• (b) a higher amount that the AFSA may, by written notice, set from time to time.

(2) A firm’s Capital Conservation Buffer must be made up of CET 1 Capital above the amounts used to meet an Islamic Bank’s CET 1 Capital ratio, Tier 1 Capital ratio and Regulatory Capital ratio in rule 4.11).

(3) Capital raised through the issuance of sukuk cannot form part of the Capital Conservation Buffer because that Capital does not qualify as CET 1 Capital.

5.3. Capital Conservation Ratio

(1) If an Islamic bank’s Capital Conservation Buffer falls below the required minimum, the Islamic Bank must immediately conserve its Capital by restricting its distributions.

(2) This rule sets out, in column 3 of table 5.1, the minimum Capital Conservation Ratios for Islamic bank that are required to maintain a Capital Conservation Buffer. Capital Conservation ratio is the percentage of earnings that a firm must not distribute if its CET 1 Capital ratio falls within the corresponding ratio in column 2 of that table.

(3) Earnings means distributable profits calculated before deducting elements subject to the restrictions on distributions. Earnings must be calculated after notionally deducting the tax that would have been payable had none of the distributable items been paid.

(4) If the Islamic Bank is a member of a Financial Group, the Capital Conservation Buffer applies at group level.

(5) A payment made by a firm that does not reduce its CET 1 Capital is not a distribution for the purposes of this Part. Distributions include, for example, dividends, share buybacks and discretionary bonus payments.

(6) The effect of calculating earnings after tax is that the tax consequence of the distribution is reversed out.

(7) An Islamic Bank must have adequate systems and controls to ensure that the amount of distributable profits and maximum distributable amount are calculated accurately. An Islamic Bank must be able to demonstrate that accuracy if directed by the AFSA.

Guidance: Examples of application of table

Assume that a firm’s minimum CET 1 Capital ratio is 4.5% and an additional 2.5% Capital conservation buffer (which must be made up of CET 1 Capital) is required for a total of 7% CET 1 Capital ratio. Based on table 5.1:

1. (i) If a firm’s CET 1 Capital ratio is 4.5% or more but less than 5.125%, an Islamic Bank needs to conserve 100% of its earnings.
2. (ii) If a firm’s CET 1 Capital ratio is 5.125% or more but less than 5.75%, an Islamic Bank needs to conserve 80% of its earnings and must not distribute more than 20% of those earnings by way of dividends, share buybacks and discretionary bonus payments.
3. (iii) A firm with a CET 1 Capital ratio of more than 7% can distribute 100% of its earnings.

Table 5.1 Minimum Capital conservation ratios

5.4. Powers of the AFSA

(1) The AFSA may impose a restriction on Capital distributions by an Islamic Bank even if the amount of an Islamic Bank’s CET 1 Capital is greater than its CET 1 Capital ratio and required Capital Conservation Buffer.

(2) The AFSA may, by written notice, impose a limit on the period during which an Islamic Bank may operate within a specified Capital Conservation Ratio.

(3) An Islamic Bank may apply to the AFSA to make a distribution in excess of a limit imposed by this Part. The AFSA will grant approval only if it is satisfied that an Islamic Bank has appropriate measures to raise Capital equal to, or greater than, the amount an Islamic Bank wishes to distribute above the limit.

5.5. Capital reductions

(1) An Islamic Bank must not reduce its Capital and reserves without the AFSA’s written approval.

(2) An Islamic Bank planning a reduction must prepare a forecast (for at least 2 years) showing its projected Capital after the reduction. The Islamic Bank must satisfy the AFSA that its Capital will still comply with the IBB rules after the reduction.

Guidance: Examples of ways to reduce Capital

1) a share buyback or the redemption, repurchase or repayment of Capital instruments issued by an Islamic Bank

2) trading in an Islamic Bank’s own shares or Capital instruments outside an arrangement agreed with the AFSA.

3) a special dividend.

5.6. AFSA can require other matters

Despite anything in these rules, the AFSA may require an Islamic Bank to have Capital resources, comply with any other Capital requirement or use a different approach to, or method for, Capital management. The AFSA may also require a firm to carry out stress-testing at any time.