Evaluating the Robustness of Basel Capital Accords to Combat the Effects of COVID-19 Pandemic in Islamic Banking

The purpose of this chapter is to evaluate relationship between the capital adequacy ratio (CAR) and explanatory variables as well as the possibility that any of the three Basel Capital Accords adopted in Islamic banks is appropriate to combat the effect of COVID-19 pandemic. This study employed reverse regression estimation techniques, using random effect estimator and interaction modeling. Data were obtained from IFSB database. The findings of this study indicate that bank asset quality and ROE exhibit conditional negative relationship with CAR, while ROA and bank liquidity exhibit conditional positive relationship. Therefore, the relationship between CAR and bank asset quality, bank profitability, and bank liquidity fulfilled conditional hypothesis, that is, the relationship varies according to the Basel Capital Accords approach adopted by the Islamic banks. Among the three Basel Capital Accords, the capital requirement by Basel III could not be met, thereby made it inappropriate for adoption during the period of COVID-19 pandemic, while the capital requirement of Basel I exposes Islamic banks to serious challenges which support non-risk sensitivity framework in developing Basel I. This finding is novel, as previous studies on Basel Capital Accords neither simultaneously examined all the three Basel to make inferences nor explore the possibility of conditional relationship in their CAR studies. This is the first empirical study that establishes the existence of conditional hypothesis relationship between CAR and the explanatory variables using reverse regression.