The kingdom’s reputation as an Islamic finance centre rests not only on its long history of successfully regulating its diverse sharia-compliant industry, but also its willingness to revisit its rules as needed. Fittingly, the need for continued reform of the sector was a central theme of the 21st Annual World Islamic Banking Conference, held in Bahrain in December 2014. Speaking at the opening of the event, the governor of the Central Bank of Bahrain (CBB), Rasheed Mohammed Al Maraj, reminded delegates that the long-term success of Islamic finance depends on a forward-looking stance, and the continuous development of its governance structure.
“As the Islamic banking industry has witnessed nearly four decades of growth since its inception, it is time for us to reflect on where we are and where we intend on going,” he told the attendees in his keynote speech. “Success is not just a measure of what we have achieved as compared to the past but also what we have achieved as compared to the objectives we had set out for ourselves. In other words, what is the picture of the future of Islamic finance and banking, and what needs to be done to get there.”
The “picture of the future” of Islamic finance conjured by the CBB governor is an interesting one in the context of Bahrain. The regulatory choices made by the CBB have regional, and even global, significance thanks to the nation’s status as a generator of international standards for sharia-compliance – a position which it enjoys thanks to the host of influential organisations that are based in the kingdom. These include the Accounting and Auditing Organisation for Islamic Financial Institutions, the Liquidity Management Centre, the International Islamic Financial Market (IIFM) and the Islamic International Rating Agency. The past year has seen two significant developments in the fields of sharia standards, the effects of which are likely to be felt both in the domestic and international markets.
The framework governing the Islamic financial services (IFS) sector in Bahrain is in a constant state of evolution, thanks to the proactive stance of the CBB in its approach to regulation. Two major regulatory themes emerged in 2015 which are likely to have a significant impact on the sector in the short to middle term.
The first emerged in the public sphere in the early part of the year, when the CBB executive director for financial institutions supervision, Abdul Rahman Mohammed Al Baker, used his speech at the 11th Middle East Insurance Forum to draw attention to the regulator’s initiatives with regard to the takaful (Islamic insurance) segment. A revised takaful model was mooted in 2013, when the CBB asked the industry to review its proposal for an enhanced regulatory framework. The focus of the regulatory adjustment was the issue of solvency, which on the international stage is being driven by the Solvency II directive emerging from Europe and being taken up by regulators across the globe. The Bahraini initiative seeks to harmonise the solvency standards being adopted by the world’s insurance industry with the demands of the domestic sharia-compliant insurers, thereby ensuring that they can more effectively match the risks on their books to their future obligations to policyholders. In December 2014 Bahrain also became one of the first GCC jurisdictions to implement a close-out netting law to enhance legal certainty.
A particular concern addressed by the new standards is the issue of benevolent loans, called qard by which shareholders extend a loan to the policyholder’s fund on a voluntary basis in order to meet any deficit. Some Islamic scholars, however, object to the convention on the grounds that the regular use of qard hassan contravenes sharia principles, as it is only meant to be used when a policyholders’ fund runs out of money, not to meet recurring regulatory deficits.
The new rules tackle this issue head-on, replacing the qard hasan principle with a new means by which insurers can meet shortfalls in their policyholders’ pool. Henceforth, an insurer’s total capital will be calculated by combining the available capital of the shareholders’ fund and the net admissible assets of the policyholders’ fund. This figure is then compared to the new solvency requirements, and any deficiency is subsequently met by capital injections.
The new Operational and Solvency Framework for the takaful and retakaful industry also establishes more rigorous financial supporting standards, as well as measures to improve transparency and accountability. Having published a final framework in 2014, the CBB began to implement the measures in early 2015, and the regulator hopes that its clarified regime will attract new entrants to the market and foster healthy competition. The optimism of the regulator regarding the effect of the new standards is shared by global assurance, tax and advisory services firm EY, which in its more recent report on the international takaful sector stated that the framework would heighten the sharia-compliant insurance industry’s appeal to investors and that the development is likely to boost the country’s broader Islamic finance sector. The measures are also expected to strengthen the solvency position of Bahrain’s takaful operators, the report noted, enhancing operational efficiency of the business and safeguarding the interest of all stakeholders.
Bahrain’s new takaful standards have further cemented the country’s position as regional leader in the rapidly evolving field of Islamic finance. In early 2015 news came of another development which has the potential to sharpen the nation’s competitive edge still further. In February 2015, Khalid Hamad, the central bank’s executive director of banking supervision, told Reuters that the regulator was formulating a legal instrument that would set out the basis by which a board of sharia scholars could be established to oversee the nation’s Islamic finance sector. Any such body would represent an interesting departure from the regional norm by which financial institutions consult with their own, individual sharia boards when introducing new products or processes.
As the Islamic finance industry has matured and grown more complex, the calls for a more centralised form of governance have grown louder. Oman established a central sharia board in 2014, but Bahrain’s move to establish a similar body is a considerably more significant regional development due to the nation’s status within the global Islamic finance arena.
How the board will be formulated, and the timing of its introduction, are as yet unclear, but the CBB already has experience in running a similar body: the regulator has operated its own sharia board for some years, although its remit is confined to examining and regulating on the CBB’s own products. The chief advantage of a centralised system for sharia approvals is efficiency. Presently, each institution operates its own board structure and separately works to gain sharia approval for products which in many cases have already been accepted by boards of similar institutions. By removing this unnecessary duplication of oversight, it is hoped that the speed with which novel Islamic finance products are adopted by the market will be increased. The presence of an officially sanctioned sharia board also has the potential to reduce the workload of some of Bahrain’s standard-setting institutions. “The role of a standard setting body does not change with the creation of a centralised sharia board”, Ijlal A Alvi, CEO of the IIFM, told OBG. “Standards can be reviewed by the centralised sharia board instead of being reviewed by each institution’s board. Hence it will be easier to achieve implementation.”
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