Regulatory changes in Bahrain's Islamic finance sector

Widely regarded as a leading centre of innovation in Islamic financial services (IFS) and known for its robust and responsive regulation, Bahrain is growing in influence. The kingdom’s Islamic financial institutions are regulated by the Central Bank of Bahrain (CBB), and in 2014 the CBB has made a number of refinements to its codes and rules for licensed entities. Some of these regulatory changes are driven by Basel Committee rulings, which apply to both conventional and Islamic lenders, while others represent the CBB’s attempts to ensure best practice is applied to sharia-compliant instruments and transactions.

Strategic Objectives

Moves to strengthen banks’ capital bases and promote better governance and transparency are being taken. “No transformation of the industry can be fully achieved with any confidence unless it is underpinned by an appropriate, well founded, globally accepted regulatory framework and agreed upon international standards of practice,” Rasheed Mohammed Al Maraj, the CBB’s governor, told delegates. “A framework of this nature must be sufficiently robust to bring consistency of approach, whilst at the same time it must be sufficiently flexible to accommodate the regional and local environment. This presents a major challenge, but more importantly offers the opportunity for sustainable and significant success.”

The CBB has been encouraging banks in the kingdom to consider mergers to improve their strength and competitiveness, and a number of Islamic lenders have responded to these calls by joining forces in 2013 and 2014, while regulators hint that more mergers are likely to take place going forward.

Basel Impact

A number of reforms and initiatives being pursued by the CBB as a result of Basel Committee recommendations made in the light of the financial crisis are having an impact on Islamic banks. New rules on remuneration, with a focus on employees earning more than BD100,000 ($265,000) per annum, are being introduced starting from July 2014. All banks are being asked to adhere to higher standards of transparency and disclosure in their reporting and to make more useful data available to stakeholders to help them make informed choices. In addition, the CBB is counselling its licensees to ensure their institutions have adequate liquidity in addition to required capital so their operations can be sustained during a crisis.

Al Maraj said that as a result of these incremental changes the composition of balance sheets at both conventional and Islamic banks had changed, with directors making major reforms to their firms. “The overall outcome is that Islamic finance is benefitting from these changes. The over-reliance on real estate and infrastructure projects is being systematically replaced with a recognition that revenue-generating assets, which in turn provide identifiable, sustainable profits for the future, are the way forward,” he said.


The CBB also hopes to see more standardised practices in Islamic banking, and it is working with bodies such as the non-profit International Islamic Financial Market (IIFM) to measure and encourage best practices. In July 2013 it made two such recommendations to Islamic banks in the kingdom based on IIFM initiatives. It urged them to ensure Treasury product transactions were governed by the International Swaps and Derivatives Association (ISDA)/IIFM Tahawwut Master Agreement. This was designed to govern the credit and legal relationship between two parties in a sharia-compliant hedging transaction. The CBB also encouraged Islamic lenders to use the new standard unrestricted wakala contract for Islamic interbank transactions developed by the IIFM. The contract replaces the more common cost-plus-profit commodity murabaha with wakala, which is based on risk-sharing and an agency agreement in which an investor authorises an agent to manage assets according to sharia principles prohibiting interest and speculation.

Get Rated

The CBB urged Islamic banks to have their institutions rated in early 2014 by the Islamic International Rating Agency (IIRA), which is headquartered in Bahrain. The IIRA told OBG that its fiduciary ratings are tailored to Islamic financial institutions, informing investors about corporate and sharia governance practices in addition to the financial risk profile of the rated entity. “We view Islamic banks as modaribs [ financial managers] that are managing investments on behalf of depositors and other investors. Asset manager quality and assessment of corporate practices to protect investors’ funds hence form an integral part of the review process under our Fiduciary Ratings Methodology that was launched in 2011. Likewise, while rating a sukuk, we also analyse its structure. We consult prominent sharia scholars in the industry on a regular basis to seek their guidance, while our rating committee members possess sufficient knowledge regarding key Islamic finance principles,” Mohammad Raza Lakhani, a financial analyst at IIRA, told OBG.

New Sukuk Rules

In early 2014 the central bank also created a new module in its CBB Rulebook on issuing securities and sharia-compliant sukuks through public offering or private placement in or from Bahrain. The rules set out the regulatory and supervisory provisions, as well as the stages of issuing, offering, floating and subscribing to different types of securities, whether conventional or sharia-compliant. The module also stipulates the roles and responsibilities of the different parties involved, as well as detailing all the procedures and paperwork that need to be prepared by an issuer. The CBB is also promising to speed up its own part in the process. “The CBB will shorten the timeframe required to grant approval for the issuing and offering of securities, provided that the involved parties, including the issuer’s board of directors, meet the requirements for the accuracy and comprehensiveness of information for investors in all types of securities, including sharia-compliant securities, newly established small and medium enterprises, and private placement,” said Al Maraj in a newsletter to Islamic banks.

Another key step was for the CBB to announce it will accept all applications submitted by GCC issuers, provided they meet the group’s unified standards, thus paving the way for the integration of GCC securities markets and helping to boost the economy by attracting overseas investment to its primary securities market.

Takaful Regulations

The CBB also released new rules in the third quarter of 2014 governing the fast-growing Islamic insurance, or takaful, industry, which according to EY estimates will handle $17.1bn in contributions around the world by 2015. Abdul Rahman Al Baker, executive director of financial institutions supervision at the CBB, said the rules covering the operations and solvency of takaful firms had been developed after two years of consultations with the industry and were designed to help takaful firms distribute surpluses and dividends. The takaful industry is one of the fastest-growing segments of Bahrain’s insurance sector. Gross contributions of takaful companies grew 7% to BD57.2m ($151.58m) in 2013, up from BD53.7m ($142.31m) in 2012, according to the CBB.

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The Report: Bahrain 2015

Islamic Financial Services chapter from The Report: Bahrain 2015

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