As a pioneer in Islamic finance regulations and the home of some of the most important standard-setting institutions in the global sharia-compliant arena, Bahrain is at the forefront of the international Islamic financial services (IFS) industry. Islamic banks in the kingdom continue to expand, serving the region as well as the domestic market, while sharia-compliant insurance activity is about to receive a welcome fillip in the form of an improved regulatory structure.
Regional Centre
When civil strife in Lebanon during the 1970s brought a slew of bankers to Bahrain, the concept of Islamic finance in its modern form was in its infancy. The subsequent emergence of Bahrain as a financial centre coincided with a renewed interest in the potential of sharia-compliant banking, the idea of which had been propagated by a handful of young Muslim economists since the 1960s. It was not long before the banking centre of Bahrain began to take on an Islamic flavour. In 1979 Bahrain Islamic Bank was established as the first Islamic lender in the kingdom, and over the following decade it was joined by more sharia-compliant institutions as Bahrain’s reputation as the GCC’s financial centre grew. By 1990 the kingdom’s status as a centre for Islamic finance was sufficient for regional Islamic financial institutions to choose it as the home of a new standard-setting body, the Accounting and Auditing Organisation for Islamic Institutions (AAOFI).
The existence of AAOFI in Manama has placed Bahrain as a leader in the global IFS industry, its standards acting as a reference for regulators across the world. Subsequent years have seen it joined in Bahrain by a raft of other institutions that provide support or standards for the domestic and international IFS sectors, including: the International Islamic Financial Market (IIFM), the General Council for Islamic Banks and Financial Institutions, and the Islamic International Rating Agency. More recent arrivals include the Thomson Reuters Global Islamic Finance Hub, Deloitte’s Islamic Finance Centre, and the Islamic centre at the Bahrain Institute for Banking and Finance (BIBF), which offers a range of undergraduate and postgraduate courses on sharia-compliant finance.
Regulatory Framework
Much of the momentum that has gathered around Bahrain as an IFS centre stems from the willingness of the Central Bank of Bahrain (CBB) to establish a robust regulatory framework for the young industry. In 2001 Bahrain became the first country in the world to implement regulations specific to Islamic banking, and since then the CBB Rulebook has been widely regarded as the benchmark for sharia-compliant governance. In the same year, the nation further enhanced its reputation for innovation in Islamic finance when the central bank (then the Bahrain Monetary Agency) became the first to develop and issue sukuk (Islamic bonds).
By 2005 a comprehensive regulatory framework had been implemented for Manama’s growing takaful (Islamic insurance) industry, while the following year the CBB, in partnership with IFS institutions, established the Waqf Fund as part of its strategy to maintain the nation’s position on the front line of global Islamic finance. Since that time the fund has financed a range of research, education and training projects and worked with industry participants to develop new market standards. In 2014 the ICD-Thompson Reuters Islamic Finance Development Indicator named Bahrain as the GCC region’s leading Islamic finance market and the second out of 92 countries worldwide. The report, which is the only numerical measure representing the overall health and development of the global Islamic financing industry, also ranked Bahrain as having the best IFS governance in the world.
Banks
As of July 2015 some 24 Islamic banks were licensed to operate in Bahrain, all but two of which (Kuveyt Türk and Türkiye Finans) were locally incorporated. As is the case with their conventional counterparts, Islamic banks have licenses according to two categories: six retail institutions serve the local market, offering sharia-compliant products to both nationals and expatriates, while 18 wholesale Islamic banks are granted limited access to the local economy and primarily operate as offshore investment entities.
One institution, the Al Baraka Group, holds both a retail and a wholesale licence. Between them, Bahrain’s Islamic lenders offer an array of sharia-compliant products and services, such as murabaha and istisna’a (types of sales contracts), mudaraba (profit-sharing agreements), ijara (Islamic leasing bonds), musharaka (joint ventures), Al Salam (short-term bonds), restricted and unrestricted investment accounts, syndications and other structures found in conventional finance that have been modified to comply with sharia principles.
The growth of the Islamic banking segment within the wider banking sector has been rapid; according to the CBB, in a five-year period, between 2000 and 2015, the market share of Islamic banks increased from 1.8% of total banking sector assets to 13.5%. The result of this substantial expansion has created what is now one of the most dynamic Islamic banking markets in the world. In the retail segment local players compete for business with the Islamic arms of banking groups with a regional footprint, such as Al Baraka. The more fragmented wholesale segment contains industry veterans, such as Capivest, which received its licence in 1981 and is now part of Ibdar Bank; the Islamic operations of regional conventional giants, such as ABC Islamic Bank; the wholesale divisions of large Islamic retailers; and large investment firms, with a presence in other financial capitals. All of them have faced challenges in recent years.
The exposure of Islamic lenders to the real estate sector, due to the physical asset-based finance model demanded by sharia, meant that they were particularly vulnerable to the effects of the global economic crisis. The balance sheets of Islamic lenders were considerably weakened by declining real estate prices in the post-2009 environment, and non-performing loans emerged as a structural weakness in the segment. However, the intervening years have seen a strengthening of financial soundness indicators, as reported in the CBB’s most recent financial stability report. Non-performing loans in the Islamic retail segment fell from 13.1% in September 2013 to 12.6% in March 2014, while the wholesale segment saw a decrease from 5.4% to 5.1% over the same period.
Although the earnings picture over the past year was mixed – with retail banks enjoying an increase in return on assets and return on equity between March 2013 and March 2014, and wholesale institutions experiencing a slight decrease – both of these segments are well positioned for future growth: capital adequacy stood at 17.7% for retail banks and 24.6% for wholesale banks at the close of the period. Both retail and wholesale banks also experienced a strengthened liquidity position, according to the regulator.
Takaful
Bahrain’s status as a centre of Islamic finance rests on more than just its vibrant Islamic banking sector. The expansion of sharia-compliant lending has in recent years fuelled the rapid expansion of Bahrain’s takaful industry, which as of July 2015 was comprised of eight locally incorporated takaful and retakaful firms: ACR Retakaful, Chartis Takaful Enaya, Legal and General Gulf Takaful, Hannover Retakaful, Medgulf Takaful, Solidarity General Takaful, Takaful International Company and the T’azur Company. As with Islamic banking, takaful has expanded at a faster pace than its conventional counterpart over the past decade, driven by increasing demand for sharia-compliant cover, growing public awareness about the merits of insurance, the entry of international players to the domestic market and the existence of a well-regarded legislative framework that covers the industry’s activities.
Market Growth
According to the CBB, the takaful market grew almost 14 times in terms of premiums between 2003 and the close of 2014. In 2001 takaful firms accounted for around 3% of the gross written premiums in the insurance sector, according to the CBB, but by 2012 their share of the market had increased to 22%. Similarly, the retakaful business, which began in Bahrain in 2006 with the licensing by the CBB of Hannover Retakaful company, accounts for around 20% of the total reinsurance and retakaful premiums.
A second retakaful company, ACR Retakaful, entered the market in 2008. However, while growth in the sector is strong, competition for takaful business in the region is intense. Saudi Arabia, if its cooperative model of insurance is included in the takaful definition, claims a 77% share of gross takaful contributions in the GCC, according to EY, followed by the UAE (15%), Qatar (4%), Bahrain (2%) and Kuwait (2%). Historically, Bahrain’s competitive edge has usually derived from its advanced regulatory framework, and therefore in a bid to grow its takaful and retakaful industry it has begun to implement a new regulatory framework for market participants which focuses on their solvency positions, enhancing operational efficiency of the business and safeguarding the interest of all stakeholders (see analysis).
Islamic Investment
As the first country in the world to allow its central bank to develop and issue sukuk, Bahrain has some claim to being an Islamic investment pioneer. It has since established itself as a frequent issuer of dollar-denominated sukuk as well as of monthly local currency sukuk offerings that have traditionally been picked up and held to term by institutions. The CBB and Bahrain Bourse (BHB) have recently moved to widen the investment base of its sharia offerings.
In January 2015 the BHB launched a new mechanism, the first of its kind in the Middle East, which allows both individuals and institutions, Bahraini and non-Bahraini, to directly subscribe to government issuances of sukuk and bonds through registered brokers, and trade them on the secondary market at the BHB. In order to encourage retail investors, the BHB specified a low minimum subscription rate of BD500 ($1320). The implementation of the system represents a significant broadening of exchange activity, and provides a useful route to yield for the investment community.
Bahrain, already a major centre of fund activity, is also emerging as a vibrant market for Islamic funds. According to the CBB, there are 88 Islamic funds incorporated and registered in Bahrain with total assets amounting to $1.4bn as of March 2014. The importance of their function within the IFS sector was highlighted at the World Islamic Funds and Financial Markets Conference (WIFFMC) which was held in Bahrain in May 2015. Describing the CBB’s approach to the fund segment, Abdul Rahman Mohammed Al Baker, executive director of financial institutions supervision at the CBB, said that the regulator was through its enabling legislation promoting “the development of new products for investors in both Islamic and traditional finance, while at the same time providing credible regulation in both areas”.
Regulation
The nimble yet robust regulatory approach that Al Baker was able to showcase at the WIFFMC is based upon the CBB Rulebook, the six volumes of which cover conventional banks, Islamic banks, insurance licences, investment firm licences, specialised licences and capital markets. Beyond this central legislative pillar sharia-compliant financial activity is subject to a number of national laws, including the CBB and Financial Institutions Law of 2006 and the Bahrain Anti-Money Laundering Law of 2001.
Oversight of the IFS sector is undertaken by the Islamic Financial Institutions Supervision Directorate (IFISD), which maintains a similar regime as that applied to the conventional sector. This includes formal meetings with Islamic banks at least twice a year to discuss prudential matters, as well as a financial review every 12 months in which the IFISD examines the institution’s financial report before it goes to its board.
Through rulebook updates and ad hoc announcements the CBB is able to fine-tune the regulatory framework governing the IFS sector, and react in a timely fashion to market issues as they arise. The large number of standard-setting organisations that have established themselves in Bahrain has proved to be a useful asset in the CBB’s regulatory armoury: in 2015 a wakalah (agency contract) standard formulated by the IIFB was used by the regulator to create a one-week Islamic deposit facility by which Islamic banks can profitably park excess liquidity. A lack of liquidity management options has been a challenge to the Islamic segment since its inception, and therefore the new instrument is both a useful solution to the problem as well as an example of the fruitful symbiosis between the CBB and the standard-setting organisations which call Bahrain home (see analysis).
Industry Developments
The IFS sector’s usefulness to the economy continues to grow as Islamic banks and insurance companies claim a larger share of the market. In the second half of 2014 the Economic Development Board, the public agency with an overall responsibility for attracting inward investment into Bahrain, established an initiative aimed at harnessing the growth of the Islamic banking sector to promote the development of Bahrain’s small and medium-sized enterprises (SMEs). The project sees the Economic Development Board join forces with the Islamic Corporation for the Development of the Private Sector (ICD), the private-sector arm of the Islamic Development Bank, to establish an Islamic ijara company in Bahrain that will offer SMEs sharia-compliant financing products. The ijara company will also be used as a training centre to help Bahrainis in the area of Islamic finance. In addition, ICD plans to set up a software development centre in Bahrain to develop software solutions for ijara, takaful, mortgage and Islamic banking, for export to the international market.
Human Resources
The issue of human resources is a challenge for both conventional and Islamic institutions, but for the latter the problem is compounded by the need to locate candidates who are both well versed in the technical requirements of banking and insurance, and also possess a thorough understanding of the requirements of sharia. Bahrain’s ability to attract key talent to its jurisdiction has mitigated this issue in the past, as has the presence of the BIBF in the kingdom. The well-regarded financial institute runs more than 300 programmes in both general concepts, such as banking and insurance, to more specialised areas of expertise like advanced banking practices, accounting, IT, Islamic banking, and leadership and management disciplines. As of 2015 the BIBF offered an array of Islamic finance courses, ranging from an introduction to Islamic finance and sharia for bankers to more technically challenging areas such as sharia auditing, structuring Islamic products, Islamic project finance, Islamic asset securitisation and Islamic commercial jurisprudence.
The range of sharia-compliant educational options will soon be extended by the BIBF thanks to its signing in late 2014 of a memorandum of understanding with the UK’s University of Bolton to develop an MBA in Islamic banking. According to the agreement, the BIBF will act as lead content provider for Islamic finance subjects and will supervise all dissertations, while the University of Bolton faculty will focus its attention on the core MBA subjects that make up the remainder of the course. The nation’s principal university is also playing an important role in supplying the sector with new talent: in 2015 Bahrain University’s first students graduated from its new bachelor’s degree in Islamic finance. The four-year programme, developed with the assistance of the Waqf Fund, combines sharia studies with finance, business, banking and statistics, and is one of the first of its kind in the world.
Outlook
Islamic banks and insurers face many of the same challenges as their conventional counterparts, the most salient of which is the effect that a sustained reduction in oil prices will have on economic growth in regional markets. However, the high capitalisation levels insisted upon by the regulator leaves them well positioned to weather economic headwinds, as well as holding sufficient room on their loan books to take advantage of lending opportunities as they arise. Within Bahrain, the capital expenditure underwritten by a Gulf aid programme (see the Economy chapter) is likely to drive big-ticket lending in the short term, while on the retail side an increasing demand for sharia-compliant financing is giving Islamic institutions a competitive advantage in a crowded market. The same capital expenditure will also benefit Bahrain’s takaful industry. Low penetration rates and the potential expansion of mandatory lines offer other possible routes to profit for the nation’s various sharia-compliant insurers.
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