Autumn 2014

SHARIA PANEL: Sharia standards in Bahrain

Dubai, Kuala Lumpur and even London aspire to be hubs for Islamic finance, but Bahrain still has a strong and respected role in this sector. Funds Global asked some key players in the country about the latest developments.

Hatim El-Tahir
Leader, Deloitte Islamic Finance Knowledge Centre

What are the prospects for a harmonious standard for sharia-compliant investing that crosses all boundaries?

Improved work practices in the sharia-compliant investment domain has been crowned by the establishment of the International Islamic Liquidity Management Corporation, which has put in place sound standards for a global liquidity management platform. It is also hoped that the creation of a cross-border short- to medium-term “depot” will enhance process standardisation, drive down cost and ultimately boost marketability of sharia-compliant asset classes.

How can experienced but busy Islamic scholars nurture a new breed of managers to deal with the high workload in this sector?
Collective efforts from different business quarters concerned including governments, regulators and industry standard-setting bodies should be able to assess and come up with a practical blueprint for a global sharia code of practice and professional development.

Are there certain asset classes that are difficult to access in a sharia-compliant manner? Which ones are they and why?
Broadly speaking, sharia scholars have shown consensus over the incompatibility of derivative markets and related asset classes. In particular, they reject complex structures and valuation processes which may question the economic benefit. However, scholars are constantly reviewing practices and structures of this industry and have approved some products such as profit-rate swaps.

Najla Al Shirawi
Chief executive, Securities & Investment Company (SICO)

What have been the most interesting developments in Islamic finance in Bahrain during the past 12 months?
The most notable development has been consolidation of the Islamic financial sector, which comprises six retail and 18 wholesale sharia-compliant banks.

In 2013, Al Salam Bank Bahrain acquired BMI Bank. Despite implementation risks and the fact that the merger will not address BMI Bank’s asset quality issue, it will enhance and entrench the franchise, strengthen financial metrics, and provide a greater likelihood of systemic support when needed. 

Also in 2013, Ibdar Bank was formed through the first-ever three-way Islamic banking merger, which joined Bahrain-based Capital Management House, Capivest and Elaf Bank.

Another significant development has been the successful restructuring of a number of Islamic wholesale and retail banks, including Venture Capital Bank, GFH, Bank Alkhair and Bahrain Islamic Bank, which were badly affected by the global financial crisis of 2008. Initiatives such as the development of new strategies and business models, and the introduction of stringent cost reduction exercises, have resulted in these institutions returning to profitability.

What changes to regulation would assist the growth of the Islamic finance sector in Bahrain, if any?
The scope of regulations will need to be expanded to encourage product innovation and developments. Diversifying Islamic financial products is a key focus for the industry. Instead of the past practice of copying conventional financial instruments, Islamic institutions are now busy developing new products within an Islamic framework.

In Islamic finance, the link between financial intermediation and economic growth is arguably stronger than in conventional finance. 

Sharia-compliant investments and financings, by nature, have to be accompanied by underlying transactions based on assets or trade that contribute to the real economy. One of the objectives – and an important one – of implementing Islamic financial systems is to promote equitable wealth creation and economic growth. 

According to experts, this can best be reinforced through capital markets instruments, and supported through further development of domestic and regional capital markets. 

This can only happen by taking important measures which enhance market efficiency, strengthen market infrastructure, widen the Islamic investor base, and develop new capital market instruments.

Establishing a solid foundation for Islamic funds, and promoting the growth of the Islamic investment industry, remain important considerations. In order to achieve them, a strong Islamic financial system needs to be developed. The Central Bank of Bahrain (CBB) has been proactive in enforcing measures to strengthen the Islamic financial system in the kingdom and ensure higher market efficiency.

Recent measures include advising all Islamic banks to seek credit ratings; requiring full compliance to all sharia principles, and full disclosure of assets and liabilities which are not sharia-compliant; and urging all Islamic banks to use standard documentation – issued by the International Islamic Financial Market (IIFM) – on unrestricted Wakala transactions as a replacement for commodity Murabaha. The CBB has also issued a new regulatory and supervisory module on the issuing and offering of securities and sharia-compliant sukuk through public offering or private placement, in or from the Kingdom of Bahrain, which forms a major part of the CBB’s Capital Market Rulebook Volume 6. 

In addition, the Waqf Fund, in consultation with the CBB and the industry, has started to review practices related to internal sharia review, and internal and external sharia audit to improve consistency and transparency.

Jarmo Kotilaine
Chief economist, Bahrain Economic Development Board

What have been the most interesting developments in Islamic finance in Bahrain in the last 12 months?
Bahrain has seen a number of mergers in the Islamic banking sector, encouraged by the Central Bank of Bahrain (CBB), to create stronger entities with the resources and scale to be able to be in a position to compete regionally and internationally.

The country has also seen a number of regulatory initiatives pursued by the CBB. 

Among these have been moves to develop rules for the supervision of sharia-compliant advisory firms that would reduce costs, particularly for smaller institutions, by enabling them to outsource some functions.

What changes to regulation would assist the growth of the Islamic finance sector in Bahrain, if any?
The new regulations surrounding the takaful industry, which are currently being finalised, have the potential to open up the industry to larger international businesses by making it easier for firms to distribute surpluses to policy holders and dividends to shareholders by amending how solvency ratios are calculated. 

There is strong potential in the broader insurance sector in the region as penetration rates catch up with international levels and as strong economic growth drives demand for both life and non-life products.

Are there certain asset classes that are difficult to access in a sharia-compliant manner?
The scope of the investable universe reflect both the relatively young age of the modern Islamic finance industry and that most countries at the forefront of Islamic finance and still emerging markets where elements of the financial sector are still at relatively early stages of its development. 

In the GCC, Islamic banking is well developed, as are the equity capital markets. In recent years, we have seen dramatic progress in the area fixed income markets thanks to the rapid growth of sukuk. 

The next stage, contingent on further market growth, is the emergence of liquid secondary markets.

We have begun to see the emergence of a greater number and growing range of funds to cater to more investor needs, but in practice the market is still heavily dominated by money market and equity funds.

In the coming years, we expect to see more momentum in the area of real estate funds. Certain areas, such as commodities, are more complex. In some instances, product development in complicated by relative absence of derivative products. For instance, some more “exotic” asset classes such as hedge funds are inherently more difficult to incorporate into a sharia-compliant framework.

In general, the fragmentation of the global Islamic finance market place limits the availability of international and regional funds, which are a big part of the conventional universe.

©2014 funds global mena

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