The Islamic Finance and Markets Law Review: Bahrain
Bahrain's financial sector is well developed and diversified, consisting of a wide range of conventional and Islamic financial institutions and markets, all of which are subject to a sophisticated legal and regulatory framework.
Bahrain (through the Central Bank of Bahrain (CBB)) has one of the most comprehensive regulatory regimes for regulating shariah-compliant activities in the world. Oman and Pakistan are close competitors, although Malaysia is generally regarded as having the most comprehensive. The difference is that Oman and Pakistan have separate legislation dealing with sukuk issuances (as does Jordan), but other legislation in those jurisdictions either does not fully cater to non-commercial banking and capital markets activities or is quite nascent.
The CBB's legislative model differs from Oman and Pakistan in that it is less prescriptive and allows financial and other institutions to align their businesses with rapidly fluctuating global trends. This means the CBB maintains an open dialogue with all its licensees and regularly seeks their (and other market participants') input on legislative updates and further regulation. This is one of the features that distinguishes the CBB's approach to regulation from the rest of the regulators in the Gulf Cooperation Council (GCC).
The term 'Islamic finance' or 'Islamic banking' has wider application in Bahrain rather than just applying to commercial banks, and includes non-deposit-taking investment or merchant banks and private equity institutions operating in a shariah-compliant manner. The CBB licenses each of these institutions appropriately in accordance with their proposed activities. The ambit of this chapter does not include a discussion on each of these licences, as this information is available on the CBB's website.2
Legislative and regulatory framework
i Legislative and regulatory regime
Persons wishing to undertake regulated Islamic banking services must be licensed by the CBB as an Islamic bank licensee. Regulated Islamic banking services consist of three determinant activities: accepting shariah money placements or deposits, managing shariah profit-sharing investment accounts and offering shariah financing contracts. If an institution has the requisite licence, it may be able to offer all three regulated activities alongside various supplementary activities. Islamic bank licensees must operate in compliance with shariah economic principles, and only Islamic bank licensees may hold themselves out to be fully shariah-compliant institutions. Ultimately, it is the type of licence issued by the regulator that determines whether an institution is shariah-compliant.
Every individual Islamic bank in Bahrain has its own internal shariah board, which determines the shariah compliance of its products. As of August 2021, there were 363 financial institutions, including 90 banks, registered in the banking sector,3 of which 17 are Islamic banks licensed by the CBB.4 The CBB does not interfere with this internal process, but is usually very helpful and facilitates discussions about new ideas and concepts. The CBB must approve new products before they can be offered to customers. Banks also need to inform their customers of associated risks and any unusual product features if the capital is not protected. If the capital is protected then the banks must inform the customers that there is a chance that the actual return may be lower than the anticipated or projected return. Notably, from 26 February 2020 onwards, licensees including conventional banks, Islamic banks, financing companies and microfinance institutions are no longer required to seek the CBB's prior approval before placing advertisements for financial products and services through newspapers, websites or any other media. In any event, the CBB has reiterated that any advertisement and sale promotion must be in terms that are clear, understandable, and not misleading or deceptive in any way.5
Islamic bank licensees are divided into two subcategories: Islamic retail banks and Islamic wholesale banks. Specific regulatory requirements may differ between these two subcategories where appropriate to address their risk profiles.
Islamic retail banks may undertake transactions in any currency, with both Bahraini residents and non-residents. To qualify as an Islamic retail bank, the activity of offering shariah financing contracts must account for a significant portion of the institution's business. This is defined, broadly, as accounting for over 20 per cent of an institution's assets.
Islamic wholesale banks may also undertake transactions without restriction when dealing with the government and its agencies, CBB bank licensees and non-residents. However, they may only undertake transactions denominated in Bahraini dinars or with a resident of the Kingdom of Bahrain if these transactions are to be wholesale in nature. Wholesale transactions are defined in terms of transaction size (broadly, 7 million dinars or more for the activities of accepting shariah money placements or deposits and offering shariah financing contracts, and US$100,000 or more for any of the other activities falling within the definition of regulated Islamic banking services). Islamic wholesale banks are allowed to transact in dinars (or any other currency) for any amount with the government, Bahrain public sector entities (as defined in the guidelines for completion of the Prudential Information Returns for Islamic Banks Form) and CBB bank licensees. Islamic wholesale banks may also transact in dinars for any amount (where required) to fund their normal operating expenses when investing for their own account in securities listed on a licensed exchange.
Islamic bank licensees are subject to certain licensing conditions. These licensing conditions are consistent with international good practice, such as the relevant Basel Committee and Islamic Financial Services Board standards. In December 2019, the Operational Risk Management module of the CBB Rulebook, which relates to establishing parameters and control procedures to monitor and mitigate operational risks, was entirely revised to ensure better alignment with the principles and guidance from the Basel Committee on banking supervision. There was a grace period for compliance, thanks to covid-19, until 30 June 2021.6
Islamic bank licensees must satisfy the CBB that their controllers are suitable and pose no undue risks to the licensee. There are also certain procedures, as set out in Articles 52 to 56 of the Central Bank of Bahrain and the Financial Institutions Law (CBB Law)7 on controllers. Licensees and their controllers must also observe the CBB's capital markets requirements in respect of changes in holdings of shares of listed companies.
There are differing requirements for locally incorporated licensees (Bahraini Islamic bank licensees) and branches of foreign banks (overseas Islamic bank licensees). Requirements for overseas Islamic bank licensees are less onerous than those for Bahraini Islamic bank licensees. It should be noted that between October 2019 and April 2020, the CBB updated several modules of its Rulebook to extend the scope of provisions that previously were only applicable to locally incorporated licensees to branches of foreign bank licensees (e.g. sections of the General Requirements module relating to corporate and trade names, business transfers, cessation of business and controllers, as well as rules relating to stress testing, auditors, accounting standards and public disclosure requirements).
A licensee that carries on an activity such as dealing in shariah-compliant financial instruments as agent (i.e., buying or selling, or subscribing for, shariah-compliant financial instruments on behalf of a client) should not determine the terms of the transaction and should not use its own financial resources for the purpose of funding the transaction. This means that the licensee must act as an agent and must not have a say in the terms of the transaction. Such a licensee may, however, receive or hold assets in connection with the transaction in its capacity as agent of its client. The following are examples of activities that, when taken in isolation, are unlikely to be regarded as acting in the capacity of an agent:
- appointing professional advisers;
- preparing a prospectus or business plan other than in connection with the Regulatory and Supervisory Module on Issuing and Offering of Securities and Sharia Compliant Sukuk of 2013 (OFS Module);
- identifying potential sources of funding;
- assisting investors, subscribers or borrowers to complete and submit application forms other than in connection with the OFS Module, the CBB Rulebook Volume 6 (Capital Markets) and the CBB Rulebook Volume 7 (Collective Investment Undertakings); or
- receiving application forms for processing or checking and onward transmission other than in connection with the OFS Module, the CBB Rulebook Volume 6 (Capital Markets) and the CBB Rulebook Volume 7 (Collective Investment Undertakings).
Islamic bank licensees must maintain a minimum daily cash reserve balance with the CBB, set as a ratio of their total non-bank dinar funds, whether placed by way of call or unrestricted investment accounts (or similar), as well as taken through the issuance of dinar-denominated Islamic investment certificates. The current required ratio is 5 per cent and may be varied by the CBB at its discretion.
Islamic bank licensees, including branches of foreign bank licensees,8 must arrange for their external auditor to confirm the accuracy of the data reported on the eligible accounts report for the deposits or unrestricted investment account protection funds. In the case of branches of foreign bank licensees in the Kingdom, the CBB will also take into account who acts as the auditor of the parent entity.9
ii Regulatory and supervisory authorities
Conventional banks and shariah-complaint banks (referred to collectively as licensees) are both regulated by the CBB; however, the rules for each differ. The accounting standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) are compulsory for all Islamic banks, and for conventional banks if they are maintaining Islamic units. From April 2020, the same accounting standards now also apply to branches of foreign bank licensees.10
The CBB's supervision of licensees is a mixture of onsite assessment (including the quality of systems and controls, and of books and records) and offsite supervision (which focuses on the analysis of regulatory returns, as well as of audited financial statements and other relevant public information). The CBB strengthened its supervisory role by establishing a centralised Shariah Supervisory Board (SSB) in 2015 and launching the shariah governance framework, which became effective in June 2018. In January 2020, the CBB established a new rule that the internal shariah audit function of Islamic banks must be governed by a policy and procedures manual prepared by the management of the licensee in consultation with the SSB. Such policy must be approved by the board of directors and the procedures approved by senior management of the licensee.11
Onsite examinations are undertaken by the CBB's own examiners, as well as by experts appointed for the purpose by the CBB (such as accountants and actuaries). Offsite supervision also includes regular prudential meetings with licensees to review performance, strategy and compliance matters (such as capital adequacy, large exposures and liquidity).
For banks, a risk profiling system has been developed to underpin the above supervisory efforts by providing a detailed framework for assessing the impact and risk profile of individual licensees and prioritising subsequent supervisory efforts. Work is underway to extend this profiling system to insurance companies.
The CBB may amend or revoke an entity's licence in some cases including, but not limited to, where a licensee fails to start business within six months or ceases to carry out its licensed activities in the Kingdom, or where the legitimate interests of its customers or creditors call for an amendment or revocation of a licence.12 Should a licensee fail to satisfy the CBB's regulatory requirements, enforcement measures include formal warnings, directions (e.g., to cease or desist from an activity), formal requests for information, adverse fit and proper findings, financial penalties or investigations. Extreme violations of the CBB's regulatory requirements may entail cancellation of a licence, being put into administration or being subject to criminal sanctions.
|Types of product offered*||Description of product|
|Mudarabah savings account||A mudarabah savings account is based on the shariah principle of unrestricted mudarabah. Under the mudarabah principle, the customer will act as a capital provider and the bank will act as a mudarib (entrepreneur) using its expertise. The bank pools all customer funds with its own capital and invests it in shariah-compliant modes of investments. The resulting profit is shared between the bank and customers according to predetermined ratios. Mudarabah is a profit-and-loss sharing product, and the better the bank performs, the higher the profits earned.|
|Term investment deposit (mudarabah)||A term investment deposit is based on the shariah principle of unrestricted mudarabah. Under the mudarabah principle, the customer is an investor (rab-al-mal ) for a fixed period and the bank will act as a mudarib (entrepreneur) using its expertise. The bank pools all customer funds with its own capital and invests it in shariah-compliant investments for a specified investment term and expected profit rate. The resulting profit is shared between the bank and customers according to predetermined mutually agreed ratios.|
|Izdihar savings account||An izdihar account is a savings account based on the Islamic principle of unrestricted mudarabah, which means customers can earn a profit on their savings. Funds are placed in a common investment pool where they are invested in strict compliance with shariah principles to generate the best possible returns. Profits generated from the investments are shared between the bank and customers according to a pre-agreed profit-sharing ratio.|
|Current account (qard hasan)||A current account is based on the Islamic contract of qard hasan (interest-free loan). A person, as a depositor, will be the lender, and the bank will be the borrower. The deposited funds are invested in halal activities only. Irrespective of the profit or loss generated by the bank from such investments, the funds are guaranteed payable on demand without any profit or penalty.|
|Wakalah investment||Wakalah investment is based on the Islamic concept of wakalah istithmar, under which a person becomes the principal (muwakkil ) and the bank becomes the investment agent (wakeel ) of your funds. The bank invests these funds in shariah-compliant financing and investment activities. The targeted profit earned from the investments is distributed to the customers upon maturity of the account. The bank (as wakeel ) deducts its agreed agency fee (wakalah fee) and, at maturity, pays both the targeted profit amount and the principal funds to the customers as per the terms of the wakalah agreement.|
|* In relation to certain mudarabah, wakalah or musharakah-based savings accounts and products that are not capital-guaranteed, it is possible that a customer may not be guaranteed a return and may even lose its principal. The CBB has strict criteria for offering these types of products, including suitable disclosures (i.e., product summary, risk factors). Customers must therefore assume complete performance risk, although, in practice, it is unusual for banks not to provide the anticipated profit and return principal.|
i Private equity investments
For Bahrain-based private equity funds, whether they are to be established in a shariah-compliant manner or generally established as a conventional fund, no particular structure is used.
Common structures would be Cayman Islands exempt limited partnerships (if in the form of a partnership or a Cayman Islands exempt corporate fund). An investment may also be set up in Bahrain as a private investment undertaking. This is a flexible type of fund that only needs to be registered with, rather than approved by, the CBB, and that has very limited restrictions on its ability to invest, although there are very high thresholds on the type of investor and the minimum investor amount in respect of investing in such a fund.
In general, any fund that is to be shariah-compliant will have to obtain a fatwa and make its investments in shariah-compliant products and in compliance with the various tenets of shariah.
ii Real estate investments
In respect of real estate funds, no particular structure is used, and the same considerations in respect of a conventional fund would be taken in establishing a shariah-compliant real estate fund.
Common structures are offshore limited partnerships and companies, locally domiciled funds and real estate investment trusts. The Trust Law13 was introduced in late 2016, enabling the establishment and listing of real estate investment trusts known as Bahrain real estate investment trusts (BREITs). BREITs are governed by the Trust Law, Volume 7 (Collective Investment Undertakings) of the CBB Rulebook as well as the BREIT Listing Rules issued by the Bahrain Bourse.
BREITs can be established as either an expert collective investment undertaking (CIU) or an exempt CIU. Expert CIUs may be offered only to expert investors, who must deposit a minimum of US$10,000. Exempt CIUs are lightly regulated but may only be offered to accredited investors who invest at least US$100,000. BREITs are gaining more attention in Bahrain, although very few have been launched to date.
GCC nationals and wholly owned GCC entities may own land in Bahrain on a freehold basis. A non-Bahraini person or legal entity can own real estate or land in certain designated areas where foreign ownership is permissible.
iii Investment funds
Investment funds are generally established in Bahrain as companies, partnerships or trusts. No particular type of fund structure is used to enable it to be shariah-compliant.
A common structure used when a fund is to be marketed to retail investors would be a shariah-compliant expert fund. This type of fund requires a minimum investment of US$10,000 and can only be offered to investors who already hold financial assets of at least US$100,000. Expert funds can be leveraged by borrowing up to a limit of 20 per cent of the value of assets under management.
A further example of a type of investment fund used in Bahrain is a shariah-compliant exempt fund. This can only be marketed to accredited investors (who already hold assets worth US$1 million) and the minimum investment amount is US$100,000. This type of fund is lightly regulated.
Bahrain introduced the Investment Partnership Law14 in 2017, and in doing so is the first country in the GCC region to have introduced national legislation enabling the formation of limited partnerships in a manner comparable to structures utilised in reputable offshore fund domiciles. Key features of the Law include the ability for a general partner of a Bahrain investment limited partnership to be established as a subsidiary or a special purpose vehicle (SPV) of an investment business. This would allow sponsors not to be unduly exposed in terms of liability while using one of the preferred and widely recognised international models for private equity funds. The Law also aims to make Bahrain a more attractive market for investors by setting a high liability standard in respect of general partners. A limited partner is expressly prohibited from participating in the management of the partnership. A limited partner is not liable for the partnership's obligations and debts beyond its own contribution. However, the limited partner may need to return its share of profit paid out within six months of the partnership's insolvency, to the extent necessary to discharge the partnership's debts or obligations.15 The investment limited partnership may only carry out certain activities within the financial sector, including private investment undertakings, collective investment undertakings, securitisation and insurance captives, as well as any other activities subsequently approved by the CBB.16
The Protected Cell Companies Law,17 enacted in Bahrain in 2016, allows for the formation of protected cell companies (often called segregated portfolio companies or sub-funds). Both a limited partnership fund and a segregated portfolio fund can be established as a shariah-compliant fund. A protected cell company is a corporate structure in which a single legal entity is comprised of a core legal entity under which there are several divided cells or portfolios. The protected cell company allows for each cell to be managed by a single or separate investment manager. As a fund develops, expands and targets under or varying asset classes, new cells can be established, which enables long-term flexibility and provides opportunities for investors to be exposed to new asset classes or sectors at lower costs for the fund promoter or manager. Each cell's assets can be ring-fenced and are therefore only available, or exposed to, the creditors and shareholders of each particular cell. A protected cell company does have the option to enter into an agreement with a third party in which the third party will have the right of recourse to the assets of the core entity in respect of any liability that may accrue to him or her in the course of his or her dealing with any of the protected cell company's cells, in addition to the assets of the relevant cell.18 The development of the Investment Partnership Law and the Protected Cell Companies Law signifies a will to develop the funds industry in Bahrain.
As at the end of June 2021, the number of mutual funds stood at 1,766 funds, of which 73 were Bahrain-domiciled, compared with 1,970 funds as at June 2020. The number of shariah-compliant funds stood at 88 as at June 2021.19
All Bahraini Islamic bank licensees must obtain the CBB's prior specific written approval if they intend to be involved in an SPV in the capacity of an originator, sponsor or manager of that SPV, or if they intend to participate in the creation of an SPV or acquire a holding of 20 per cent or more of the equity capital of an SPV. All Bahraini Islamic bank licensees must seek prior specific written CBB approval if they are appointed as nominee shareholders of SPVs or hold votes by proxy arrangement in SPVs on behalf of other investors. In addition to providing necessary information to the CBB when requesting approval, Bahraini Islamic bank licensees that are involved with SPVs must not allow such SPVs to:
- obtain any conventional financing;
- give any type of financial guarantees, warranty or indemnity to the rab-al-mal (capital provider), the muwakil (principal) or investors in the SPVs; and
- ensure that there are no restrictions on the availability of financial and other information relevant to the SPV or in terms of access to its business premises and records.
The Trust Law replaced the Bahrain Financial Trusts Law of 2006, and aims to provide detailed guidance on the creation and administration of financial trusts within the Kingdom. While such trusts are widely used in other jurisdictions, they are new to the Middle East, and Bahrain is one of the first countries to put in place this type of legal framework. The Trust Law formally recognises trusts governed by the laws of other jurisdictions, thereby giving certainty to foreign investors who may want to set up a trust in Bahrain.20 This development allows for the development of onshore shariah-compliant structures to hold assets, particularly for families who have previously tended to use offshore jurisdictions to do so. These trusts are also used in the development of BREITs, which can be established pursuant to the CBB fund regulations.
Bahrain currently has no income tax, corporation tax (except for oil, gas and petroleum companies that are engaged in exploration, production or refining, regardless of their place of incorporation) or capital gains tax, and no estate duty, inheritance tax or gift tax. However, Islamic finance transactions involving real estate may be subject to taxes. For example, if the legal ownership of land is transferred or registered, this could result in registration fees. On all property purchases, a registration fee of 2 per cent is levied, which is reduced to 1.7 per cent if registration and payment are completed within 60 days of the relevant transaction. If an Islamic financial transaction involves payments under an ijarah, this will generally not be subject to taxation. In Bahrain, Islamic finance transactions typically involve no actual movement of legal ownership: only the economic or beneficial value or ownership is transferred, which is not subject to any taxes.
Under existing Bahraini laws, payments under bonds, sukuk or notes will not be subject to taxation in Bahrain, no withholding will be required on such payments to any holder of notes, and gains derived from the sale of notes will not be subject to Bahraini income, corporation or capital gains tax. In the event of the imposition of any withholding, the issuer will have undertaken to gross up any payments subject to the withholding.
Following an extraordinary meeting of finance ministers in Jeddah in June 2016, the GCC countries approved the introduction of value added tax (VAT) in the GCC. Bahrain signed the GCC Unified VAT and Excise Treaties on 1 February 2017, and brought into effect on 1 January 2019 the VAT Law.21 The National Bureau for Revenue oversees the VAT regime and is responsible for the registration and assignment of those subject to VAT, and for the enforcement of VAT-related obligations.
The VAT standard rate is currently set at 5 per cent although some supplies are zero-rated, exempt from VAT or outside the scope of VAT. VAT was introduced on a staggered basis depending on the size of a business's turnover. Businesses with annual turnover exceeding 5 million dinars became subject to VAT from 1 January 2019, businesses with turnover of between 500,000 and 500 million dinars became subject to VAT from 1 July 2019, and businesses with turnover of 37,500 to 500,000 dinars became subject to VAT from 1 January 2020. Businesses below the 37,500-dinar threshold but with a turnover above 18,750 dinars are entitled to voluntary registration if desired.
There can be no doubt that from a commercial and legal perspective, the introduction of VAT heralds a significant development in the region. The new VAT regime is consumer-friendly, with zero ratings for basic necessities such as healthcare, education and basic food items, and the construction of new buildings, both residential and commercial properties. The introduction of VAT by GCC governments will be regarded by many as a constructive measure to assist, diversify and strengthen those countries' respective fiscal revenue streams in an era of falling oil prices, and to promote economic stability in the long term. It is important to note in this regard that the International Monetary Fund (IMF) has previously encouraged the GCC countries to introduce VAT.
Islamic financial transactions are generally exempt from VAT if the income earned by a supplier is by way of interest or a profit margin akin to interest, or by way of an implicit margin. However, fees, commissions and commercial discounts received by Islamic finance providers are not exempt and are subject to VAT at the standard rate of 5 per cent.
To ensure compliance with the VAT regime, the CBB issued a circular in January 2020 requiring all bank licensees to send their annual audited financial statements for 2018 and subsequent years as they become available to the National Bureau for Revenue.22
It is also notable that VAT has been introduced as part of a GCC-wide customs union. Therefore, it is vital that the design of local regimes takes this customs union into account, to avoid overload and unnecessary complexity for governments and businesses alike.
There is no separate insolvency regime for Islamic finance in Bahrain. The Bankruptcy Reorganisation and Bankruptcy Law (Bankruptcy Law)23 and the Commercial Companies Law,24 as amended, apply to bankruptcies, reorganisations and insolvency matters in Bahrain. There are separate insolvency rules for financial institutions licensed by the CBB under the CBB Law. Following the consultation period during which all CBB licensees, listed companies in Bahrain, law firms and audit firms provided their feedback, the Bankruptcy Law came into effect on 8 December 2018, replacing the Preventative Composition Law.25 The Bankruptcy Law does not apply to those licensed by the CBB, and therefore does not apply to Islamic finance services.
Bahrain has a dual court system consisting of civil and shariah courts. Shariah courts deal primarily with personal status matters (such as marriage, divorce and inheritance). Shariah courts of first instance are located in all communities. A single shariah Court of Appeal sits at Manama. Appeals beyond the jurisdiction of the shariah Court of Appeal are taken to the Supreme Court of Appeal, which is part of the civil system.
The shariah acts only as a guiding principle, and as such the terms and conditions of Islamic finance products are determined by national laws. In Bahrain, disputes revolving around Islamic finance contracts and products are heard before the civil courts.
2020 and 2021 have seen government authorities worldwide fast-track protective measures to support individuals and businesses that have been affected by covid-19. In March 2020, the CBB directed financial institutions in Bahrain to implement measures to lessen the financial impact, such as rescheduling loan contracts, temporary deferrals of monthly loan payments and the reduction of fees and commissions for affected customers. Most recently, in May 2021 the CBB issued a circular to all retail banks and finance companies to provide the option of further postponing loan repayments to all individuals and companies until 31 December 2021.26 The CBB also prohibited retail banks from freezing the accounts of customers who have lost their job or retired. This prohibition was included in the Business Conduct module of the CBB Rulebook relating to Islamic bank licensees. Instead, licensees must agree on other arrangements with their customers for the repayment of their financing.27
At a virtual economic forum in June 2020, the IMF confirmed GCC countries should expect their economies to shrink by 7.6 per cent in 2020 due to the impact of covid-19, which has led to a global decline in oil demand, a key driver of the economies of the GCC. His Excellency Rasheed Mohammed Al Maraj, the recently reappointed governor of the CBB, outlined his expectation that the Kingdom's economy will contract in line with the IMF's forecasts. Despite ultimately contracting by 4.8 per cent in 2020, the economies of the GCC countries fared better than feared. As the region recovers from the economic effects of the covid-19 pandemic and lower oil prices, it is estimated by the World Bank that the GCC's economy is likely to grow at an aggregate 2.2 per cent in 2021.28
A recent report29 estimates that global Islamic finance assets will reach US$3.5 trillion by 2024. The six GCC countries, despite recording a marginal growth in Islamic banking assets, control 42 per cent of the world's Islamic‐banking assets. The next‐largest markets are Asia, with 28 per cent, and the Middle East and North Africa (MENA) region (excluding GCC countries), with 25 per cent.30 The consolidation of market share in the GCC banking sector has continued, including Islamic banking licensees, as Dubai Islamic Bank completed the takeover of its smaller rival Noor Bank in January 2020, as well as the acquisition by National Bank of Bahrain of Bahrain Islamic Bank. The proposed merger of Kuwait Finance House and Ahli United Bank of Bahrain was initially postponed until December 2020, and is now suspended indefinitely in order to evaluate the fallout from the pandemic and any material changes in the banks' assets.
In May 2019, AAOIFI approved in principle the exposure draft of governance standards named 'Shari'ah compliance and fiduciary ratings for Islamic financial institutions'. The non-mandatory standards require Islamic financial institutions to make publicly available information regarding solvency, financial stability and compliance.31 This information could then be used by ratings agencies and investors alike, providing greater transparency and certainty in the Islamic finance market. Eight public hearings were conducted for the standards, including those held in Bahrain, Malaysia, Oman, Pakistan, Saudi Arabia, Sudan, Turkey and the United Arab Emirates (UAE).32 In July 2020, the AAOIFI Shari'ah Standards were adopted by the Central Bank of UAE.33
The Basel Committee recommendations made in light of the global financial crisis have led to a number of reforms and initiatives. Banks are now being asked to be more transparent, for example, by making more useful data available to stakeholders so that they can make informed choices.
These changes have resulted in major reforms. According to the governor of the CBB:
the overall outcome is that Islamic finance is benefiting from these changes. The over-reliance on real estate and infrastructure projects is being systematically replaced with recognition that fixed income assets, which in turn provide identifiable, sustainable profits for the future, are the way forward.
The CBB is working with bodies such as the non-profit International Islamic Finance Market (IIFM) to standardise Islamic banking practices further. One of its recommendations has been to ensure that Treasury product transactions are governed by the International Swaps and Derivatives Association (ISDA/IIFM Tahawwut Master Agreement). This Agreement is designed to govern the relationship between the parties in a shariah-compliant hedging transaction. The use of these agreements is not mandatory in Bahrain.
The CBB has also urged Islamic banks to have their institutions rated by the Islamic International Rating Agency (IIRA), which has its headquarters in Bahrain. The IIRA ratings inform investors about corporate and shariah governance practices in addition to the financial risk profile of entities.
Bahrain is growing in influence as a leading centre of innovation for Islamic finance. In recognition of the concentration of Islamic finance institutions, its sophisticated regulations and the increase in Islamic banking assets, the Kingdom has ranked top in the MENA region on the annual Islamic finance development indicator for the seventh consecutive year.34 A number of amendments were made to the CBB's codes and rules between 2014 and 2021, with the aim of promoting best practice and on the basis of certain rulings of the primary global committee of banking supervision (the Basel Committee). Takaful contributions to the Bahrain market have consistently averaged around 22 per cent, which compares favourably with the likes of the United Arab Emirates, which averages around 16 per cent.35 At present, there are six Islamic takaful insurance companies and two retakaful companies operating in Bahrain. Bahrain is also a market leader for Islamic securities (sukuk).
1 Salman Ahmed is a partner, Benjamin O'Brien-Mcqueenie is a senior associate and Samer Almaz is a trainee solicitor at Trowers & Hamlins.
7 Decree No. 64/2006.
8 CBB Rulebook, AU-1.5.5.
9 CBB Rulebook, AU-1.1.4.
10 CBB Rulebook, AU-B.1.2.
11 CBB Rulebook, SG-4.1.2.
12 CBB Rulebook, LR-3.2.
13 Decree No. 23/2016.
14 Decree No. 18/2016.
15 Decree No. 18/2016, Sections 8 and 15.
16 Decree No. 18/2016, Section 2.
17 Decree No. 22/2016.
18 Decree No. 22/2016, Article 18 (c) .
20 Decree No. 23/2016, Articles 5 and 6.
21 Decree No. 48/2018.
23 Decree No. 22/2018.
24 Decree No. 21/2001.
25 Decree No. 11/1987.
27 CBB Rulebook, BC-4.17
29 'The State of the Global Islamic Economy Report 2019/20', published by DinarStandard in collaboration with Salaam Gateway.
30 Islamic Financial Services Industry Stability Report 2019, Islamic Financial Services Board.