The Development of Islamic Banking in Bahrain
During the last 30 years Islamic banking and finance has developed, evolved and thrived not only in Bahrain, but also across the world to become a major global industry. Bahrain is recognised as having the pre-eminent financial services centre in the Middle East, across a range of asset classes such as private banking, fund management, insurance, and capital markets and is noted as a pioneer in Islamic banking and finance.
There are currently 27 Islamic financial institutions – 24 Islamic banks and three banking related institutions – registered in Bahrain, the largest concentration in the Middle East. Many institutions have their Islamic banking business in Bahrain, including BNP Paribas, CITI Islamic Investment Bank, ABC Islamic, Al-Baraka Islamic Bank and UBS.
Bahrain is considered the hub of Islamic banking due to its extensive heritage and progressive approach to Islamic finance. Its evolution into an international centre for Islamic banking came, in part, from a recommendation made in 1978 at the Organisation of the Islamic Conference (OIC) – an inter-governmental organisation of 56 states that collaborates to ensure progress and well-being for the global Muslim community. There was discussion at the conference about the need for Muslims to have specific economic and financial products and services to adhere to their religious beliefs and principles. The Muslim community, both in the Middle East and worldwide, needed financial products and services that mirrored their faith in a way that conventional banking could not. Islamic banking was the solution to this requirement.
Bahrain was already emerging as the prime location for financial services in the Gulf region and was identified as the natural location to develop Islamic banking and finance. The Bahrain Monetary Agency (BMA), the central bank and single regulator to the financial sector in Bahrain, played a fundamental role in the adoption of Islamic banking in Bahrain, establishing the necessary supervisory and regulatory framework to enable this sector to flourish.
The first Islamic bank – the Bahrain Islamic Bank – began operating in 1979 and its success saw further development of specialised Islamic products, including leasing, loans and investment schemes. Products and services have since been introduced not only by Islamic institutions, but also by conventional banks.
The growth of Islamic banking in the years following the establishment of Bahrain Islamic Bank was slow. By 1994 there were just five Islamic investment banks and one offshore banking unit. The trigger in stimulating the Islamic finance market came around the time of the Gulf war, which raised oil prices and revenues, increasing the demand for Islamic tailored investments.
The BMA has been at the forefront of providing best practice regulatory framework for Islamic banking and finance. As the regulatory body in Bahrain, the BMA faced complex challenges with the Islamic finance sector. It tackled these challenges by implementing high levels of regulation and supervision in all aspects of Islamic finance. Regulatory aspects were introduced to protect customers, investors and all businesses within the local financial services centre. The BMA established the Bahrain Institute of Banking and Finance (BIBF) to facilitate Islamic finance training and education. Providing the local workforce with relevant training is a step towards ensuring the future of the financial services sector.
In terms of regulation, the Islamic financial sector is subject to the same supervisory regulations as conventional banks, including any requirements of the Basel agreements. However, Islamic banking is by nature a very unique method of finance and thus necessitates a unique set of requirements and a different style of regulation. The Prudential Information and Regulatory Framework (PIRI) – regulations which cover capital adequacy, asset quality, management of investment accounts, corporate governance and liquidity management – was the first comprehensive framework created specifically to deal with Islamic banks.
The key aspect of regulation for Islamic financial institutions is the need for all transactions, products and services to comply with Shari’a law. Shari’a law forbids the making of interest, so to overcome this, Islamic financial institutions devised a method of finance based on transactions associated with tangible assets, with no guarantee of return. The BMA recognised the importance of regulation and supervision that doesn’t contradict Shari’a law in any way – the PIRI framework meets this requirement.
The leading standard setter for Islamic financial institutions is the Accounting and Auditing Organising for Islamic Financial Institutions (AAOIFI). It was founded by members from a number of Islamic countries in 1990 to increase transparency and standards for accounting, auditing and governance within the Islamic Finance Sector. AAOIFI worked closely with organisations like the International Accounting Standards Board to devise standards for reporting and accounting practices. The BMA became the first central bank to implement the standards for the local market, which were then adopted by Sudan, Jordan and Qatar. Also, the BMA is a founder member of the International Islamic Financial Market (IIFM), an independent, non-profit international organisation aimed at ensuring the continued growth of Islamic banking and finance as a viable alternative to the conventional financial system.
Bahrain, through the BMA, has been at the forefront of the development of the Islamic sukuk – government bonds and bills tailored for Islamic investors. The Bahraini government was the first to issue Islamic securities – the BMA has so far issued $1,146m of Ijara sukuk (Islamic leasing bonds). As a result of the popularity of these Islamic bonds, they are attracting international interest from conventional banks. Success in developing sukuks has led to other GCC countries looking to Bahrain to manage their sukuk programmes.
In response to the need for an intermediary agency to underwrite Islamic financial trading, the Liquidity Management Centre (LMC) was developed in Bahrain in 2002. The basic aim of the LMC was to create an active secondary market for short-term Shari’a compliant treasury instruments for Islamic banks, helping to boost the liquidity of Islamic banking market and creating additional investment opportunities for financial institutions and investors. The LMC, which commenced commercial operation in May 2003 is the first of its kind, and provides a local and international stimulus to the Islamic banking industry by providing liquidity management in line with Shari’a principles.
Since the 1970s Islamic banking has witnessed an annual growth rate of approximately 10 per cent every year. The success of the sector is set to increase further, with a projected growth rate for Islamic banking in the MENA region forecast to be 10-15 per cent per year. The global Islamic sector is expected to grow by 20 per cent by 2010.
The sustainable growth of the sector depends on investor and customer confidence, a secure regulatory framework, support organisations, further product innovation and skilled talent development. Many of these aspects are in place already and the BMA is committed to helping the progress of the industry well into the future.
There is room for expansion and improvement in the sector in Bahrain, particularly in the areas of product innovation and the industry recognises the need for local Islamic banks to become more international in their outlook. These are goals for the Islamic finance sector in Bahrain to work towards.
Bahrain is in a prime position at the heart of Islamic banking to help build a thriving future for the sector by facilitating the support organisations and offering high calibre training for its financial sector workforce. As the demand for Islamic products grow, worldwide expansion for the sector looks incredibly positive.