Anwar Khalifa Al Sadah: Challenges facing the Islamic financial services
industry
Welcome address by His Excellency Mr Anwar Khalifa Al Sadah, Deputy Governor of the Bahrain
Monetary Agency, at the 8th AAOIFI Annual Conference on Islamic Banking 2006, Manama,
11 June 2006.
* * *
Your Excellencies, Ladies and Gentlemen,
First, may I take this opportunity to express my thanks to AAOIFI and especially to the Chairman of the
Board of Trustees of AAOIFI, H.E. Shaikh Ebrahim bin Khalifa Al-Khalifa, for the opportunity to speak
here today. No doubt, AAOIFI has performed an invaluable role in enhancing and standardising
accounting and auditing practices in the Islamic finance industry, thereby giving credibility and
international acceptance to the financial statements of Islamic institutions. The BMA recognises the
importance of AAOIFI's role as a standard setter in the development of the Islamic financial industry.
In fact; the Agency's vision to develop the Islamic financial sector as a major player in the global
economy would not have been possible without AAOIFI. Bahrain is the hub of Islamic finance, and this
has been achieved through the proactive relationship between the BMA and the industry participants.
A host of other institutions must also be mentioned for their important work in the growth and
development of Islamic finance. The BMA recognises the role IFSB plays in harmonising regulatory
practices, and also the work of the International Islamic Financial Market, the International Islamic
Rating Agency, and the Liquidity Management Centre.
In the short time available to me this morning, I wish to look back over the last fifteen years since the
establishment of AAOIFI in 1991 and to look forward at the challenges facing the Islamic financial
services industry.
Since its inception, AAOIFI has issued 24 financial accounting statements and standards, five auditing
standards, four governance standards, 17 Shari'a standards and two codes of ethics. We and other
players in the market including IDB and other Islamic banks have worked hard with AAOIFI on
developing new standards and applying the AAOIFI standards on financial institutions. All Islamic
banks in Bahrain are required to follow AAOIFI standards and many other regulators in the region
either recommend AAOIFI standards or have based their own standards upon AAOIFI standards.
We also appreciate and value the proactive role played by the IDB in developing the industry. As far
as regulatory issues are concerned, the Agency, in consultation with the industry, also developed a
regulatory framework in 2001 for Islamic institutions, known as the Prudential Information and
Regulations for Islamic Banks or "PIRI", which implements both the standards developed by AAOIFI
and the Basel Committee''s various guidelines. We realised that Islamic banks needed a credible and
Basel compliant framework if Islamic banks were to become more than niche players and interact in
conventional markets. The PIRI framework covers:
• Capital adequacy;
•
Asset quality, including large exposures and related party exposures;
•
Regulatory treatment of investment accounts;
•
Prudential requirements concerning liquidity management;
•
Analysis of earnings quality; and
•
Corporate governance and risk management systems.
The PIRI rules became the backbone of the BMA Islamic Banking Rulebook in 2005.
Also the BMA, since it became the single regulator for the entire Financial System in 2002, has given
special attention to Takaful insurance by developing a healthy environment for Islamic insurance
companies to work in. The Agency introduced a comprehensive regulatory framework for Takaful and
Retakaful in 2005 for the business of Islamic insurance licensees; a framework that follows best
international standards and yet accommodates the special nature of these companies. BMA Islamic
Insurance licensees must comply with the accounting and Shari'a standards set by AAOIFI, like their
banking counterparts. There are currently 12 Takaful companies licensed in Bahrain. Global annual
revenues for Takaful are over $2bn with forecasted growth to $11bn in 2015, based on the current
growth rates of 8% per annum for general Takaful and 20% for Family Takaful.
For banks, we are working on applying Basel 2 in an Islamic banking context, and will be releasing
new Basel 2 compliant capital adequacy rules later this year for implementation in 2008. We have also
very recently streamlined our bank licensing requirements, meaning now that Islamic and conventional
banks are divided into two categories, wholesale and full commercial banks. The wholesale category
replaces the investment and offshore categories of licence. This is not a re-labelling exercise, but
reflects the Agency's focus on the regulation of institutions according to their activities. I would urge
attendees to refer to the Agency's website for details of the single licensing framework. The new
Volume 4 of the Rulebook introduces a comprehensive regulatory framework for investment business,
in line with international standards. Volume 4 provides for 3 categories of investment firms licensee,
depending on the nature of activities they undertake.
Category 1 investment firms may undertake all types of investment banking activities (except
accepting deposits or investment accounts). Category 2 firms may undertake all types of activities
except dealing as principal. Finally, Category 3 firms are limited to advising and arranging deals. All
three categories may handle Islamic financial instruments such as Sukuk, either in a trading or
advisory capacity.
Capital adequacy is however, not the only area where we have worked with AAOIFI. In 2001 the
Bahrain Monetary Agency (BMA) began issuing Islamically structured short-term government bills
(AlSalam Sukuk) and three and five year Ijara leasing certificates. In doing so, the BMA became the first
central bank to issue such Shari'a compliant certificates.
As at March 2006, approximately US$1.3bn of Ijara and Sukuk certificates were outstanding, providing
much needed Shari'a investment and liquidity possibilities for Islamic institutions and conventional
banks alike in the local market.
The BMA has also developed a standard murabaha agreement for its own dealings with banks, and
launched last year standard murabaha contracts for banks dealing in commodities, notably through the
London Metals Exchange ("LME"). This process has culminated in the BMA signing an MoU with the
LME in July 2003, and subsequently signing an MoU with the Tokyo Commodities Exchange to
develop a framework to enable institutions and brokers to conduct Shari'a compliant transactions on
the Exchange.
Corporate Governance is the other major arena where we have worked with and supported AAOIFI.
The Agency recognises the need for explicit rules for banks to act clearly in the interest of investment
account holders and demonstrate how that responsibility fits in with the bank's responsibility to its
stakeholders. That is why we have required banks to follow not only the auditing standards set by
AAOIFI but also its governance standards. The role of the Shari'a Boards needs to be further
developed by applying greater and more effective governance standards. Also, the subject of Shari'a
compliance needs to show further convergence. Shari'a judgements (or Fatwas) are as important to
Islamic finance as accounting standards or legal opinions. That is why we support the role of AAOIFI's
Shari'a Board in harmonising the Fatwas of individual banks. There must be uniformity of not just
accounting and regulatory standards, but also of Shari'a judgments. We will continue to work with
AAOIFI in this area in the future.
However, Islamic banking is dominated by small institutions. If Islamic banking is to grow successfully,
we do not need more small Islamic banks. We need bigger Islamic banks that can compete
successfully and handle large projects. We need consolidation and convergence in the industry. The
need for convergence applies not just to the number and size of banks, but also to convergence of
procedures and practices. There is clear evidence that we are experiencing a convergence of
regulatory and auditing standards for Islamic banks and their products. The regulators, the auditors,
the standard setters and the Islamic institutions banks have a mutual interest in the continuing
development of a stable well governed and sound Islamic financial services industry. In this respect,
the next fifteen years are likely to bring greater challenges, rewards and greater penetration by Islamic
institutions of the global market.
In conclusion, I wish you all, a very successful conference. Thank you for your kind attention.