Bahrain's Leading Position in Islamic Finance Briefing

1. A Briefing on Bahrain’s Approach in Islamic Finance Khalid Hamad Executive Director – Banking Supervision Central Bank of Bahrain Rome, 11 November 2009

2. Bahrain Financial Sector in Brief • Contribution to GDP: 25% (US$10.9 bn growth 6.5%) Capital Market Stock Market capitalization US$16.9 billion6 Brokers, 51 Listed Companies 37 Mutual funds & 20 Sukuk Funds Industry 2,751 Authorized Funds NAV US$9.1 billion Local Funds 138NAV US$ 5.2 billion Islamic 100Conventional 2651Foreign Funds 2,613 1

3. Single Regulator with 40 yrs experience Well Tested Regulatory Framework Availability of skilled resources Supportive Monetary Operations Comprehensive Regulatory Framework Host of AAOIFI, IIFM & CIBAFI CBB Specific Dispute Resolution Court Fund for Research and Training HR Development Fund

4. Islamic Banking Regulatory Framework Taking the Lead in Islamic Financial Services Decentralised Shari’a Compliance Approach Introduced Islamic Finance in 1978 Dedicated training centre on Islamic Finance Applied Islamic version of Basel II in Jan 2008 Takaful Regulatory Framework CBB Shari’a Compliant Repo (2009) Trust Law & Funds Regulation Regular Sukuk Issuer since 2001

5. Islamic Finance Concept & Model • Islamic finance is based on the prohibition of • Usury • Uncertainty • Speculation or Gambling • Transaction involving Arms, Pornography, Alcohol and Illegal Drugs • 4 main types of contracts involving deferred sale or leasing of underlying asset • Trade (buy & sell), e.g. Murabahah • Fund mgt (isterbah), e.g. Mudharabah • Musharakah (Joint venture) • leasing (Ijara) • On Financing activities: always asset backed, except “Qardh hasan” (interest free loan) • On Investment activities: Client/ Bank relationship is based on “Profit Sharing” OR “Profit Sharing & Loss Bearing” • Mudharabha or Agency concepts (Fiduciary Relationship) • Current account is based on “Qardh hasan” concept • Three Books Model • Own Funds • Unrestricted Investment Accounts (On balance sheet) • Restricted Investment Accounts (Off balance sheet)

6. V 1 Conventional Banks V 6 Capital Market V 2 Islamic Banks CBB Rulebooks V 5 Ancillary Services V 3 Insurance Takaful V 4 Investment Business Regulatory Framework The CBB is the Single Integrated Regulator of Bahrain Financial Services Industry Since 2002 supported by the issuance of the new CBB law in 2006 Rule-based prudential requirements and clearly defined regulated activities 5

7. Regulatory Framework Prudential Regulations • Licensing Requirements • Definition of Regulated Islamic finance services • Definition of Deposit Vs Investment • Governance Requirements • Controllers Requirements on • Major Shareholders • Fit & proper tests on Board and senior management • Composition of Boards and its sub-committees • Shari’a Compliance Requirements • Minimum of three persons Shari’a Supervisory Board • Internal Shari’a Reviewer • Capital Adequacy Requirements (Basel II) • Credit risk (different RWs for different Islamic contracts) • Market risk (securities price risk and commodities risk) • Operational risk • Displaced commercial risk (applying conversion factors for assets financed by URIA) • PER & IRR are part of capital base • Applying 200% RW on holding of real estate Based on Basel, IFSB & FATF Standards

8. Regulatory Framework Prudential Regulations • Risk mgt requirements • Credit, market, operational & liquidity risks • Specific consumer finance requirements • Requirements on risk concentration • Prohibition on investing in or financing major shareholders • Regulatory Compliance requirements • Business & Market Conduct requirements • Selling practices requirements • Code on Best Practices on Consumer finance & Charges • Financial crime regulations • Detailed quarterly and annual public disclosure requirements • Detailed disclosures on IAH funds • Detailed Basel II disclosures • Quarterly public reporting • Enforcement requirements Based on Basel, IFSB & FATF Standards

9. Regulatory Framework Actg & Auditing Standards • 6 Governance standards covering • Shari’a supervisory board • Internal & external Shari’a review • Audit & governance committee • Governance principles, etc.. • 27 Islamic Accounting standards (Complimenting IFRS) • Accounting treatments of main Islamic finance contracts • Disclosures • Treatment of investment accounts holders • Takaful • Consolidation • Fair value • Islamic windows, etc.. Based on AAIOFI & IFRS Standards

10. Regulatory Framework Actg & Auditing Standards • 5 Auditing standards covering (complimenting ISA) • objectives & principles • auditors’ responsibility • terms of engagement • auditors’ report • testing for compliance with Shari’a, etc.. • 2 Ethics standards • Staff Code for Islamic financial institutions • Code for auditors and accountants • 30 Shari’a standards • Covering all Islamic financial services contracts Based on AAIOFI & IFRS Standards

11. Recent Regulatory Initiatives Compliance Roadmap Shari’a Trainee Upgrading Compliance & Risk Mgt Risk Mgt Assessments By 3rd Party Guide on Regulatory Compliance

12. HR Development Initiatives Partnership with Industry • Bahrain Institute of Banking & Finance (BIBF) • Various qualifications on accounting (CPA, CMA, Charted), risk management, CFA, Series 7, capital market, ICA, Sharia audit and compliance, etc.. • Master degree & Diploma on Islamic finance • Diploma in insurance/ Takaful & conventional finance • Advanced Diploma on Islamic jurisprudence • Bahrain Insurance Institute • Various Insurance & investment qualifications • CIPA & ISR by AAIOFI • Human Resources Development Fund • Offering scholarships for obtaining qualifications • Waqf Fund financing training development & research • Upgraded BIBF Islamic finance diploma • Partnership with university to upgrade Shari’a studies • Introducing Shari’a ethics principles program • Graduate sponsorship program • Established research panel to mentor researchers

13. Main Monetary Policy Challenges Integration Exercise • Money is not a commodity in Shari’a leading to difficulties in setting up • Monetary operations, and • Money market • Absence of a reference profit rate • Is it possible to use commodity prices? • Inadequate sukuk and other Shari’a compliant instruments • Most IFIs are not ready to issue financial instruments • Small market size • Legal & tax issues • Few countries issuing sovereign sukuk • Most central banks do not solicit shari’a compliant funds given that they are generally not allowed to engage in commercial trades • This leads us to the necessity of integrating Islamic finance tools into the overall monetary operations rather than conducting a separate

14. Bahrain’s Monetary Policy Tools for Islamic Finance Dual System • National Shari’a Supervisory Board • Parliamentary decision to restrict government borrowing thru sukuk only • Regular issuance of S/T and L/T Sukuk since 2001 • 3 mths Alsalam sukuk ( $ 48 mn ) dinar based • 6 mths S/T Ijarah sukuk ( $ 80 mn ) dinar based • 6 issues with different maturities (3 – 10 yrs) • L/T Ijarah sukuk ($830mn) • L/T Ijarah sukuk ($ 828 mn) dinar based • Shari’a compliant REPO in 2009 • Based on non obligatory promise concept (Wa’ad) • Must involve the Central Bank • Based on outright sale contract • Provides IFIs with liquidity through commodity murabaha • Thru money market, or • Financial support against pledge on financial instruments • Interest free cash reserves requirements

15. Thank You.