Bahrain tightens Islamic finance rules with mandatory external audit

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Bahrain is tightening its rules for Islamic banks by requiring all of them to undergo independent, external audits to certify they are following sharia (Muslim law).

The move, announced by the central bank on Sunday, could make Bahrain among the strictest jurisdictions for Islamic banking and help Manama maintain prominence in the industry, which it helped to pioneer, against competition from centers such as Dubai and Kuala Lumpur.

Islamic banks in the Gulf have traditionally used in-house boards of scholars to determine whether their products and operations obey sharia, which includes rules such as bans on interest payments and pure monetary speculation.

Some scholars argue this decentralized approach allows more flexibility and diversity, but it is not transparent and is vulnerable to conflicts of interest, since scholars are employed by the banks which they vet.

Bahrain is therefore insisting Islamic banks introduce external audits, starting with reports issued in 2020 on their business in 2019. A consultation paper issued by the central bank last year proposed that external audits be annual, but Sunday’s statement did not say how often they would occur.

The central bank said it would provide guidance later on who would be qualified to conduct external audits. Banks would not be required to make audit results available to the public.

Because of Bahrain’s prominence in Islamic banking, its decision may add momentum to global pressure for more centralized regulation of the industry.

“It is expected to serve as an example for the region and the global Islamic banking market,” the central bank said.

In May, the UAE approved the formation of a high sharia authority for Islamic finance, which is expected to set rules for governance of banks. Malaysia already has country-level sharia boards in its central bank and capital markets regulator which oversee the industry.

Bahrain’s central bank said it would also issue new rules, effective from next June 30, on sharia boards within banks, ensuring their independence and clarifying their roles and responsibilities.

Rulings of in-house sharia boards on financial products and the reasoning behind them will have to be made available to the public, in a move that could press scholars across the industry to develop more uniformity of opinion.

The central bank said it would soon issue training and competency requirements for members of sharia boards and for sharia auditors. This could address another source of uncertainty in the industry: a lack of consensus on minimum qualifications for scholars.Bahrain tightens Islamic finance rules with mandatory external audit.

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