Oman's central bank took a strict approach to regulating Islamic banking in rules for the sector which it released on Wednesday, setting higher standards for the industry than many other countries.
The sultanate announced last year that it would introduce Islamic finance, becoming the last country in the six-nation Gulf Cooperation Council to do so. Business activity is expected to start early next year.
The central bank's rules cover areas including banks' liquidity management, the administration of boards of sharia scholars who oversee Islamic financial institutions, and the operation of conventional banks' Islamic windows - and in many cases, the rules appear considerably stricter and more detailed than regulations in other countries.
A major provision is tight restriction of the use of tawarruq as a money market instrument for banks; this is expected to limit banks' flexibility in managing their funds overnight, and could thus raise their costs.
"Commodity murabaha or tawarruq, by whatever name called, is not allowed for the licensees in the Sultanate as a general rule," the document states.
In tawarruq, one party buys an asset from a vendor with payment deferred, and sells it to a third party for cash. Organised tawarruq, where transactions occur in exchange for a financial obligation, has been criticised by some Islamic scholars because of its weak link to real economic activity.
In April 2009 the Jeddah-based International Islamic Fiqh Academy, an international body of scholars, issued a resolution criticising organised tawarruq as a "deception", hurting its acceptability in the industry.
Omani banks had lobbied the central bank to permit tawarruq, at least temporarily while the new industry found its feet. But the rules do not appear to permit this, saying tawarruq can only be used in emergency situations on a one-off basis for a period of no more than three months.
Interbank transactions which are allowed include mudaraba, musharaka and wakala placements, all common Islamic finance structures.
The rules state that financial accounting standards from the Accounting and Auditing Organisation for Islamic Financial Institutions, a Bahrain-based industry body, will be followed.
In the area of vetting and supervising Islamic products, Oman is opting for the decentralised approach which prevails in the Gulf. It will allow each bank to have its own sharia board to supervise products, rather than imposing a centralised board for the whole industry as Malaysia does.
Smaller institutions will be allowed to outsource the sharia board function subject to central bank approval.
But unlike other countries in the region, the central bank has set out strict requirements for scholars, including criteria for whether they are fit and proper, maximum tenures, and limits on the number of board seats that an individual can hold.
Each sharia board must have a minimum of three scholars; they can only be appointed for three-year terms and serve a maximum of two consecutive terms. Board chairmen should preferably serve on a rotation basis, the rules state.
Scholars must demonstrate an understanding of both legal and financial matters and have a minimum of 10 years' experience, and banks are encouraged to develop local expertise by increasing the membership of Omanis in sharia boards.
The scholars are not allowed to serve in two competing Islamic financial institutions within the country, and they can work in a maximum of four non-competing institutions.
They are also required to attend a minimum of 75 percent of board meetings or risk being disqualified; sharia boards must meet at least four times a year, and must disclose the number of meetings in the bank's annual report. Sharia scholars will face performance assessments, both collectively and individually.
These provisions appear to go a long way to addressing complaints of potential conflict of interest and lax standards on sharia boards that have plagued Islamic finance in recent years.
Two full-fledged Islamic banks, Bank Nizwa and Al Izz International Bank, will be joined in Oman by conventional banks using Islamic windows to offer sharia-compliant products through their branch networks.
According to the rules, a single branch cannot operate both an Islamic window and conventional banking services, while the windows must disclose the sources and the uses of their funds.
Banks that plan to offer sharia-compliant products through Islamic windows include Bank Sohar, Bank Dhofar , Bank Muscat, Ahli Bank and National Bank of Oman (NBO).
The rules also outline stock market listing requirements, ownership limits, minimum paid-in capital amounts, and a 12 percent minimum capital adequacy ratio for Islamic banks.
Banks may be allowed on a case-by-case basis to issue sukuk (Islamic bonds) to raise Tier 1 capital and to issue subordinated sukuk, while the treatment of sukuk under bankruptcy and insolvency proceedings is outlined in detail. Islamic collective investment schemes will be regulated by the Capital Market Authority.