Central bank hopes to build on kingdom's reputation for being major hub for Islamic finance in Gulf
Bahrain's central bank will release a new regulatory framework for Islamic insurance (takaful) this quarter, in an overhaul of standards which the regulator hopes will attract new business in a sector it helped to pioneer.
The kingdom has been a major hub for Islamic finance in the Gulf, but in the last few years that role has been challenged by growing competition from Dubai and Doha.
Bahrain already has takaful-specific rules but regulatory refom could help it grab a larger chunk of the sector, which Ernst & Young estimates will globally total $17.1 billion in gross contributions by 2015.
The new rules, developed after two years of consultations with the industry, cover the operations and solvency of takaful firms, said Abdul Rahman Mohammed Al Baker, executive director of financial institutions supervision at Bahrain's central bank.
They are expected to increase takaful firms' ability to distribute surpluses to policy holders and dividends to shareholders, he said.
"We are in the final process of the new solvency framework for takaful. This will not only enhance the industry in Bahrain but also have an impact around the world."
Addressing how takaful solvency requirements - a concept similar to capital adequacy ratios for banks - are calculated will help to ensure firms match the risks on their books to their future obligations to policy holders, Al Baker said.
This is expected to provide greater clarity to the sector while attracting firms to set up in Bahrain, he added.
"This is very innovative and very fair. It will make a big difference for international players entering the market. Solvency could change a lot of things, from liquidity to profitability levels."
An alternative to conventional insurance, takaful is based on the concept of mutuality, where a takaful operator sets up a shareholders' fund to oversee and manage separate pools of money contributed by policy holders.
But this relationship has raised concerns because of the use of "benevolent loans", known as qard hasan, which shareholders extend on a voluntary basis to plug any deficits in a policy holders' fund.
The practice is criticised by some scholars as contradicting Islamic risk-sharing principles; they say qard hasan is meant to be used when a policy holders' fund runs out of money, rather than to handle recurring regulatory deficits.
The abolition or replacement of qard hasan has long been on the industry's agenda, but a broad consensus has not been reached.
Bahrain's rules call for a new way of calculating capital and replacing qard hasan with capital injections. Under the proposed rules, total capital would include both the available capital of the shareholders' fund and the net admissible assets of the policy holders' funds, said Al Baker.
This amount would be compared to the solvency requirements for policy holders' funds to determine excesses or deficiencies of capital; any deficiency would then be addressed by capital injections from shareholders instead of qard hasan.
Calculation of these amounts would require the endorsement of the firm's sharia board and board of directors, while distribution of surpluses from policy holders' funds would also need central bank approval.
In addition, the new rules require financial reporting by takaful firms annually rather than once every three years, restrict the use of performance fees, and introduce the concept of earmarked assets.
Earmarked assets are defined as high-quality and highly liquid assets specifically allocated in the shareholders' fund to strengthen the solvency and liquidity positions of policy holders' funds, said Al Baker.
In December, the central bank formally combined existing rules for issuing and listing financial securities, including sukuk, in an effort to make the process more efficient.
The incorporation of an issuing agent or special purpose vehicle for sukuk will not take more than 48 hours from the time offering documents are approved, whether for local or for international sukuk issuance, Al Baker said.
The regulator hopes to appeal to issuers across the region as the rules were prepared in accordance with unified standards accepted by Gulf Cooperation Council member states, he said. Bahrain is the first country to adhere to the standards, which were adopted by GCC countries last year, he added.