Bahrain's Waqf Fund, a non-profit body set up by the central bank, has proposed mandatory external sharia audits for Islamic financial institutions to help strengthen compliance and improve the image of the industry.
Regulators around the world are increasing their scrutiny of Islamic finance, including the boards of sharia scholars who rule on whether activities follow religious principles.
Since sharia boards tend to be paid by the institutions whose activities they oversee, the scholars can be open to accusations of conflicts of interest - prompting calls for separate and independent oversight.
The Waqf Fund, established in 2006, is backed by 21 institutions such as banks and mostly focuses on educational initiatives. Bahraini regulators do not have to accept its proposals but since it is chaired by the central bank's executive director of banking supervision, Khalid Hamad, its recommendation appears likely to be adopted.
While the proposal is for Bahrain, it may have an impact on Islamic finance globally because of Bahrain's central role in the industry.
The proposal ties in with growing pressure for reforms to the sharia oversight system in other countries. For example, Kuwait's central bank governor Mohammad al-Hashel suggested in a December speech that an independent legal entity should oversee the way in which Islamic financial institutions certify they are following sharia principles.
The Waqf Fund will develop a framework for external sharia audits with a team of audit firms, scholars and the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI).
"An independent sharia audit should be made mandatory by regulators in order to achieve the desired benefits," the fund said in a statement on Sunday.
Because it suggests that sharia compliance audits be part of the existing external auditor framework, the Bahraini fund's proposal is more specific than Hashel's proposal in Kuwait.
The Waqf Fund also called for a revamp of AAOIFI standards to provide more detail on sharia review and audit functions, while making AAOIFI's sharia auditor certification mandatory for people involved in the review process. Bahrain is one of the few jurisdictions where AAOIFI standards are mandatory.
Many countries, including Malaysia and Pakistan, have over the past year taken steps to overhaul their Islamic finance rules; the reforms have included taking a more active role in monitoring sharia scholars. In Malaysia, scholars are now legally accountable for the financial products they approve and liable to fines and prison time for wrongdoing.
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.
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