Bahrain to require external sharia auditors for islamic banks

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Bahrain's central bank has proposed new governance rules that would require Islamic banks in the kingdom to conduct external sharia audits of their operations, representing a shift away from the long-held practice of self-regulation. Islamic banks in the Gulf have traditionally used in-house boards of Islamic scholars to determine whether religious principles are being obeyed, such as a ban on payment of interest. Some scholars argue that this decentralised approach allows more flexibility and diversity in Islamic finance, but there has been growing support in the region for measures to increase transparency and reduce scope for conflicts of interest. Such measures would aim to address concerns of potential customers who believe that the banks too closely mimic conventional finance operations.

Bahrain's central bank said that a public consultation period for its draft rules would close on Oct. 16. The draft is part of an effort by Bahrain to regain prominence in Islamic finance, an industry it helped to pioneer, against competition from centres such as Dubai and Kuala Lumpur. Islamic banks are subject to general financial oversight by national regulators in all countries where they operate, but in many countries authorities have largely left questions of sharia-compliance to the in-house sharia boards.

The new guidelines for Bahrain would oblige banks to have all their operations audited annually by external sharia experts such as Islamic advisory firms. The auditors would need to be approved by the central bank. Scholars sitting on banks' in-house sharia boards would be required to disclose potential conflicts of interest in writing, and where conflicts are found to exist, to recuse themselves from decisions.

These provisions could place Bahrain among the strictest jurisdictions for sharia scholars. Other proposals include disclosure requirements that would include publication of the aggregate remuneration paid to in-house scholars. The banks would also have to disclose any non-permissible income and specify how they intend to dispose of assets generated by non-sharia-compliant earnings or acquired through prohibited expenditure.

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